Tax, Trust and Probate Artictles ~ Autumn 2007


Buy to Let – Get Your Tax Return Right!
HM Revenue and Customs are concerned that many buy to let landlords are not paying enough tax. It is estimated that up to 80,000 have overstated their deductions for tax purposes by including the capital element of mortgage repayments (not allowable) as well as the interest on the sum borrowed (allowable). The key point here is that if the mortgage on your buy to let property is of the repayment type (which may not be the most tax-efficient way to finance it!), make sure the sum you claim on your tax return as a deduction for interest paid does not include the capital repayment.
The taxation of rental income is complex, with a variety of different rules applying depending on circumstances. The rules relating to the treatment of losses also vary depending on the type of rents you receive. For example, there are different rules for all of the following types of residential letting:
·        rent a room receipts for rooms let in one’s own house;
·        furnished holiday lettings;
·        furnished lettings; and
·        unfurnished lettings.
It is also worth mentioning that the responsibility for asking for a tax return if you have taxable income and do not receive one lies with the taxpayer. If you are not sent a tax return and have taxable income not subject to PAYE, you should request one or face a possible penalty.
Also, there is usually also considerable scope for tax planning to mitigate the effect of Capital Gains Tax on the disposal of let properties.
It is always worth taking professional advice to make sure that your investments of all kinds are managed in a tax-efficient way. Contact <<CONTACT DETAILS>> for further advice.
Partner Note
Financial Notes, Summer 2007.
Gift or Convenience?
When people rely on the assistance of carers to manage their day-to-day affairs, it is often easier for them to deal with things informally, but this can sometimes cause problems.
In a recent case, an elderly lady had help from a long-term carer named Miss Meek. Two years before the woman died, she transferred the money in her bank account (approximately £300,000) into another account in their joint names. She did not specify whether she intended the transfer to be a gift of funds to Miss Meek or not.
The question put to the court after her death was ‘who owned the money?’ In the absence of any evidence that a gift to Miss Meek was intended, the court concluded that the £300,000 remained part of the estate.
In cases like this, the sensible thing for the transferor to do is to make a record of their intention and ensure, if possible, that the bank mandate shows the ownership of the account. Failure to be clear on such points can lead to delay and unnecessary expense in administering the estate.
We can advise you on organising your affairs so that they are both administratively convenient and uncontroversial for your executors.
Partner Note
Sillett v Meek [2007] EWHC 1169 (Ch).
HMRC in Private Residence Relaxation
As the tax law changed many yearsago, it is often forgotten that where a property is occupied rent-free by a dependent relative it will qualify for Principal Private Residence relief (PPR) for Capital Gains Tax (CGT) purposes, provided that the property was acquired before 6 April 1988 and that the conditions for dependent relative relief were satisfied by that date.
Although the number of cases affected will be relatively small, HM Revenue and Customs (HMRC) have announced that they have changed their view of the law and will now give PPR for properties which are occupied by dependent relatives which are let. This relief is available in addition to the principal private residence exemption on the owner’s own home.

Any property which qualifies as a principal private residence which is wholly or partially let as residential accommodation is eligible for an exemption for CGT which is known as the ‘letting relief’. This was introduced in 1980 and provides that the proportion of the overall gain attributed to the letting is exempt up to the lower of £40,000 or the amount of the principal private residence exemption.

Up until 1988the principal private residence exemption also applied to residences that were occupied by dependent relatives. HMRC hitherto has taken the view that the ‘letting’ relief could not apply to properties that qualified for exemption as being occupied by dependent relatives.

This previous view was set out in HMRC’s CGT Manual as follows:

‘The further relief provided by Section 223(4) [letting relief] is not available in respect of a dwelling house which qualifies for private residence relief because it has been the residence of a dependent relative’.

The HMRC notice announcing the change of view indicates that, in their opinion, error or mistake claims are not available in respect of closed years of assessment as the previous view of HMRC was the ‘generally prevailing practice’ at the time.

