Inheritance Tax Planning and Compliance Requirements | Trust Law

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  Inheritance Tax Planning and Compliance Requirements 2014 Mark Barrett Tax Partner, Ronan Daly Jermyn Introduction In June 2012 the Boston Consulting Group and Bloomberg compiled a report (  Global Wealth 2012: The Battle to Regain Strength  ) that placed Ireland 14th in a global list of countries with the most millionaires per capita, which was the second-highest place for any EU country. According to the data, despite economic carnage and an unemployment rate that remained above 14%, approximately 33,000 Irish households ranked as “millionaire households”. It is reasonable to assume that in the period of just over two years since that report was compiled, the number of millionaire households has not decreased and has most likely increased in line with the return to growth in our economy.This wealth may have been accumulated from years of hard work and astute financial planning or, in some situations, the luck of a timely land disposal or exit from a business. Irrespective of how it was generated, the changes to the capital acquisitions tax (CAT) regime that have been introduced since 2009 have made it more difficult to preserve this wealth when it forms part of a deceased’s estate. At the beginning of 2009, a family of four children could inherit an estate of € 2m between them without giving rise to an 76  Inheritance Tax Planning and Compliance Requirements 2014  inheritance tax liability. The same estate today could result in an inheritance tax liability of € 363,000. The changes that have had the greatest impact are: › the phased reduction in the parent/child exempt threshold from € 542,544 in 2009 to the current level of € 225,000, with corresponding reductions to the other group thresholds; and  ›the gradual increase in the CAT rate from 20% in 2008 to the 33% rate now in force.While succession planning is often well down the list of priorities for wealthy individuals or families, I have found in recent years that the scale of the potential tax liabilities that could arise on death has brought a renewed focus on planning to mitigate those liabilities and to plan for the payment of any tax that does arise. The aim of this article is to highlight some practical considerations in inheritance tax planning, which are based on my own experi-ences of advising clients in recent years and reflect the changed legislative and economic landscape that we find ourselves in. Pay and File Date It is timely to remind practitioners that all gifts or inheritances with a valuation date on or after 14 June 2010 have a fixed CAT pay and file date. CAT on all gifts and inherit- ances with a valuation date in the 12-month period ending on 31 August in a particular year must be paid and filed by 31 October of that year. This replaced the previous regime, whereby a CAT return had to be filed and the tax paid within four months of the valuation date. I mention this filing deadline at the outset because in my experience the awareness of it is not as extensive as that of the income tax filing deadline. There can be a very short timeframe between a valuation date arising in, say, late August and a payment date for CAT of 31 October. Where the valuation date is the date of grant of probate, it may not be possible for the executors to generate sufficient cash from an illiquid estate in a two-month period. Care should therefore be taken, where possible, to plan the steps that will need to be followed once probate is granted.  Valuation Date Determining the valuation date of an inheritance is one of the most difficult aspects of CAT to advise on. It is also one of the most important issues, as it is the date on which the property will be valued, and the pay and file date is also determined by reference to it. The Capital Acquisitions Tax Consolidation Act 2003 (CATCA 2003) s30(4) defines the valuation date of an inheritance as the earliest of: › the date on which the inheritance can be retained for the ben- efit of the beneficiary, ›the date on which the inheritance is actually retained for the benefit of the beneficiary and ›the date on which the inheritance is transferred or paid over to the beneficiary. In practice, the date of grant of probate is generally taken as the valuation date; however, there are several situations where an earlier or later date can arise. In any one estate, there can be several different valuation dates for different bequests. For example, if cash is distributed by the executors before the date of grant, the valuation date would be the date of the distribution. If the residue is not ascertained at the date of grant (for example, due to a claim on the estate), the valuation date for the residue would be later than the date of grant. There can be significant tax conse-quences where values of assets fluctuate between the date of death and the date of grant of probate. For example, at times so far during 2014, the ISEQ index of shares was up over 25% on the previous 12-month period, and the value of residential property has grown by double digits in some areas. An estate with a share portfolio valued at, say, € 1m at a date of death in 2013 could have been worth € 1.3m by the date of grant of probate in 2014, resulting in a potential additional inheritance tax liability of € 99,000 (  € 300,000 x 33%). It is timely to remind practitioners that all gifts or inheritances with a valuation date on or after 14  June 2010 have a fixed CAT pay and file date. CAT on all gifts and inheritances with a valuation date in the 12-month period ending on 31 August in a particular  year must be paid and filed by  31 October of that year. This replaced the previous regime, whereby a CAT return had to be filed and the tax paid within four months of the valuation date. 2014 Number 3 Inheritance TaxPlanning and Compliance Requirements 2014 77  Great care should be taken in considering the valuation date. The facts should be fully explored to establish the types of assets involved, the nature of the bequest, the date of retention by the executors, the solvency of the estate and whether any legal or financial claims exist against the estate. In the above example, if the valuation date could be justified as a date earlier than the date of grant of probate, the associated tax savings could be substantial. Discretionary Trusts The use of discretionary trusts as a tax-planning tool is based on a simple philosophy: “tax deferred is tax saved”. A discretionary trust allows for CAT to be deferred until the assets within the trust are distributed to the beneficiaries. To counteract the retention of property within a trust and prevent it growing without the imposition of a CAT charge, once-off (6%) and annual (1%) discre- tionary trust taxes apply. In the period from December 1999 to November 2008, when the rate of inheritance tax was 20%, I would generally have advised clients to use discretionary trusts as part of will planning only where the property within the trust would be distributed before the 21st birthday