A miserly allowance

The Finance (No.2) Bill 2015 includes a new inheritance tax (IHT) additional nil rate band (ANRB) that attaches to the deceased's residence, and applies where the death occurs on or after 6 April 2017.

The ANRB is set at £100,000 for 2017/18 and will increase each year, rising to £175,000 by April 2020. This will result in the maximum ANRB available to the surviving spouse being £1m. This is made up of each spouse's nil rate band (NRB) of £325,000, and their additional NRB of £175,000.

In order to qualify, the dwelling house must have been a 'residence' at some point during the deceased's beneficial ownership and if there is more than one residence, the executors can nominate any one of them. It does not have to be the 'main residence'. The dwelling house must be inherited by a 'lineal descendant' (a child or grandchild, including step-children, adopted and fostered children).

The ANRB tapers away by £1 for every £2 that the net value of the estate exceeds £2m. It ceases to be applicable, we understand, if the net estate exceeds £2.2m in 2017/18 (rising to £2.35m by 2020/21).

Ultra-high-net-worth individuals are unlikely to be getting excited by the new rules, neither will those without children who currently cannot benefit. For example, two elderly siblings living together in a property worth £1m where the property is left to the survivor, there will be IHT on the property to the extent that it exceeds their NRB. If the same property was owned by a married couple with children, under the new rules, there would be no IHT to pay on the property (in 2020). A further blow to this category is that the NRB will remain static at £325,000 till 2021.

Also frustrated by the new rules will be those who have carried out tax planning with their family home, using schemes such as reversionary leases and double trusts to get the property out of their estate, while retaining the right to live there for the rest of their lives. Once the ANRB is in force, many users of these schemes will be better off with the IHT regime.
The time, money and (in many cases) pre-owned assets tax spent on putting the schemes in place will effectively be wasted.

It will be interesting to see what impact the new rules have on the format of wills for those who can benefit. The ANRB will not apply if the dwelling house is inherited on trust, unless a lineal descendant has a qualifying interest in possession in it, or it is a qualifying trust for a minor or an 18-25 year old. This means that if the family home passes into a discretionary trust, the ANRB cannot be claimed, even if the beneficiaries are limited to lineal descendants.

We may therefore see more use made of 'interest in possession' trusts and letters of wishes being left to executors, specifying how they should make use of the ANRB (e.g. which property to elect, and if discretionary trusts have been used, requesting these be wound up in favour of lineal descendants and the appointment 'written back' into the will under section 144 Inheritance Tax Act 1984).

Also, at present, there appears to be a loophole in the rules, where the first spouse dies before April 2017 (i.e. before the new rules come into force). It appears 100 per cent of the unavailable ANRB can still be transferred to the second spouse and used if they die after 6 April 2017, even if the dwelling house has been gifted to children on the first death. In this scenario,
it looks most beneficial for the first spouse to give their interest in the residence to their children, so that the second spouse's estate can receive maximum IHT relief. We may therefore see letters of wishes discussing this.

The new rules are very welcome but are noticeably limited in their application. It remains to be seen whether enough objections are voiced while the legislation progresses through parliament to warrant any widening of the beneficial class - if for no other reason, then the government has suddenly created a tax incentive to adopting a child.

Caroline Cook is a senior associate at Wedlake Bell

She writes the regular comment on inheritance in Private Client Adviser