The situation for open years of assessment, or years when amended returns can still be submitted, is explained in the notice as follows:

‘If taxpayers wish to amend their 2005/06 return they must do so by 31 January 2008. Taxpayers who have already filed their 2006/07 returns have until 31 January 2009 to amend their returns. If there is an open enquiry into a return and we are able to amend it at the conclusion of the enquiry, we will amend it to reflect our current view’.

If these circumstances apply to you, you should look to amend your tax return within the available window for changes. Contact <<CONTACT DETAILS>> for individual advice.
Partner Note
From: Institute of Chartered Accountants Tax Faculty Newswire, Issue 369, August 2007.
How Inheritance Tax Works
Inheritance Tax (IHT) is paid on your estate when you die and also when money is transferred into some trust funds. Some other transfers during one’s lifetime may also be subject to IHT. The first £300,000 (at 2007/8 rates) of the estate is exempt from IHT. This is called the nil rate band. The assets in the estate are valued on death, the nil rate band subtracted and the remainder of the estate is taxed at 40 per cent.
IHT used to concern only the wealthy. Nowadays, however, the increase in value of residential property means that more and more people find themselves within its ambit.
There are exemptions from IHT for the following:
  • property transfers between spouses or civil partners (not between unmarried partners);
  • gifts to institutions such as the National Trust, charities and political parties; and
  • gifts in consideration of marriage or civil partnership (within permitted limits), annual gifts to the value of £250 to anyone and gifts which are part of normal household expenditure (such as birthdays).
You are also allowed to give away up to £3,000 per annum. This allowance can be carried forward to the next year, if not used in a tax year. The carry forward is for one year only.
Gifts made ‘out of income’ are also excluded. These must be of a scale that does not affect the lifestyle of the donor and must normally be regular – an example might be school fees paid by a grandparent.
What Can be Done to Reduce IHT Liability?
  • Potentially Exempt Transfers (PETs). A gift will normally cease to be part of a person’s estate if they survive seven years after making it. If they die within seven years, then the IHT to be paid will be reduced on a sliding scale depending on the time interval between the making of the gift and the death of the donor.
  • Equity Release. An Equity Release Scheme (of which there are several types) allows money locked in freeholds to be released. This can be given away as a PET and if the donor survives more than seven years then it will not normally attract an IHT liability.
  • Life Assurance. Policies are available which may pay all or some of your IHT liability. These can be written in such a way that they pass directly to your family and do not become part of your taxable estate.
  • Holding Exempt Assets. Certain assets (such as shares in AIM-listed companies and in family businesses) are wholly or partially exempt from IHT if certain conditions are met.
  • Trust Funds. Setting up a trust fund used to be a common way to leave money. This can be an effective way of minimizing the impact of IHT. However, the 2006 Budget has made some of these less attractive. If you have established such a trust or are thinking of doing so, it is sensible to seek professional advice. 
Says <<CONTACT DETAILS>>, “Whatever action you do take, make sure you take good professional advice. In particular, it is essential to have a proper will drafted. We can do this and can also review your financial situation and advise you of any IHT reliefs which may be available and whether property is held in the most advantageous manner. If your family is facing a potential IHT burden, contact us for advice on the right steps to take.”
IHT Planning – Need for Care
A decade of house price inflation has meant that many house owners have assets in excess of the ‘nil rate band’ amount for Inheritance Tax (IHT) – currently £300,000. Since no one likes to pay tax unnecessarily, many wills are written in a way that seeks to minimise or eliminate the IHT charge.
Transfers of assets between spouses or civil partners are normally free from IHT and it is now common for the family home to be jointly owned so that it passes to the surviving spouse directly, so any IHT liability will normally arise on the second death.
Often, the basic IHT minimisation strategy is to put a clause in the will which gives the children (or puts into trust) the maximum sum allowable without incurring an IHT charge. Use of such wording allows the sum transferred to increase in line with increases in the IHT nil rate band. If such a clause is contained in the will of the first spouse who dies, it means the family will obtain the benefit of the nil rate band on both deaths.
