Nil-rate band transfer
Richard Wallington, May 2010
Richard Wallington TEP is a Barrister practising at 10 Old Square, Lincoln’s Inn.
Inheritance Tax (IHT) nil-rate band (NRB) transfer is a familiar concept by now. It can apply on the death of anyone who dies on or after 9 October 2007 who has previously been in a marriage or civil partnership, where the marriage or civil partnership came to an end on the death of the other spouse or civil partner. It can apply irrespective of how long ago the predeceasing spouse died. In the case of civil partners this is limited by the fact that civil partnership only commenced on 5 December 2005. As regards spouses, however, old learning on Capital Transfer Tax (‘CTT’, 1974–1986) or estate duty (1894-1974) may have to be revisited.
The basic structure of NRB transfer is that, in calculating the IHT on the second death, the NRB in the applicable IHT rate table at the time of the second death is increased by a percentage, and that percentage is the percentage of the NRB in the IHT (or other relevant tax) rate table at the time of the first death which was not then used up on non-exempt gifts. This is subject to a maximum of 100 per cent increase on the second death. Without this limit there could be more than 100 per cent increase where the second death was of someone who had been a party to more than one marriage or civil partnership ending in the death of the other party, or the first death was of someone who died on or after 9 October 2007 after having been a party to a marriage or civil partnership which ended on the death of the other party. NRB transfer needs to be claimed on the second death, and the extent of the unused NRB on the first death needs to be proved to the satisfaction of Her Majesty’s Revenue and Customs (HMRC).
The NRB transfer legislation is in Inheritance Tax Act(‘IHTA’) 1984 ss 8A–8C, inserted by Finance Act 2008 s 10, Sch 4 paras 1, 2. The computation rules can be found in the standard IHT textbooks, and in the HMRC Inheritance Tax Manual at paras 43000–43068. Rather than expounding these in detail, this article concentrates on specific topics of interest or difficulty, and on some of the implications of nil-rate band transfer for will drafting. In what follows, D1 is the first of a pair of spouses or civil partners to die, and D2 the second.
The first death: what is and what is not using up the NRB
A matter which is made clear by the second parenthesis in the definition of ‘M’ in IHTA 1984 s 8A(2) is that an asset shortfall on the part of D1 counts as not using up D1’s NRB, so that to the extent that his or her assets fall short of the NRB at his or her death there is transferable NRB (assuming no aggregable lifetime transfers by D1). Where one spouse or civil partner owns less than an NRB-worth of assets while the other has assets which significantly exceed the NRB, this means that there is no longer a need for the richer to transfer assets to the poorer by lifetime gift in order to take full advantage of the NRBs of both in the event of the poorer dying first.
Reasons, other than poverty of D1, for D1’s NRB to be unused and therefore transferable are exemption, typically for assets going to D2 or to charity, business or agricultural relief, or relief where the death was caused by service in the armed forces. Where D1 died before 22 March 1972 there was no spouse or charity exemption from estate duty, and there is only likely to be transferable NRB in such a case if D1 had insufficient assets to use up the NRB, or the relief for persons whose deaths are caused or contributed to by service in the armed forces applied. In relation to deaths on or after 22 March 1972 there was an exemption for gifts to spouses, but it was limited to GBP15,000 until it became unlimited with effect from 13 November 1974 as part of the phasing-in of CTT. The exemption for gifts to charity was introduced for deaths on or after 22 March 1972, but in relation to deaths before 15 March 1983 it was subject to a cash limit (increased from time to time) where the gift was made on or within one year of death.
D1’s NRB will have been wholly or partly used up if and to the extent that D1 made lifetime transfers, or events occurred which were treated as lifetime transfers by D1, which were taken into aggregation with D1’s estate on death in determining the amount of IHT, CTT, or estate duty payable on D1’s death. This again follows from the definition of ‘M’ in IHTA 1984 s 8A(2). From 20 March 1968, aggregable transfers or other events were ones occurring within the seven years preceding D1’s death, except in the period from 26 March 1981 to 18 March 1986, when transfers made or occurring after 26 March 1974 and within the preceding ten years were aggregable. Between 10 April 1948 and 19 March 1968 the period was five years.
