Surfe

Surfe has requested advice on the tax implications of the creation of a discretionary trust and a
calculation of the estimated inheritance tax liability on her death. The following information was
obtained at a meeting with Surfe.

Surfe:
– Is an elderly widow who has two adult nephews.
– Intends to create a trust on 1 January 2021.

Death of Surfe’s husband:

– Surfe’s husband, Flud, died on 1 February 2009. He had made no gifts during his lifetime.
– In his will, Flud left £140,000 in cash to his sister and the remainder of his estate to Surfe.

The trust:
– The trust will be a discretionary (relevant property) trust for the benefit of Surfe’s nephews.
– Surfe will give 200 of her ordinary shares in Leat Ltd and £100,000 in cash to the trustees of
the trust on 1 January 2021.
– The inheritance tax due on the gift will be paid by Surfe.
– The trustees will invest the cash in quoted shares.

Leat Ltd:
– Leat Ltd has an issued share capital of 1,000 ordinary shares.
– Surfe owns 650 of the company’s ordinary shares.
– The remaining 350 of its ordinary shares are owned by ‘Kanal’, a UK registered charity.
– Leat Ltd is a property investment company such that business property relief is not
available.

Leat Ltd – Value of an ordinary share:

– As at 1 January 2021 1 July 2023
£ £
As part of a holding of 75% or more 2,000 2,400
As part of a holding of more than 50% but less than 75% 1,000 1,200
As part of a holding of 50% or less 800 1,000

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Surfe – Lifetime gifts:
– 1 February 2009 Surfe gave 350 ordinary shares in Leat Ltd to ‘Kanal’, a UK registered
charity.
– 1 October 2020 Surfe gave £85,000 in cash to each of her two nephews.
Surfe’s death:
– It should be assumed that Surfe will die on 1 July 2023.
– Her death estate will consist of the house in which she lives, worth £1,400,000, quoted
shares worth £600,000 and her remaining shares in Leat Ltd.
– Her will divides her entire estate between her two nephews and their children.

Required:
(a) Outline BRIEFLY:
(i) The capital gains tax implications of:
1 the proposed gift of shares to the trustees of the discretionary trust
2 any future sale of the quoted shares by the trustees; and
3 the future transfer of trust assets to Surfe’s nephews. (4 marks)
(ii) The inheritance tax charges that may be payable in the future by the trustees of the
discretionary trust.
You are not required to prepare calculations for part (a) of this question. (2 marks)
(b) Calculate the inheritance tax liabilities arising as a result of Surfe’s death on 1 July
2023. (11 marks)
(Total: 17 marks)

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(b) Inheritance tax payable on Surfe’s death on 1 July 2023

Tutor’s top tips

 Always work chronologically, starting with the earliest gift.

 There will be three different elements to the tax payable on Surfe’s death:

1 Tax on potentially exempt transfers (PETs) within seven years prior to death.

2 Further tax on chargeable lifetime transfers (CLTs) within seven years prior

to death.

3 Tax on the death estate.

 Before you can calculate the death tax, you need to establish the tax that was
paid during lifetime, as this will be deducted from the death tax.

 It is very important that you clearly label your answer so that the marker can see
whether you are calculating lifetime tax or death tax.

Lifetime tax

1 February 2009 – Gift to charity

Gifts to charity are exempt from IHT.

1 October 2020 – Gifts to nephews

These gifts are potentially exempt transfers.
£
Transfer of value (£85,000 × 2) 170,000
Less: Annual exemption
Current year (2020/21) (3,000)
Previous year (2019/20) (3,000)
–––––––
Gross transfer 164,000
–––––––

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No lifetime tax is payable.
Tutorial note 1

Remember that PETs are not chargeable during lifetime, and do not affect the
nil rate band, although they do still use up the annual exemptions.

