EXCLUDED PROPERTY TRUSTS

5 Meaning of estate
(1)For the purposes of this Act a person’s estate is the aggregate of all the property to which he is beneficially entitled, except that...
(b) the estate of a person immediately before his death does not include excluded property.

The exemption from Inheritance Tax afforded by s5(1)(b) IHTA as quoted above is obviously an extremely attractive and valuable one.

 For a period in the early part of this decade planning was widely used whereby the taxpayer would acquire an interest in an Excluded Property Trust and the value of that interest would immediately fall outside the charge to Inheritance Tax.  The planning was particularly popular in so-called “deathbed” scenarios where the taxpayer had a limited life expectancy such that more conventional Inheritance Tax planning ideas were not considered viable.

Whilst HMRC would not necessarily agree with the analysis that simply acquiring an interest in an Excluded Property Trust resulted in a decrease in the chargeable estate of the purchaser, they were sufficiently concerned by the wide use of the planning to change the legislation in Finance Act 2006. The changes were contained at subsections (3B) and (3C) of section 48 IHTA 1984 and the relevant subsections of section 48 now state:

48 Excluded property
(1)A reversionary interest is excluded property unless—
(a)it has at any time been acquired (whether by the person entitled to it or by a person previously entitled to it) for a consideration in money or money’s worth, or
(b)it is one to which either the settlor or his spouse is or has been beneficially entitled, or
(c)it is the interest expectant on the determination of a lease treated as a settlement by virtue of section 43(3) above...

 (3)Where property comprised in a settlement is situated outside the United Kingdom—
(a)the property (but not a reversionary interest in the property) is excluded property unless the settlor was domiciled in the United Kingdom at the time the settlement was made, and
(b)section 6(1) above applies to a reversionary interest in the property but does not otherwise apply in relation to the property.
but this subsection is subject to subsection (3B) below...

(3B) Property is not excluded property by virtue of subsection (3) or (3A) above if— (a) a person is, or has been, beneficially entitled to an interest in possession in the property at any time, (b) the person is, or was, at that time an individual domiciled in the United Kingdom, and (c) the entitlement arose directly or indirectly as a result of a disposition made on or after 5th December 2005 for a consideration in money or money’s worth. (3C) For the purposes of subsection (3B) above— (a) it is immaterial whether the consideration was given by the person or by anyone else, and (b) the cases in which an entitlement arose indirectly as a result of a disposition include any case where the entitlement arose under a will or the law relating to intestacy.

The result of the changes introduced by subsections (3B) and (3C) meant that the planning idea of simply acquiring an interest in an Excluded Property Trust would no longer result in that interest being treated as Excluded Property for calculating their chargeable estate. Therefore it appeared that this planning idea was no longer possible.
However, that does not mean that Excluded Property Trust planning is no longer viable. It is still possible for a taxpayer to become the holder of an interest in an Excluded Property Trust and for this interest to still qualify as Excluded Property.
By becoming the holder of an interest in an Excluded Property Trust but not falling foul of subsections (3B) and (3C) it is still possible to reduce the value of a person’s chargeable estate.

Example
The taxpayer (a widow) has a chargeable estate, after taking into account the Nil Rate Band and any other reliefs, of £2million made up of her main home and investments. If she were to re-arrange her estate such that £2million were held via an interest in an Excluded Property Trust and the value of the estate were matched by an equal debt owed to the Excluded Property Trust, the taxpayer’s Inheritance Tax Position would be as follows:

TOTAL CHARGEABLE ESTATE

£2,000,000

LESS: DEBT OWED TO EXCLUDED PROPERTY TRUST
    £(2,000,000)

   
ESTATE CHARGEABLE TO IHT

£0

In most cases the taxpayer’s chargeable estate will be made up of assets that the client cannot dispose of in order to obtain the interest in the Excluded Property Trust, however it is still possible to undertake the planning via the use of short-term borrowings.