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Making sure your hard earned wealth goes to where you want it (2).

In a recent article, I discussed how UK non-domiciled individuals can gift money for the benefit of younger family members but still retain control and access to the gift.

This week, I want to look at an option to gift for those who may still be UK domicile, even if non-UK resident.


Background to Inheritance Tax (IHT)

If a UK domiciled individual (this could be a non-UK resident that has been an expat for some time) gifts something but still gets benefit from the gift then this is termed a “gift with reservation of benefit”. Therefore, it would be treated as if the gift was never made and would be included in the estate for the calculation of UK IHT.

However, HMRC (Her Majesty’s Revenue and Customs) have confirmed that a properly constructed discounted gift trust (DGT) will not be treated as a gift with reservation because an interest is retained and “carved out” before the gift is made. http://www.hmrc.gov.uk/manuals/ihtmanual/IHTM44112.htm


Who is this suitable for?

The DGT is suitable for the following- 

  • Individuals that have surplus capital that they wish to gift to future generations
  • Individuals who are relatively healthy (I will come back to that)
  • Individual who are not healthy but wish to gift a significant sum in excess of the nil-rate band of  325,000 GBP

 
How the discount works

If we use the cake analogy, normally one cannot have ones cake and eat it. So, a gift that provides a benefit to the person that gifted it is not a gift at all. However, what if a slice of the cake was reserved for the use of the donor of the gift?

This would not be a gift with reservation as this slice had not been given away.

The DGT is designed to allow someone to give away a large sum, yet still retain the right to regular capital payments for life. The remainder of the money is left to the beneficiaries, excluding the donor of the gift.

The “slice” needs to be valued by an actuary as it is not the same as the monetary amount within that slice. This is calculated by reference to the health of the donor, the amount of regular payments to the donor and the age of the donor. The actuary calculates the “value” of the future payments. In other words, what capital sum would a theorectical buyer pay for the regular income? Usually, significantly less than the actual capital.

If , for example, a 100,000 GBP gift was valued at 50,000 GBP, then the donor would have received and immediate discount on the gift for IHT purposes. Effectively saving 20,000 GBP in IHT during the first 7 years of the trust. After 7 years, the savings will be 40% of the whole gift.


Why is health important?


Let’s look at a hypothetical situation where the donor has a short life expectancy of only a year. Would a hypothetical buyer of the income want to pay for the future lifetime regular income of someone who is terminally ill? The answer is no, this means the value of the discount would be zero.

This shows why the discount must be underwritten at outset to ensure tax efficacy.

For those that have a life expectancy of over 3 year, but possibly less than 7 years, then IHT savings are available after 3 years for the part of the gift that exceeds 325,000 GBP. These are due to rules know as Taper Relief.


Trust Structure


As with all of these structures, it is important that the correct trust wordings are used and that appropriate tax advice is given at outset. Additionally, it is important that the correct investment structure is established to maintain tax efficacy.

The DGT is very IHT efficient , if used correctly. This does allow people to ‘have their cake and eat it’. However, it is important to point out that the regular income to the donor must be paid for this to work.


About the Author: Christopher Lean is a consultant at Square Mile Financial Services (http://www.squaremilefs.com ) and an Associate of the Personal Finance Society (Chartered Insurance Institute).