For a number of years now advisors have recommended nil rate band discretionary trusts (NRBDTs) as part of tax efficient will planning for married couples.  This is to ensure that each party to the marriage utilises their inheritance tax free nil rate band (currently £300,000 each).

As some of you will know, the 'test case' known as Phizacherley (SpC 591) is HMRC's crude attempt to use 'anti-avoidance' provisions to overturn the tax saving benefits of using NRBDTs. 

The case involved the death of Dr Phizackerley who owned a house jointly with his wife as tenants in common. 

Mrs P died first on 26 April 2000 leaving an estate of approximately £210,000 including her half share of the house which was valued at £150,000.  Her will included a NRBDT and at the time the nil rate band was £234,000, therefore the entire estate went into the trust.

After Mrs Ps death Dr P entered into a common arrangement under which he took over his late wife’s half share of the house from the trust, promising to pay the trustees on his death the sum of £150,000.

Dr P died on 2 July 2002, leaving an estate valued at approximately £530,000 including the entire value of their home less the IOU to the trust.

HMRC argued that the executors were not entitled to deduct the IOU on the grounds that Dr P had fallen into anti avoidance provisions detailed in the Finance Act 1986 s103 in relation to gifts with reservation of benefit.  They based their argument on the fact that Mrs P had not worked during her married life so the purchase of the house in joint names of Dr P and Mrs P represented a gift from Dr P to Mrs P.

HMRC won this case, however we believe it will only affect a limited number of people, i.e. those where one spouse has not earned a living during their married life.  Even in those circumstances it will only affect the IHT position if the non working spouse dies first.  Obviously this cannot be planned for so if you believe you may be affected you should contact your advisor. 

Consideration should be given to amending your wills, so that on the death of the first spouse everything is left to the surviving spouse.  After the death of the first spouse a deed of variation could be entered into in order to use the first spouse’s nil rate band.  In these circumstances FA 1986 s103 cannot apply.

Where the wills have already enacted (i.e. where first spouse has already died), if affected by this issue, the surviving spouse should consider 'repaying' the debt to the trust.  For example by substituting a charge on property (IOU) with other assets.

If there is any doubt as to who provided the funds for the trust asset (be it a share of the house or assets in the deceased's sole name) then do not use the IOU/Loan arrangement.

Posted on 01 Jun 2007