However, problems can arise.
Consider the situation where, on the first death, the will sets up a ‘maximum’ nil rate band trust in an estate where the assets owned by the deceased consist of the family home, valued at £300,000, and other assets valued at £250,000. If the bequest into trust is the primary bequest, the shortfall of £50,000 in the other assets will be met by the trust taking a share in the value of the house (there are several ways this could be done). If, five years later, the property is sold and a substantial capital gain arises, the trustees could find themselves with a Capital Gains Tax (CGT) liability. The surviving spouse would claim the CGT ‘principal private residence’ exemption, but the overall effect is that avoiding one tax may lead to a charge to another. This may be avoidable, for example, by the surviving spouse ‘buying out’ the trust’s interest, but that produces its own complications.
A different sort of problem can arise where a will contains specific legacies. If these are given priority over the nil rate band legacy, the latter will only be fully satisfied if there are sufficient assets remaining. For example, if the net assets in the estate are £380,000 and charitable bequests of £100,000 are made, then only the remaining sum can be transferred into trust. Any erosion of the value of the estate (which is common where care home fees have to be met) will lead to the family’s share of the estate being reduced while the amounts given to the charities are not. There will be no IHT saving, since only the value of the estate after charitable bequests is taxable.
Problems such as these can be avoided through a combination of careful thought concerning your will and estate planning and keeping your situation under review to make sure that the arrangements you have made are still appropriate for changes in personal circumstances and changes in the law.
To make sure your family wealth is protected from unnecessary taxation, contact <<CONTACT DETAILS>>.
Partner Note
See New Law Journal, 3 August 2007 p1108.
LPAs and Advance Directives
One of the changes introduced by the Mental Capacity Act 2005 is that from 1 October 2007 the Enduring Power of Attorney (EPA) has been replaced with a revised type of power called a Lasting Power of Attorney (LPA). However, EPAs made prior to 1 October will continue to be valid.
An LPA allows a donor to nominate one or more attorneys to make decisions should they lose the mental capacity to do so themselves. Unlike the EPA, an LPA will need to be registered with the Court of Protection before it may be used by the attorney(s). A person can make two types of LPA, one dealing with financial matters (as do EPAs) and one concerning personal welfare. A Personal Welfare LPA (PWLPA) can be used to set up an ‘advance directive’ regarding giving or refusing medical treatment in circumstances where the donor has lost the capacity to make such decisions themselves. The PWLPA is legally binding if it is valid and applicable to the treatment proposed. This new power has caused anxiety for some people, who worry that making a PWLPA might allow a relative to ‘pull the plug’ when they themselves might not wish that to happen.
No matter what the PWLPA states, the final decision regarding any treatment given will rest with the responsible clinician. The PWLPA cannot compel treatment to be given which is contrary to medical advice.
There are considerable legal safeguards built into advance directives, which in any event will only apply when the person creating the directive no longer has mental capacity. Where there is genuine disagreement about the existence, validity or applicability of an advance decision, those providing care or treatment will be able to apply for a ruling from the Court of Protection.
 “Whilst it is obvious that a LPA should always be drawn up with the benefit of professional advice, it will come as a relief to many to know that there are strong legal safeguards,” says <<CONTACT DETAILS>>. “If you need advice on how to deal with your affairs, or those of a family member, in the event that mental capacity is lost, contact us.”
Mental Capacity and Carers
In April this year, the Department of Health introduced a new Mental Capacity Advocate service. At the same time, a new code of practice was introduced which makes it clear that the ill-treatment or neglect of a person lacking mental capacity is a criminal offence.
The changes are the result of the Mental Capacity Act 2005, which aims to give additional protection to vulnerable people over the age of 16 who are not able to make their own decisions.
