Robert and Catherine Smith have assets of more than £3.5m and live in Buckinghamshire. The Smiths have two adult daughters and four grandchildren.
Robert, 60, is the director of his family-owned textile manufacturing company. He draws a salary of £50,000 a year plus dividend income of £10,000. Catherine, 56, is a volunteer at a local hospice.
The Smiths have sizeable assets. Their family home is worth £750,000 and they have a holiday cottage in west Wales worth £250,000 which they bought a few years ago. They also hold £500,000 in cash, £750,000 in a portfolio comprising stocks and bonds and controlling shares in the family company worth £1m. Robert also has an antique furniture collection valued at £250,000.
It is hardly surprising therefore that the couple's main financial goal is to limit their inheritance tax liability. Robert already makes gifts out of income to his children and uses the small gifts exemption to pay into savings accounts to build up a nest egg for his grandchildren, but he is eager to learn new ways of lessening the tax burden. David Kilshaw at KPMG says that, when calculating IHT, it is important to bear in mind that personal and business assets are included in a person's estate. At the moment, Robert's will leaves everything to Catherine, and while that appears to be a tax-efficient plan, as the transfer of assets between spouses is exempt from IHT, it actually leaves Catherine with an enormous charge.
In light of this, Mark Taylor, a certified financial planner at Platinum Portfolios, suggests that the Smiths' existing wills should be rewritten to include a gift up to the value of the current nil rate band of £263,000 to a discretionary trust on death. “As long as Robert and Catherine are alive, the trust will not exist, allowing unfettered access to all property and investments,” he explains. “On the first death, the trust will come into effect and the executors will transfer assets up to the value of the nil rate band to the trustees. The surviving spouse can still benefit from the fund at the discretion of the trustees without any adverse IHT consequences on the second death.”
With regard to Catherine's charge, the tax situation could be managed more efficiently, Taylor adds. “An ‘equalisation' exercise should be carried out to ensure that, in the event of either death, there are sufficient assets to make use of the nil rate band. It appears that at present the bulk if not all of the assets are held in Robert's sole name.”
Kilshaw agrees and says that the couple should think creatively about how to reduce the value of Robert's estate. For example, he says, “if Robert's shares in his company qualify for business property relief a deduction made from the value of business property when it is assessed for IHT purposes it could reduce the value of his personal estate of by £1m.”
Another way to reduce the size of the estate would be for Robert to gift his antique furniture collection to a museum with charitable status. He says: “On a gift of the chattels to a museum there would not be an IHT charge on his collection upon death.” Kilshaw says that the Smiths should also think about gifting their holiday cottage to their two daughters. “In this instance, Robert would incur only a limited exposure to a capital gains tax charge on making the gift as the value of the property has not increased substantially since they purchased it,” he says.
Simon Williamson, managing director of Broadway Financial Planning, agrees that gifting the Wales home is a sound idea. “If Robert and Catherine wish to continue to use it then they should pay a market rent to a trust,” he says.
On the other hand, though, “It might be sensible for the holiday house to be transferred to Catherine first and for her to transfer it into a trust as she would have a longer life expectancy,” says Williamson.
The couple's other financial concern has to with the corporate structure of the family textile manufacturing company. When it was set up, Robert entered into an agreement with his business partner the other shareholder that if either died before retirement, the surviving shareholder would be obliged to buy and the personal representatives obliged to sell the deceased's shares. In retrospect, Robert realises that this arrangement leaves him very little scope for manoeuvre. What should he do?
First, says Williamson, this contract should be reviewed by Robert's solicitors. “If the buy-and-sell agreement is binding, there can be inheritance tax disadvantages because the Inland Revenue will generally not allow business property relief (BPR).”
But, Williamson adds, there may be a more effective arrangement: a cross option agreement. “If Robert and his business partner entered into such an agreement, the surviving director would have an option to purchase the deceased director's shares within a specified period. There is also a corresponding option for the deceased's estate to sell them,” he explains. “The key difference is that, since neither party must exercise their option, there is no binding sale and BPR for IHT purposes is therefore preserved.”
Williamson also says that Robert would be wise to agree on the way in which his co-shareholder might buy him out on retirement. “If Robert's shares are worth £1m, it may be in his interest to make arrangements with the co-shareholder for payment of this sum. Robert's dividend of £10,000 a year is a very modest return on an investment of £1m.”
There is a caveat, however. “Robert should remember that, if he does sell the shares, he will lose the business property relief exemption from IHT.”
Names and some identifying details have been changed to protect privacy.