Before 9 October 2007, it was not possible for the nil rate band (NRB) from the first deceased spouse (reference to spouse in this article includes civil partner as defined under the Civil Partnership act 2004) to be transferred to the survivor for use on their later death. If an individual left their entire estate to a surviving spouse, there would be no Inheritance Tax (IHT) due on the first death but when the survivor died, they would then only have a single IHT NRB to use.
Such a scenario saw many couples losing a whole NRB because they did not use it for taxable beneficiaries on the first death. It was very much a case of use it or lose it.
What is the nil rate band?
Every individual in the UK currently has a tax free allowance of £325,000 for Inheritance Tax purposes.
How do you avoid a deceased spouse’s nil rate band going to waste?
In order to avoid the first NRB going to waste on the first death, a standard Will writing practice was therefore to carve out a NRB discretionary trust whereby the NRB was transferred into trust upon the first death, with the survivor as a discretionary beneficiary, usually along with the children and remoter issue of the deceased. The balance of the estate would then likely pass absolutely as a residuary gift to the surviving spouse. The NRB was used and there would be no IHT on the first death.
Once the legislation changed such that after 9 October 2007 it became possible for spouses to transfer any unused NRB to the survivor* it would appear that the NRB discretionary trust became a less necessary strategy to avoid the danger of losing a previously unused NRB.
However, at the same time, there also arose a common misconception, that on the death of the first spouse, as well as the transfer of unused NRB being available, that all assets of the deceased can pass automatically to the surviving spouse.
Of course, jointly held assets are transferred automatically by survivorship, such as is common with the family home or joint bank accounts.
What role does a NRB discretionary trust play today?
We commonly encounter executors, surviving spouses and beneficiaries who do not understand that where there is a NRB discretionary trust written in the Will, then the trust has first call over assets held in the deceased’s sole name, such that assets to the value of the available NRB at the time should be appropriated into the trust.
This is particularly common where we have Wills written before 9 October 2007, and it is often not until the second death that it suddenly comes to light that the NRB discretionary trust exists and ought to have been dealt with on the first death.
As happens in such cases, once the Grant of Probate has been obtained, the executors simply transfer all the assets in the deceased’s sole name to the survivor, completely disregarding the fact that there is a prior NRB discretionary trust in existence which needs to be constituted.
However, unless the trust has been formally appointed out to the beneficiaries by way of a Deed of Appointment of Capital within the first two years after the death of the first spouse, once that two year period has expired, then the trust still exists even if assets have not been formally appropriated into the trust.
If the deceased’s assets which would otherwise have been appropriated into the trust have been transferred to the survivor, then the survivor is effectively holding those assets on constructive trust for the NRB discretionary trust, and the survivor is deemed to owe the trust the value which would otherwise have been appropriated into the trust.
How would the HMRC act in these situations?
Indeed, HMRC are likely to treat the NRB as already having been used even if the assets were not transferred to the trustees of the NRB discretionary trust, accepting that there is a debt for the value of the NRB against the estate of the second death. Consequently, no transferrable nil rate band (TNRB) can be claimed by the executors on the second death.
Thus, on the surviving spouse’s death, there is effectively a debt against their estate for the value of the assets incorrectly transferred into their name.
The value of that debt is going to be linked to the value of the NRB in place at the date of the first death; before 6 April 2009, the value of the debt is going to be less than the current £325,000, according to which tax year the death occurred.
However, if it can be demonstrated that the value of the solely owned assets of the first deceased was less than the NRB at the time, then there will be a percentage of TNRB available for use on the second death.
Once the debt has been repaid to the trustees of the NRB discretionary trust arising on the first death, those funds can either be invested to benefit future generations, for ongoing family estate and IHT planning or to ringfence assets from the dangers of bankruptcy or divorce. Alternatively, the funds can be appointed out to the beneficiaries by way of a Deed of Appointment of Capital.
It would be just as well for a detailed Trustee Minute and Resolution to be drafted by the trustees to confirm the position once the value of the debt has been ascertained and before any distributions are made.
Furthermore, if more than ten years have passed since the first death, then consideration needs to be given to whether there is any IHT reporting is required for the purposes of 10 year anniversary Principal IHT charges. Even if no IHT is due on the event, an IHT100 tax return should be submitted where the value of the trust exceeded 80% of the IHT Nil Rate Band for the 10 year anniversary in question.
How Moore Barlow can help
Our private wealth lawyers offer a comprehensive range of services to help you protect and grow your assets, plan for the future, and ensure that your loved ones are taken care of.
Our team of experienced private wealth lawyers and advisors are dedicated to providing tailored solutions that meet your unique needs and goals, so you can enjoy peace of mind knowing that your wealth is in safe hands.
* The ‘transferable NRB’ is available to survivors of a marriage who die on or after 9 October 2007, regardless of when the first spouse died. For civil partners, the first death must have occurred on or after 5 December 2005, the date the Civil Partnership Act became law in the UK.