The Act is based on five key principles:
1.      Every adult has the right to make their own decisions unless it can be demonstrated that they lack the mental capacity to do so;
2.      A person must be given all practical help to make a decision before it can be concluded that they lack capacity to do so;
3.      The fact that a decision may seem to be unwise is not necessarily an indication that the person lacks mental capacity;
4.      Any decision made by a third party for the person lacking mental capacity must be in that person’s best interests; and
5.      Decisions made for persons lacking mental capacity must be those which least fetter their rights and freedoms.
One of the most important elements in the new regime is that any professional who provides care or treatment is required to take account of the views of anyone nominated by the person who lacks mental capacity, their carers, or anyone appointed under a Lasting Power of Attorney.
Anyone who is involved in looking after a person who lacks mental capacity will be expected to be aware of the code of practice (see and must consider it when making any decision concerning that person.
The Mental Capacity Advocate service will appoint an independent Mental Capacity Advocate to support persons lacking mental capacity who have no one to speak for them.
If you have a relative who seems likely to lose mental capacity, or you are concerned about what will happen should you lose the ability to make your own decisions, there are steps that can be taken to help reduce the impact of this on others and which allow the affairs of the person affected to be conducted in an orderly fashion. It is highly preferable to make any necessary arrangements before mental capacity is lost rather than afterwards. Consult <<CONTACT DETAILS>> for advice on the available options.
Poisoned Mind Invalidates Will
A case involving an elderly woman whose will was changed in favour of her abusive alcoholic son shows that the courts are ready to act when there is clear evidence of undue influence being exerted when a will is created or changed.
The woman had three sons and maintained a close relationship with two of them. They visited her regularly, helped her manage her finances and helped her with household chores. However, her relationship with her third son was described as ‘strained’ and she was said to be afraid of him.
The woman subsequently went to live in a nursing home, but she was removed from the home, against medical advice, by her third son. She died shortly thereafter. During the period she was living with her third son, she was prevented from seeing her other sons and she began making false accusations against them.
After the woman died, it was discovered that she had made a new will, giving her entire estate to her third son. This replaced her earlier will, which had split her estate equally between her three children.
The other two brothers contested the new will. The court found that the third brother had poisoned his mother’s mind against them by making false allegations about them. In the judgment of the court, the new will had been procured by undue influence and the original will was the final valid will.
Preying on the minds of the elderly or those who find it difficult to resist pressure is regrettably common and can cause many problems and much ill-feeling. If you believe that a will in which you have an interest has been altered or replaced as a result of someone exercising improper influence over its creator, contact us for advice regarding the steps you can take.
Partner Note
Edwards (deceased) and Edwards v Edwards and another [2007] All ER (D) 46 (May).
The ‘Seven Year Rule’ for IHT
It is widely known that when assets are gifted by one person to another a potentially exempt transfer (PET) arises for Inheritance Tax (IHT) purposes. Once a donor has survived for seven years, the PET falls out of charge and can no longer affect the IHT payable by the estate. Whilst this is widely understood, it isn’t strictly correct!
The problem arises if there is a PET which fails (i.e. becomes chargeable due to the donor failing to survive for seven years). If that occurs, transfers made in the seven years prior to the date of the failed PET are indirectly brought into the computation also. In practice, this may mean that a recipient of a gift made (say) five years prior to death may face an IHT liability as a result of an earlier gift.
The planning point here is that until there is a clear period of seven years after a PET is made, it can be brought into account for IHT purposes and the resulting sum payable will depend on earlier PETs, if any have been made within seven years of the failed PET. Secondly, unless the donor survives the full seven years after making a gift, the recipient may face an IHT charge on it. The amount of that charge will depend on the amount and date of earlier gifts. Potentially, the final IHT position may be affected by a gift made any time within the 14 years before the date of death.
IHT planning needs to be approached with great care and should only be undertaken with expert professional advice – there are many pitfalls. Contact <<CONTACT DETAILS>> for advice on all IHT planning matters.
Partner Note
Example based on one used by Robert Truncheon of McIntyre Advisory Services in his lectures.