of the youngest primary object of the trust or where the trust was for the benefit of an incapacitated individual. In these circumstances, neither the initial charge to discretionary trust tax of 6% nor the annual 1% charge would apply. Where the discre- tionary trust taxes applied, after a period of, say, 12 years, these taxes would be nearly as much as the inheritance tax liability that was being deferred. However, in view of the current inheritance tax rate, serious consideration should be given to establishing a discretionary trust in a will, paying the initial and annual discretionary trust taxes, and thereby deferring a potential 33% inheritance tax liability. I find that the decision to use trusts is made by experienced investors who understand the concept of trusts, are comfortable with the investment decision-making of their trustees and believe that it is possible to preserve more wealth by investing 94% of their assets and suffering an annual 1% levy, rather than losing up to 33% of their estate at the outset. I would encourage anyone advising a wealthy individual to “do the maths” and let their client make an informed decision on the potential use of a discretionary trust. Section 72 Insurance Policies A “Section 72” policy is an insurance policy that complies with the criteria set out in s72 CATCA 2003, the primary conditions being that the policy is expressly effected for the purpose of paying “relevant” tax and in respect of which annual premiums are paid. The benefit of such a policy is that the proceeds are exempt from inheritance tax to the extent that they are used to discharge inheritance tax. With a current tax rate of 33%, this can represent a significant saving. In the early 1990s the top rate of inheritance tax was 40% and the exempt threshold for parent/child benefits was £150,000 index-linked; therefore it was almost a financial necessity for many families to have a s72 policy in place. As the CAT regime became more benign, the popularity of these s72 policies waned to the extent that very few clients could see the merits in them. This position has now come full circle.I find that clients have very polarised views on the attractions of these policies. Some take the view that it is for the beneficiaries to take care of their own taxes out of their inheritances and that the individuals should not also be required to spend their after-tax income to fund insurance premiums. Others take the view, in particular where estates do not comprise liquid assets, that the funding of tax out of the estate could require the sale of property, which could lead to difficulties in paying tax on time. It might also result in the sale of assets that have been in the family for generations. I find that where individuals have funds, say, on deposit, which could be subject to 33% tax on their death, they see the attraction of taking out a policy with a predetermined value on death, which then does not attract tax if used to pay inheritance tax. In essence, they are swapping a taxable asset for a non-taxable one. It can pay to be creative in funding the premiums for the policies: for example, through the disposal of property to companies (perhaps at a capital loss) or the disposal of a primary residence when trading down (and availing of principal private residence I find that where individuals have funds, say, on deposit, which could be subject to 33% tax on their death, they see the attraction of taking out a policy with a predetermined value on death, which then does not attract tax if used to pay inheritance tax. 78  Inheritance TaxPlanning and Compliance Requirements 2014  (PPR) relief). An alternative is to use the annual exemption of € 3,000 per individual to provide funds to beneficiaries to take out their own policies for the payment of tax on expected inheritances. Business Relief  This important relief has the effect of reducing the value of qualifying business property by 90% for CAT purposes. Where shares in companies are involved, it is necessary to establish the percentage value of the shares that is derived from business assets and non-business assets, with relief applying only to the business asset element. I have come across many instances where substantial cash reserves and investments have accumulated within companies in the last five to six years, as directors/share-holders have decided to retain profits within companies both for prudent commercial reasons and to avoid the increased level of income tax/levies that could apply on salary or dividends. Business relief should apply to cash that is held within companies for working-capital purposes or to meet short-term business liabilities. However, where accumulated cash might be considered “excess cash”, it will be necessary to satisfy Revenue that it qualifies as a business asset. For example, it could be argued that the cash is held for regulatory purposes or for the funding of future acquisitions or business premises or that it is retained as a precautionary balance of reasonable amount. Where a company holds cash or investments that do not qualify for business relief, it may be worthwhile considering various means of extracting these from a company. These could include using them for pension funding; financing a share buy-back, if it can be implemented efficiently in compliance with legal and tax requirements; and executing a share-for-undertaking transaction, whereby the cash/investments remain with the existing company etc. While, on the face of it, this may result only in wealth being redistributed between the different asset classes of an individual, it has the practical advantage of maximising the business relief available and minimising the tax payable by a beneficiary whose benefit consists of shares in a family company, and not the cash to pay the tax on the benefit (which may be locked up in the company). Prior Benefits and Free Use of Property In conclusion, I would sound a note of caution for practitioners to assess fully the previous benefits received by a beneficiary. The economic downturn resulted in many situations where parents provided financial assistance to their children, in terms of both cash and the free use of property. While the annual exemption of € 3,000 per individual may shelter part of such benefits, any excess must be aggregated when calculating CAT liabilities. It is easy to overlook such benefits, which can accumulate to a significant amount over a period of years and should be examined and highlighted to any beneficiary.Read more on The Taxation of Gifts and Inheritances In conclusion, I would sound a note of caution for practitioners to assess fully the previous benefits received by a beneficiary. NEWS & MOVES IN THE TAX WORLD Inform us of your news by contacting: Samantha at +353 1 663 1707 or sfeely@taxinstitute.ie Announce your latest tax appointments and internal tax promotions  > Inform the Irish tax community, colleagues and friends of your latest tax announcements. 2014 Number 3 Inheritance TaxPlanning and Compliance Requirements 2014 79
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