The first death: forward planning for a later NRB claim
It is now important, and since NRB transfer was first announced in October 2007 it has been important, to make forward provision for a future NRB transfer claim when administering the estate of the first to die of a married couple or a civil partnership, if there is unused NRB. A ‘NIP’ or Nil-rate band Information Pack needs to be compiled, containing all the documents which would be relevant to establishing the amount of NRB unused on D1’s death, to be kept with the will of D2. The documents which HMRC require (IHT Manual para 43012) are as follows: a copy of the IHT account or full written details of the assets in D1’s estate and their values; D1’s death certificate; the marriage or civil partnership certificate for the couple; a copy of the grant of representation or confirmation to D1’s estate; a copy of D1’s will, if there was one, or a note of how the estate passed if there was no will; a copy of any instrument of variation, disclaimer, or appointment out of a discretionary trust falling within IHTA 1984 s 144, or other instrument or Court order which altered the dispositions taking effect for IHT purposes on D1’s death; any valuations of assets that pass under D1’s will or intestacy other than to D2; the value of any other assets that also passed on the death of D1, for example jointly owned assets, assets held in trust in which D1 had a qualifying interest in possession and gifts made in the seven years prior to death; any evidence to support the availability of relief (such as agricultural or business relief) where the relievable assets pass to someone other than D2.
It will be apparent that prudent preservation of evidence for a future NRB transfer claim will in some cases go beyond what is required to agree with HMRC that no IHT is payable on D1’s death. For example, HMRC may agree that no tax is payable without final determination of the value of assets passing to non-exempt beneficiaries, because it is clear that the taxable value of the assets will not exceed the NRB. The precise taxable value of those assets will only become an issue for IHT purposes on the death of D2. It is therefore important to obtain detailed and credible valuation evidence for inclusion in the NIP as part of the administration of D1’s estate, and where the assets in question qualify for business or agricultural relief to preserve the evidence in support of that relief.
Where D1 died on or after 9 October 2007 and had previously been married or in a civil partnership which ended on the death of the other party, it is possible for D2’s personal representatives to make a retrospective claim to any transferable NRB which could have been claimed, but was not claimed, on D1’s death, provided that it does not affect the IHT payable on D1’s death (IHTA 1984 s 8B(2)). This is an important provision to bear in mind in administering the estate of a D1 who is also a D2 from a previous marriage or civil partnership from which there is available transferable NRB, and the value of the estate is approximately in the region of the NRB in the IHT rate table at the time of death. If there is any possibility of the value of the estate exceeding the current NRB, even if it will only be by a very small amount, a claim should be made for NRB transfer, even if the amount of tax saved will be less than the cost of making the claim. If no such claim is made, there only has to be one penny of IHT payable on D1’s death to preclude a subsequent claim by D2’s personal representatives to the NRB transfer which could have been claimed on D1’s death.
The second death: claims
D2’s personal representatives have a ‘permitted period’ of two years from the end of the month in which D2 dies in which to claim NRB transfer from D1 (IHTA 1984 s 8B(1), (3)), or, if it ends later, within three months of them first acting as D2’s personal representatives. HMRC’s IHT Manual makes the point that the latter period will start to run from before the grant of representation where, for example, executors appointed by B’s will do acts which show an intention to act as such executors before there is a grant. If there is a dispute which has to be settled before the personal representatives can be identified, the three-month period will, in HMRC’s view, commence from the Court order identifying the executors (para 43007 of the IHT Manual).