Trust Expenses – Tax Deductible or Not?
It may come as something of a surprise to trustees of trusts to discover that the rules for the deductibility of expenses of a trust for tax purposes are far from cut and dried. With the rate of tax applying to discretionary trusts set at 32.5 per cent or 40 per cent, depending on the type of income, this is clearly a significant issue.
Expenses which are deductible for tax purposes are those which are incurred for the purposes of the trust:
·        in that year; and
·        are properly chargeable to income (or would be so chargeable but for any express provisions of the trust).
This means that to be allowable as a deduction for tax purposes, an expense can only be claimed as a deduction for tax purposes in the year it is paid. Expenses incurred but not settled in the period can only be claimed in the tax year in which they are paid. It also means that expenses which are deductible are those which would be chargeable to income in the absence of any express provisions of the trust. In other words, any definition of what is or is not an expense in the trust deed is ignored for the purposes of working out the allowability or otherwise for tax purposes. However, there is no precise definition of what expenses are, or are not, allowable for tax purposes.
Recently the Special Commissioners had to decide whether a variety of expenses incurred by the trustees of a large trust were allowable deductions for income tax purposes where it was clear that some of the expenses related both to the ‘income’ side and ‘capital’ side of the trust. HM Revenue and Customs had held that in such cases all of the expenditure was disallowable. The Special Commissioners disagreed, holding that the expenditure should be fairly apportioned between the allowable and disallowable elements.
Partner Note
CTA88/S686 (2AA). See
Clays Trustees v HMRC [2007] WTLR 644 (SJ, 27 July 2007, p994).
Trustees’ Responsibilities – Be Careful
Traditionally, trustees of trusts used to regard their responsibilities as being almost exclusively the safeguarding of the assets of the trust. The Trustee Act has, however, raised the bar for trustees somewhat and it is clear that many of them are unaware of their responsibilities.
Under the Act, trustees have been given the specific responsibility of assessing the suitability of trust investments and to keep these under review. In carrying out this task, they should consider investment spread and risk in the same way that other investors do. Secondly, trustees are required to obtain proper advice when this is necessary or appropriate.
The point at which the balance between making investment returns and managing the investment risk is struck will depend on the trust deed and on the needs of the beneficiaries.
Trustees should therefore make sure they are familiar with the trust deed and their role and should take advice as required concerning the management of any assets owned by the trust. Where the trust has the ability to invest in a range of assets and it is feasible to do so, the investment portfolio should be kept under review. In some cases, the trust assets are fixed – for example, the trust may own a house, or shares in a family company for which there is no ready market. However, even in such cases, if trustees become aware of interest by a potential purchaser in the trust assets, they should take steps to follow up such interest unless the trust deed forbids the sale of the assets.
“This is potentially an important issue for trustees,” says <<CONTACT DETAILS>>, “as any failure causing loss to the trust which is serious enough to be deemed to be a breach of trust can lead to a claim on the assets of the trustee as the trustee’s appointment is a personal one. People who are, or are considering becoming, trustees should examine the trust deed and seek to minimise their risk where appropriate, for example through the use of indemnity clauses or the use of trustee insurance.”
If you are concerned about your legal position as a trustee or need advice regarding any trust matter, contact us.
What is a Trust Fund?     
A trust comes into effect when a ‘settlor’ places money, land or other assets in the hands of trustees. The trustees are the legal owners of the property but are obliged to hold and manage the property for the benefit of a person or a group of people, who are called beneficiaries.
Types of Trust
  • Bare Trust. In this type of trust, the beneficiary has an immediate and absolute right to the property in the trust. The trustees have no discretion as to how the fund is managed. The income of these funds is taxed as if it is the income of the beneficiary. Bare trusts normally arise when gifts are made to minors who cannot legally hold them.
  • Discretionary Trust. Here the trustees have discretion over to whom and when payments should be made and also whether conditions should be attached. They are usually given discretion as to the investment of the fund. This type of fund may or may not be allowed to accumulate income.