1 January 2021 – transfer of shares and cash to trust

This transfer is a chargeable lifetime transfer.
£ £
Value of shares (W1) 400,000
Cash 100,000
–––––––
Transfer of value 500,000
Less: Annual exemption
Current year (2020/21) (used)
Previous year (2019/20) (used)
–––––––
Net chargeable amount 500,000
Nil rate band (NRB) at date of gift (2020/21) 325,000
Less: Gross chargeable transfers in 7 years pre gift (0)
–––––––
NRB available (325,000)
–––––––
Taxable amount 175,000
–––––––
Inheritance tax at 25% (Surfe is paying the tax) 43,750
–––––––
Gross chargeable transfer c/f (£500,000 + £43,750) 543,750
–––––––

Tutorial note 2

 The question states that Surfe (the donor) will pay the lifetime tax, so the rate of
tax is 25% and you must add the tax to the gift to calculate the gross transfer
for use in future calculations.

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 If the trustees (the donee) agreed to pay the tax, the tax would be at 20% and
the gross amount would be £500,000.
Death tax: 1 July 2023

1 October 2020 – Gifts to nephews

This PET is within seven years prior to death and is now chargeable
£
Gross chargeable amount 164,000
NRB at death (W2) (all available) (504,167)
–––––––
Taxable amount 0
–––––––
There is no tax payable as this gift is covered by the NRB.

1 January 2021 – transfer of shares and cash to trust

£
Gross chargeable transfer 543,750
NRB at death (W2) 504,167
Less: Gross chargeable transfers in 7 years pre gift (164,000)
–––––––
NRB available (340,167)
–––––––
Taxable amount 203,583
–––––––
Inheritance tax at 40% 81,433
Less: Taper relief
(1.1.2021 to 1.7.2023) less than 3 years (0)
–––––––
81,433
Less: Lifetime tax paid (43,750)
–––––––
Inheritance tax payable on death 37,683
–––––––

Tutorial note 3
 You should only be penalised once for any mistake that you make.

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 If you have the wrong gross chargeable transfer brought forward, or the wrong
NRB, you can still score marks for calculating the IHT at 40%, stating that taper
relief is not available and deducting your figure for lifetime tax paid.
1 July 2023 – death estate
£
House 1,400,000
Quoted shares 600,000
Shares in Leat Ltd (based on 80% holding) (W1)
(450 × £2,400) 1,080,000
––––––––
3,080,000
NRB at death (W2) 504,167
Less: Gross chargeable transfers in 7 years pre death
(£164,000 + £543,750) (707,750)
––––––––
NRB available (0)
––––––––
Taxable amount 3,080,000
––––––––
Inheritance tax at 40% 1,232,000
––––––––
Workings

(W1) Gift of shares to the trust on 1 January 2021

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Ignoring the related property rule:
£
Value of Surfe’s holding prior to gift (650 x £1000) 650,000

Value of Surfe’s holding after gift (450 x £800) (360,000)

________
290,000
________

The higher transfer of value of £400,000 using the related property rule is
considered as transfer of value.

Tutorial note 4

 The value of the Leat Ltd shares is based on the value of the combined holding,
including the related property held by the charity, at the date of the gift.

 The most common example of related property is property held jointly by

spouses, but property that has been transferred by the donor (or their spouse) to

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 a charity or political party is also deemed to be related property for as long as
the charity still owns the property (and for five years after they dispose of it).

 Remember also that the value for IHT is calculated as the diminution in value of
the donor’s estate, and is found by calculating the value of Surfe’s shares before
the gift and deducting the value after the gift.

(W2) Nil rate band on death

£
Surfe’s NRB as at the date of death 325,000
Unused nil rate band of Flud
((£312,000 – £140,000)/£312,000) × £325,000) 179,167
–––––––
504,167
–––––––

Tutorial note 5

 As Surfe’s husband did not use all of his NRB, the excess can be transferred to
Surfe to be used on her death.

 The amount transferred is based on the proportion that was unused when
Surfe’s husband died, but this proportion is then applied to the NRB in force at
the date of Surfe’s death.

 Note that the fact that the date of the husband’s death is more than seven years
before Surfe’s is irrelevant. The unused proportion of the deceased spouse’s
NRB can always be transferred regardless of the date of the first death.