Brown to shut inheritance tax loopholes

A staggering 1.5 million homeowners are potentially caught in the inheritance tax (IHT) trap, according to figures from Halifax. But the Chancellor, Gordon Brown, plans to crack down on loop holes that allow people to ensure the value of their home does not attract a hefty inheritance tax (IHT) bill.

This means most people will have to go back to basics, concentrating on tried and trusted methods of reducing their IHT, such as those described below, rather than using special schemes set up by clever accountants.

Inheritance tax is the tax your estate pays when you die if the value of your assets is more than the nil-rate threshold of £255,000. Anything in excess of that is charged at 40 per cent, unless left to a spouse or charity. IHT owed by your estate must be paid, at least in part, within six months of death and before your family and friends receive the benefits of your assets.

Many people don't consider IHT planning a priority. After all, it is paid after their death by their beneficiaries. Many also still consider it to be a problem only for the very wealthy.

The Council of Mortgage Lenders, however, points out that the Chancellor's failure to index the inheritance tax allowance in line with house prices means tax is now payable on an increasing number of estates.

John Bunker of law firm Thomas Eggar says: 'Rising house prices across the South East have left many property owners exposed to IHT, but the misconception continues that it affects only the wealthy. With IHT applicable to estates with a value in excess of £255,000, the average house price in the South East is not far behind at £194,000. Even modest terraces, semi-detached houses and flats can be liable for IHT.'

You may be worth more than you think. The inflation in property prices means the value of your home may exceed £255,000 even before other assets are taken into account. Then you have to add on the value of your personal possessions, cash, investments and any death benefits from life policies not held in trust.

So what can you do to ensure you pass on as much of your wealth as possible to your family and friends?

Sadly, it is becoming increasingly difficult to avoid IHT on your main residence. There are various complicated tax plans on the market that aim to reduce or eliminate liability to IHT. But the Revenue is about to challenge some of these arrangements and has recently brought in legislation to kill previous schemes after several years of argument in court. There are now proposals to introduce legislation into the Finance Act 2004 to close other perceived loopholes.

Anne Young, Scottish Widows' senior technical manager, says: 'It will be interesting to see which of the many IHT schemes the Revenue views as contentious. Currently it seems to be most interested in schemes involving the family home - possibly as this forms the major part of many people's estate. However, there are some insurance company schemes that may also be at risk.'

As part of its wider strategy to protect tax revenues, the Government announced last December that income tax will in future be charged on the benefit people enjoy after they have arranged free and continuing use of major capital assets they once owned.

Arrangements such as this are often made to get around the IHT gifts-with-reservation rules. Essentially, these rules are intended to stop people giving their assets away, so that for IHT purposes they are out of their estate when they die but they can continue to enjoy the practical benefits of owning them during their lifetime.

Clive Scott-Hopkins, financial adviser at Towry Law, says: 'The sweeping proposal to assess a former owner to a tax charge on an asset he has disposed of while continuing to enjoy the benefit will almost certainly curtail several "house schemes" where the Chancellor is expecting to reap huge death tax rewards. The question remains how and when this will take effect and whether it will have a retrospective effect on existing schemes.'

The double trust plan is one scheme that will no longer be widely used. This involved two trusts, with the sale of the property into one trust and an IOU set up between the two trusts.

Bob Trunchion, a partner with accountants Macintyre Hudson, says the Chancellor has also in effect put a stop to the complex Melville 2 scheme, used by those who wanted to pass assets to the next generation but were restrained by the capital gains tax that would be payable when the gift was made.

However, Simon Higginbotham, a partner at HR Estate Planning Services, says anybody who has done a double trust plan or a Melville 2 scheme should be aware that the Revenue could decide to challenge them. 'They are still a punt and there are no guarantees they will work. Anyone who was not told this at the time they were set up has been ill-advised,' he says.

All is not lost, though. There are many other options to help reduce or remove potential IHT liability, says Higginbotham.

Bunker adds: 'Consider IHT planning as a whole, looking at all of your assets, as well as your income. However, be very careful about any IHT planning with your property, as there may be other steps you can take to reduce IHT which are easier and safer.'