Where there has been no claim by the personal representatives within the permitted period, officers of HMRC have power to allow a longer period in particular cases (IHTA 1984 s 8B(3)(b)). The HMRC IHT Manual para 43009 provides some guidance on how this power will be exercised. A late claim may be accepted where there has been a dispute which had to be settled before the identity of the personal representatives could be established, and where the personal representatives or their agents have been actively pursuing the nil-rate band transfer claim since the resolution of the dispute, but the three-month period from resolution of the dispute (the two-year period having expired) is insufficient in which to make the claim. Another possibility is where a claimant can show that an event beyond his or her control prevented him or her from making the claim within the permitted period. The examples given show that a fit of absence of mind will not be an acceptable excuse, and that only fairly exceptional cases will qualify for late acceptance of a claim. The examples include: postage in good time but an unforeseen event disrupted the normal postal service; records necessary to make the claim lost through fire, flood or theft and the records required to make the claim could not be replaced in time for it to be made within the permitted period; the claimant so seriously ill that he or she was prevented from dealing with the claim within the permitted period and from that date to the time when the claim was made. Death or illness of a close relative will only be accepted as an excuse if steps had already been taken to get the claim made on time and, in the case of death it occurred shortly before the end of this period, and in the case of illness it took up a great deal of the claimant’s time and attention during the period from the end of that period to the date the claim was made.
Where D2 had an interest in possession in settled property such that the settled property is subject to IHT as part of D2’s estate on death, the trustees of that settled property have an interest in claiming the NRB transfer. The same goes for a donee of property which is subject to a reservation in relation to D2 at D2’s death. However, during the permitted period only the personal representatives can make the claim. If they do not do so, the trustees of the settled property or the donee of the property subject to a reservation can make a claim, but it is in the discretion of officers of HMRC whether to accept it (IHTA 1984 s 8B(1)(b)). The IHT Manual gives no guidance as to when such a claim will be accepted, except to say (para 43008) that technically, the trustees of a trust that is liable to IHT following the death of a life tenant cannot make a claim until two years have passed, but that in practice, if there is no need to take out a grant, so that no personal representatives will be appointed, HMRC Capital Taxes may provisionally admit a claim by trustees or other persons liable for the tax within the two-year period and calculate the tax accordingly. This strongly suggests that claims by persons other than the personal representatives will be accepted if there are no personal representatives, and it is to be hoped that they will also be accepted where there are personal representatives but they deliberately or negligently fail to claim the transfer of NRB.
D2’s personal representatives need to be able to prove to HMRC’s satisfaction that there was unused NRB on D1’s death. Where D1’s death was before 9 October 2007, and particularly if it was long before then, HMRC are prepared to make reasonable inferences from available surviving information and documentation and a risk assessment: see para 43011 of the IHT Manual. Full documentary evidence will be required where D1 died on or after 9 October 2007: see above under ‘The first death: forward planning for a later NRB claim.’
The second death: availability of transferred NRB
The increased NRB, if claimed, applies ‘for the purposes of the charge to tax on the death’ of D2 (IHTA 1984 s 8A(3)). If the transferable NRB is claimed, the increased NRB will obviously apply in determining the IHT payable on all the property taxable as part of D2’s estate on death, whether free estate, settled property in which he or she had an interest in possession at death, or property previously given away but subject to a reservation at death. It will equally obviously have no relevance to the calculation of the immediately payable IHT on any lifetime transfers which were not potentially exempt transfers (‘PETs’).What, however, of the IHT payable as a consequence of D2’s death on transfers or deemed transfers made in the seven years preceding his or her death? The words ‘the charge to tax on the death’ (emphasis supplied) could be said to confine the availability of the increased NRB to what is chargeable on death under IHTA 1984 s 4. However, HMRC take a kindly view of this question, and accept that the increased NRB is available against the IHT on lifetime transfers which becomes payable of the result of the death: see para 43034 of the IHT Manual. It is difficult to imagine any circumstances in which a taxpayer will wish to challenge this view. It should be borne in mind that, because the transfer operates by way of notionally increasing the NRB in the IHT rate table as at the death of D2, it makes no difference to the amount of IHT payable on the death estate, whether or not the increased NRB is available in relation to IHT payable as a result of the death in respect of lifetime transfers. The taxable amount of the lifetime transfers would have to be deducted from the increased NRB before calculating the tax on the death estate, even if the increased NRB was not available in calculating the tax on the lifetime transfers themselves.
