This article originally featured in Tax Journal magazine on 20 June 2013
Michael Dawson answers a reader’s query:
We act for a wealthy husband and wife who are currently in their early seventies. They are both members of their company SSAS which holds funds for their benefit of in excess of £3m. They also have an unapproved scheme that has been set up overseas with assets in excess of £1m. We are aware that HMRC has just completely updated their manual in respect of IHT on pensions. Please could you advise what IHT charges could arise for our clients under the current regime?
Inheritance tax on pensions is a very wide subject, but the good news is that the scope of inheritance tax was significantly reduced by FA 2011. Historically, on the second death, a 40% IHT charge could be applied a.er an unauthorised pension payment charge of 70%, giving rise to an effective tax rate of 82%! From 6 April 2011, there is a scheme tax charge of 55% (where pensions are in payment) and the IHT charging provisions (in IHTA 1984 ss 151A–151E) have been repealed.
Nevertheless, there are still some circumstances where an IHT charge can apply, and the position of an unapproved scheme is different as explained below.
The freedom from IHT operates where the scheme trustees have unfettered discretion in paying death benefits. However, where the deceased has the right to have the benefits paid into their estate or to nominate who the benefits are payable to, they remain liable to IHT (IHTA 1984 s 152). A standard letter of wishes would not be caught by this provision, but care is required to ensure that there is no binding instruction.
Historically an IHT charge could apply where the member deliberately omitted to draw retirement benefits, and HMRC was successful in litigating this in the Fryer case ( UKFTT 87 (TC)). In that case, the member had been diagnosed with terminal cancer prior to her normal retirement age of 60. She died a.er her 60th birthday and it was held that the value of her right to pension benefits should be treated as part of her taxable estate. Fortunately, FA 2011 has introduced a new provision (IHTA 1984 s 12(2ZA)) which specifically removes any charge through omission of rights under a registered pension scheme (note that this does not apply to an unapproved scheme).
Nevertheless, there are still circumstances where IHT can arise where the member is in ill health and dies within two years. For instance, a transfer to another UK scheme or qualifying recognised overseas pension scheme (QROPS) could give rise to an IHT charge. HMRC’s manual (Inheritance Tax Manual at IHTM1072) does not explain how HMRC would challenge this, but the implication is that HMRC would take issue with a deliberate attempt to reduce the scheme tax charge on death.
Unapproved schemes can take many different guises, but in the absence of any reliefs, they fall within the normal discretionary trust regime, where ten year charges and exit charges apply. Old style company schemes (known as FURBS), where all the contributions were made before ‘A day’ on 5 April 2006, continue to be treated as exempt from IHT (see IHTM10727). It is important that no further contributions are added to these schemes.
For company unapproved schemes after April 2006 (known as EFRBS), there is no IHT protection and the normal ten year charge regime applies. HMRC also indicates that the gift with reservation rules may apply to the funds within the EFRBS (see IHTM 17074), so a careful review of the arrangements will be needed to ensure that an IHT charge on the death of the member is avoided.
It is also clear that if a member omits to draw down their pension benefits, an IHT charge can arise (under IHTA 1984 s 3(3)) in respect of the value in any unapproved scheme (whether created before or a.er ‘A day’). I therefore normally recommend that individuals at least draw down some pension a.er they have reached normal retirement age (which is typically defined as 60) in order to defend any possible attack.
There is no protection merely because the scheme is non-UK resident, although funds from UK regulated schemes that are transferred to overseas QROPS continue to be exempt from the discretionary trust regime. They are also protected from a charge where member omits to take benefits, as they are covered by the same legislation on UK regulated schemes, as explained above.
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