The perils of inheritance tax

By John Whiting
Tax partner, PricewaterhouseCoopers

Inheritance tax (IHT) is an increasing worry in the UK.

The IHT threshold has simply not kept up with house price inflation.

Whatever Gordon Brown said in the Budget, more estates are falling into the IHT net, more are paying IHT and the IHT yield for the Treasury is growing.

So if you want to preserve the wealth represented by your house - an asset that has probably taken you many years to pay for, with mortgage interest relief no longer available - what do you do?

Long term

IHT planning is all about gifting assets and surviving seven years, so you think about giving your house away.

But as it's where you live, you stay living there.

The catch with this simple idea is some fairly obviously anti-avoidance measures - the "gifts with reservation of benefit" (GROB) rules which state the house remains part of your estate for IHT purposes even if it becomes someone else's for capital gains tax purposes.

Needless to say, people have tried to get round the GROB rules.

I wonder if we really are tackling the right problem - that, fundamentally, inheritance tax is catching far more people than it should do John Whiting

Schemes, often involving trusts, have been tried and the Inland Revenue clearly didn't like them.

However, rather than tackle the gap in the GROB rules, they came forward in the wake of the December Pre-Budget Report with a proposal for an income tax charge.

The original owner of the property who had retained a benefit would be taxed as if they received a market rental payment for it.

The Budget confirmed that this scheme will start from April 2005.

The Revenue's approach

The result could be an unpleasant shock for some grandparents who have made particular arrangements over their house.

Indeed, the measures don't just catch houses; jewellery and paintings could also be affected.

Thankfully, representations and arguments have secured some exclusions from this new tax hit which include:

Gifts made before 18 March 1986 (when the GROB rules started)

Gifts between spouses

Gifts caught by the GROB rules

Property sold at an arms length price.

Importantly there is also a "proportionate enjoyment" exclusion.

This helps an elderly parent who passes (say) half of their home to someone else - presumably their child - who then lives and shares the house with them.

Separately, there shouldn't be a problem either where parents have helped a child buy a house with cash gifts and subsequently end up living with them.

The Revenue have offered a "get out clause", which will allow taxpayers to elect that the property should go back to being treated as part of the original owner's estate for IHT purposes.

Watch out

Whilst we have made progress in softening these provisions, they remain an unpleasant charge with a whiff of retrospection -

The Revenue, however, denies there is anything retrospective about a charge that only starts next year - even though it could catch transactions undertaken some time ago.

I always accept the taxman's right to block what they see as unacceptable avoidance.

But I wonder if we really are tackling the right problem - that, fundamentally, inheritance tax is catching far more people than it should do.

And at a time when the country needs the family to take care of elderly granny rather than have her in a care home, perhaps we need a re-review of the whole basis of these new provisions.