How to beat the taxman - Mazars - United Kingdom

Early and effective tax planning is crucial to minimise inheritance tax liabilities. Stacy Eden, head of property and construction at Mazars, the international accountancy firm, takes a closer look at the options open to residential property investors to reduce their tax bill.

20/01/2010

There are two certainties in life: death and taxes. However, when Benjamin Franklin came up with these pearls of wisdom over two hundred years ago, there was no such thing as inheritance tax (IHT).

Put simply, IHT is a flat-rate tax of 40 per cent on the value of all assets in a deceased’s estate above the Nil Rate Band of £325,000. This means that an investor with a financial portfolio and assets — or estate — worth £1 million at death will have an IHT liability of £270,000 under current legislation.

In the case of a UK domiciled property investor (someone who considers the UK as their long-term home), all assets regardless of where they are located around the world will be subject to IHT. However, if an individual is non-domiciled only UK assets, such as real estate, UK bank accounts and shares in UK companies will be liable.

A word of caution on domicile: where one spouse has a different domicile to the other, or when an individual has been a UK tax resident for 17 out of 20 years the matter becomes rather more complex and I encourage property investors to seek advice earlier rather than later on this issue. The Property and Construction team at Mazars offers expertise in IHT planning, with advice on how to reduce your tax liabilities as well as the financial support available to you.

Welcome relief

Whilst there are a number of reliefs that can help to keep your assets out of the hands of the taxman, many of these are of limited use or involve modest sums. That said, there are two significant reliefs open to property investors: transfers between spouses and Business Property Relief.

Normally, transfers of assets between spouses whether during their lifetime or upon death escape IHT. Up until 2008 elaborate tax planning was needed to make sure that an individual’s Nil Rate Band (£325,000) was not lost when the assets were left to the surviving spouse. However, since 2008 legislation has allowed any unused Nil Rate Band to be transferred to the surviving spouse for use on their death.

Business Property Relief

There is a general requirement that in order to qualify for 100 per cent Business Property Relief, the business property must be held for at least two years before the date of death or before it is gifted. In the case of pre-death gifts, they must be owned by the donee (recipient or beneficiary) up to the point of death.

Unfortunately, most businesses holding buy-to-let properties do not attract BPR – even when the investor generates all their income running a property ‘business’ and has an established office, staff, trading style, etc. This point is commonly misunderstood within the sector and as a result many property investors continue to manage their affairs in blissful ignorance of the problem they may be leaving to their heirs.

Turning our thoughts to tax planning, there are certain options available to property investors. It may be the case that you already have a standalone business that is independent of your property activities. If not, an option worth considering is whether to create or acquire a business interest that would qualify for BPR.

If your residential property ‘business’ includes a property maintenance/management/utility arm, you may want to consider two separate structures: splitting the property management activities into a standalone business and trying to build up external customers alongside carrying out your own maintenance work. Alternatively, there are always property maintenance businesses on the market and it’s worth considering whether a bolt-on acquisition can be made that isn’t too costly, that you have the time and skills to manage and doesn’t risk capital unnecessarily.

Whether you choose to adapt what you already have or make a strategic acquisition, assuming that you have a business that will attract BPR, there are clearly opportunities to protect and maximise the IHT BPR.

Borrowings

From a tax planning perspective, it is better to have any borrowings secured against the property assets rather than the assets of the business. This is because secured borrowings reduce the value on which IHT is charged and there is little point in depressing the value of something that is already exempt and much smarter to have it reducing the value of assets that will be charged.

If your estate includes cash, bank or building society deposits it is well worth considering having them held within the venture rather than outside of the business. If you can establish a business reason for retaining the asset, such as earmarking the funds for potential acquisitions or future expansion plans then these assets could benefit from BPR.

A combination of these tax-busting ideas would involve borrowing against the non relievable property and using the proceeds to buy a relievable business asset.

Agricultural Property Relief

There are certain types of businesses that attract relief, such as agricultural property but only when it’s part of a working farm. Agricultural Property Relief applies to farmland and other assets, such as farm buildings that are being used for agricultural purposes. Over and above this relief, there is a case known as Farmers Executors, which holds that when an estate is managed as one, incorporating all sources of income (farming, shooting and rental income), the assets can attract relief. Although this is not often the case, as part of a rural residential portfolio it is worth keeping in mind.

Gifting

Gifting is at the core of IHT planning and if you are in a position to give away your assets to your heirs (or move them into some form of trust that enables you to retain control), and providing you survive for seven years then it is possible to avoid IHT completely. In an attempt to prevent ‘deathbed’ transfers from escaping the taxman, gifts of property made seven years before death can be clawed back inside the IHT net.

However, you must be aware that there are financial implications of gifting assets. Property and land count as disposals for the purposes of Capital Gains Tax (CGT), which is currently charged at 18 per cent, and tax will have to be paid as if the property was sold at its market value.

Recent market conditions and the impact on property prices are likely to help and careful choice of which properties are to be given away will minimise the tax bill. In this respect, trusts continue to be useful for larger estates and as a means of claiming ‘holdover relief’ to avoid the payment of CGT all together.

More on trusts

An option for buy-to-let investors, who rely on the income and are happy for the capital growth to accrue to their heirs, may be to consider some form of trust arrangement where they are the life interest. This option is not particularly useful if you want to move larger amounts outside the IHT net as there is a chargeable lifetime transfer if the amount going into trust doesn’t fall below the Nil Rate Band.

Whilst on the surface it would appear that the options available to property investors are fairly limited, it is possible with early and effective tax planning to mitigate if not completely avoid the impact of IHT on your heirs.

Whilst death is a certainty, advice can help taxes become less so.

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About Mazars:

A jpg image of Stacy Eden is available on request.

Mazars is an international firm specialising in audit, tax and advisory services that operates as an integrated partnership in 50 countries worldwide.

In the UK, Mazars is the eighth largest partnership in terms of audit fee income, has the fastest growing tax practice amongst the Top 20 firms.

The firm employs more than 1,100 people and has over 110 partners based in 18 offices throughout the UK.