  • Accumulation and Maintenance (A&M) Trust.In an A&M trust, the settlor places money in trust for children/grandchildren until they reach a specified age (maximum age 25) when they become entitled to the trust fund.
  • Interest in Possession (IIP) Trust.Here, thebeneficiary has a right to the income but not the capital of the trust fund. For example, a beneficiary may be allowed to receive the income arising from shares during their lifetime with the ownership of the shares passing to their children on their death. The beneficiary is entitled to all of the trust income (net of tax and the trustees’ expenses) as it arises.
Prior to the 2006 Budget, IIP and A&M trusts enjoyed special tax treatment. Lifetime transfers did not attract Inheritance Tax (IHT) if the settlor survived seven years and the funds did not attract periodic or exit charges. These are now taxed in the same way as discretionary trusts unless they satisfy the following conditions:
  • the trust is for a disabled person;
  • in the case of an A&M trust, the beneficiary must become entitled to the trust fund at 18 (if this is not the case then the trust deed may be amended prior to 6 April 2008 to allow for this); or
  • in the case of an IIP trust, the present interest in possession must end not to be replaced. If the property continues to be held on trust after the ending of the present interest then the fund attracts IHT liability.
Discretionary trusts are taxed as ‘relevant property’ trusts in accordance with the Inheritance Tax Act 1984 and attract the following taxes:  
  • an ‘entry’ tax on lifetime transfers to the fund where the money transferred exceeds the IHT threshold;
  • a ‘periodic’ tax, levied every ten years, on the value of trust assets which exceed the IHT threshold; and
  • an exit charge if funds are withdrawn between ten year anniversaries.
In addition the trust must pay income tax on its income.
For advice on the use of trusts to protect your family’s assets contact <<CONTACT DETAILS>>.
Will Cannot Alter Ownership
A recent case has confirmed that in the absence of a demonstrated specific intention regarding the ownership of a property, the wording of a will cannot change its ownership.
The case arose as a result of a challenge to a will following the death of the grandmother of one of the defendants. The grandmother and her husband had made their wills in 1967 and the grandfather’s will left the family home (which was owned as beneficial joint tenants) to his wife for life and on her death to their daughter. The grandmother’s will, executed at the same time, was similarly worded. The grandfather and the couple’s daughter died in 1980. The grandmother died in 2000, having made a new will.
The question facing the court was whether the family home formed part of the grandmother’s estate or not. That in turn depended on whether the property was held by the grandparents as tenants in common or joint tenants.
A beneficial joint tenancy means that the joint tenants both own all of the property and title to it passes from one to the other on death by way of survivorship. In such cases, the property is not part of the deceased’s estate. Where ownership is by way of tenancy in common, then each person owns a share in the property. In that case, on death that person’s share forms part of their estate.
The claimants argued that when the grandfather died, his interest in the property passed to his wife in its entirety. It therefore became her exclusive property and hers to deal with as she thought fit. The defendants argued that the execution of the 1967 wills severed the joint tenancy. The first defendant in the case was the daughter of the couple’s deceased daughter. She stood to have a larger inheritance (via her mother’s estate) if her argument was accepted.
The court could not accept the proposition that the joint tenancy had been severed in the absence of specific evidence that this was so: the mere creation of the will was not sufficient. The property was therefore part of the grandmother’s estate.
“The court ruled that there was no clear intention in the 1967 wills to sever the original joint tenancy,” says <<CONTACT DETAILS>>. “In the absence of a clear intention, the courts are unwilling to ‘read into’ documents things which are not there. If the intention had been to sever the joint tenancy, it should have been done in a way that was unequivocal.”
It is advisable to keep your will under regular review to ensure that it still meets your requirements and deals with tax and other issues as you would wish.
Partner Note
Carr and others v Isard and another [2006] EWHC (Ch).
See New Law Journal, 10 August 2007.

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