Commercial Property

Commercial Property

Private Client Case Study

Mr MacDonald is a retired farmer. He owns 200 acres of land. The agricultural value of the land is £5,000 per acre. Of this area approximately 20 acres is adjacent to the village and Mr MacDonald expects planning permission to become possible within two years. The value of the land with the benefit of planning permission will be £100,000 per acre.

The land was purchased by Mr MacDonald for £2,500 per acre in March 1982.

Mr MacDonald is a widower and has one son who is the managing partner in a local firm of Accountants. The son is separated from his wife, has two minor children and like all managing partners likes a drink.

For these reasons Mr MacDonald is understandably reluctant to make over to his son any interest in the land. He would however like to make some provision for his grandchildren. His son is the sole beneficiary under his Will.

Unusually in this example we know when the client will die which is a distinct advantage when considering Inheritance Tax (IHT) planning.

Option 1 – Do nothing!

As expected planning permission is obtained in two years time and the land adjacent to the village is sold.

From the proceeds, Mr MacDonald gifts £350,000 to his son to put him back on his feet following the completion of his costly divorce.

Mr MacDonald dies two years and nine months after the gift to his son. The IHT exemption in force at the date of death is £350,000. The assets comprised in the estate are as follows:-

Farmhouse                                                                   £500,000

Value of remaining farmland                                        £900,000

Cash from proceeds of land                                      £1,300,000
(After gift and Capital Gains Tax)                     
                                                                                     2,700,000     

IHT Calculation

Failed PET                                   £350,000
Less:
Nil rate band                                (350,000)   

Chargeable                                             0

Free Estate                              £2,700,000
Less:
Nil rate band from wife’s death    (350,000)

Free Estate chargeable           £2,350,000 x 40% = £940,000






In the above scenario Mr MacDonald’s son receives the following:

Cash gift                                                                             £350,000

Estate net of IHT                                                              £1,760,000

Total                                                                                 £2,110,000
 

Scenario 2 – Take advice!

Mr MacDonald takes advice from Moore Blatch Private Client team.

They suggest he makes an immediate gift of the potential development land onto discretionary trusts in favour of his Son and grandchildren. The value of the land transferred is £100,000.

No immediate charge to IHT arises because the value transferred is within Mr MacDonald’s available nil rate band at the time. No capital gain arises on the transfer due to the availability of Holdover Relief.

When the land is sold by the Trustees there will be a CGT liability of approx £350,000.

On Mr MacDonald’s subsequent death the revised IHT position is as follows:-

Failed PET                               £100,000
Less:
Part nil rate band                      (100,000)

Chargeable                                           0


Free Estate                            £1,400,000
Less:
Balance of own nil rate band     (250,000)

Nil rate band from wife’s death  (350,000)

Free Estate chargeable              800,000 x 40% = £320,000


In the above scenario Mr MacDonald’s son receives the following:-

Net sale proceeds of land (see note below)     £1,650,000

Estate net of IHT                                               £1,080,000

Total                                                                  £2,730,000


The alternative scenario produces a saving of IHT of £620,000.

Note

The alternative scenario assumes that the trust will be appointed within 10 years of creation and in which case there will be no exit charge the calculation being based on the value of trust assets when originally settled.

Reserving a benefit

As long ago as 1986 legislation was introduced to prevent individual’s from giving away assets for the purposes of reducing Inheritance Tax (IHT) but whilst still retaining a right to benefit from the asset, either through income or capital. Such arrangements are known as a “gift with reservation of benefit” (GROB).

More recently further provisions were introduced under the “Pre-Owned Assets” (POAT) legislation which introduced an ongoing liability to income tax in relation to some schemes which had been designed to avoid the GROB provisions.

Despite the best efforts of Gordon Brown possibilities still remain.

Consider Mr & Mrs X. As part of their combined estate Mr X owns a valuable investment property which he would like to pass on to their children. However, there are currently two obstacles preventing such a gift being made now.

Firstly, the gift will be a disposal for Capital Gains Tax (CGT) purposes deemed to take place at market value. As a result a significant charge to CGT would arise immediately. Secondly, Mr X needs to retain access to the rental income produced by the property as part of his overall retirement planning.

One possible way around the problems is to use what is known as the family debt scheme and which operates as follows:-

i) Mr X sells the property to Mrs X for full market value;

ii) The sale price is left outstanding as a debt repayable on the latter of the survivor’s death;

ii) The benefit of the debt is given to the children of Mr & Mrs X.

The sale of the property to Mrs X, being a transfer between spouses, is deemed to take place on a “no gain, no loss” basis for CGT purposes and no charge to tax therefore arises.

The gift of the debt to the children is a “potentially exempt transfer” for IHT purposes and, subject to Mr X surviving the gift by the requisite 7 year period, the value of the debt will not be subject to any charge to tax on the death of Mr or Mrs X.

Mrs X, being the continuing owner of the property, will be able to continue to receive the rental income produced.

Neither the GROB, nor the POAT, provisions outlined above will apply to this scenario as the transaction takes place for full consideration.

As with any schemes there are inevitably potential pitfalls.

Firstly the sale of the property to Mrs X will be liable to Stamp Duty Land Tax (SDLT).

Secondly the value of the debt belonging to the children will represent assets owned by them in the case of bankruptcy or divorce.

 Authors Robert Arnold ( Source IFA ) and Andy Kirby (Moore Blatch Solicitors)