As mentioned above, where D1 died on or after 9 October 2007, and had previously been married or in a civil partnership which ended on the death of the other party, it is possible for D2’s personal representatives to claim any transferable NRB which could have been claimed, but was not claimed, on D1’s death, provided that it does not affect the IHT payable on D1’s death (IHTA 1984 s 8B(2)).
Will drafting: NRB transfer against NRB discretionary trusts
The main consequence of the advent of NRB transfer is that the provision of NRB discretionary trusts in the wills of spouses or civil partners becomes a specialist interest rather than a standard provision. Relying on NRB transfer seems to me to be in general very much preferable to an NRB discretionary trust as a way of making use of the NRB of the first to die, particularly in any case where the NRB discretionary trust would probably have to be constituted by use of a debt or charge scheme. NRB discretionary trusts using debt or charge schemes are complicated and artificial, and much can go wrong with them. Perhaps the worst aspect of NRB discretionary trusts is the need for ongoing effort to keep them in existence. The great advantage of NRB transfer is that once D1’s estate is administered and the relevant evidence is put into store somewhere where it can be found on the death of D2, no further action is required until D2’s death.
The main circumstance in which an NRB discretionary trust is still worth including when preparing wills for married couples or civil partners is where the available unused NRB could exceed 100 per cent, as a result of one or both of them being the survivor of a previous marriage or civil partnership which ended in the death of the other party. In such a case their wills should include the usual NRB discretionary trust clauses, to take effect on the death of the first to die, in the wills of both of them. A discretionary trust arising on the first death may also be a good idea for 100 per cent relieved business or agricultural assets which might by the time of the second death have ceased to qualify for the relief.
There may, however, be non-tax reasons for wanting an NRB discretionary trust, such as wishing to minimise assessable resources in case of means-testing of D2 for care home fees. The professional adviser must in any individual case weigh the disadvantages of complexity and possibilities for things to go wrong of an NRB discretionary trust against the risk that D2 might be the subject of a means test.
Where there is any doubt as to whether an NRB discretionary trust would be useful, the better course will usually be to provide for an NRB discretionary trust to take effect on the death the first to die, but to make sure that it is sufficiently flexible for it to be possible to wind it up within two years of the death of D1 by appointment of an absolute interest or an immediate post-death interest in possession in favour of D2 in such a way that the appointment is treated as a disposition taking effect on D1’s death by virtue of IHTA 1984 s 144.
Other will-drafting aspects
Another consequence of NRB transfer is that, from an IHT point of view, conditions as to surviving for a specified period in relation to gifts by will to the testator’s spouse or civil partner do not confer an advantage, and in some situations may be a disadvantage. One possible disadvantage would be in the rare case of both spouses or civil partners being killed in circumstances that the order of deaths is unknown, in which case a survivorship condition would prevent their estates having the double advantage of the spouse exemption and the deaths being treated as simultaneous for IHT purposes. Another possible disadvantage is where the second to die of a married couple or civil partnership dies during the survivorship period and has assets of a value less than the NRB, while the first to die has assets in excess of the NRB. NRB transfer is only forwards in time, and so the second to die’s NRB will be partly wasted. Another possible disadvantage of a survivorship condition, but it may not now arise again for some time to come as a result of the freezing of the NRB for the next few years which was announced in the March 2010 Budget, is where the survivor dies during the survivorship period and between the two deaths there is an increase in the NRB in the IHT rate table.
After the death of D1, D2 will often make a new will. Where the couple either have no children or have some but have disowned them, D2 may decide to leave his or her residue to charity, subject to giving the maximum that can be given without an IHT liability to non-exempt beneficiaries such as nephews and nieces or siblings. If the formula of ‘maximum I can give without an IHT liability’ is to be used for fixing the amount of the non-exempt gift, it is now important to make clear that the executors are directed to claim whatever transferable NRB they can claim, or that they are directed not to do so. Otherwise the executors will be left in a dilemma as to whether they should be claiming NRB transfer and thus increasing the amount of the non-exempt gift at the expense of the exempt gift.