In his Pre-Budget report on 9th. October 2007 the Chancellor of the Exchequer, Alastair Darling announced proposed changes to inheritance tax which will benefit married couples and civil partners. 

At present all individuals have a nil rate band for inheritance tax of £300,000 which means that a married couple between them can pass down £600,000 worth of assets free of inheritance tax.  Up to now however, apart from the very wealthy, most couples have been unable to leave £300,000 direct to their children on the death of the first of the couple because it would leave the survivor with insufficient means.  All property passing between spouses and civil partners is exempt from inheritance tax if they are both domiciled in the UK and so the benefit of one of the nil rate bands is lost. 

The way around this that we have been advocating for many years is for each of the couple to set up in their will a discretionary trust equal to the nil rate band.  The survivor of the couple would be one of the beneficiaries and would in practice be able to enjoy the use of the assets in the trust for the rest of their lifetime without their value being added to their own estate when they died. 

The Pre-Budget announcement now makes this device unnecessary as the nil rate band will be transferable between married couples and civil partners.  This will mean that where all or part of the nil rate band has not been utilised on the first death, whenever that occurred, the balance can be transferred and claimed on the death of the survivor provided that the death occurred on or after 9^th October 2007.  The proportion of the nil rate band that was not used on the first death can be utilised on the second death and is calculated using the nil rate band figures in force on the death of the survivor not of the first to die. 

Thus if the first spouse died in 2002/03 when the nil rate band was £250,000 and left legacies of £25,000 to the children with the remainder to the surviving spouse, 10% of the nil rate band would have been used leaving 90% available on the death of the survivor.  If the survivor died in 2007/08 when the nil rate band is £300,000, £270,000 would remain unused and could be added to the survivors own nil rate band making a total of £570,000. 

The changes will mean that artificial devices like nil rate band discretionary trust wills will no longer be necessary and married couples and civil partners will be able to leave the whole of their estate to the survivor without losing the benefit of their nil rate band.  The only circumstances in which a nil rate band discretionary trust is likely to be advantageous is if it is likely that the assets in that trust will increase in value faster than the increases in the nil rate band. 

The Chancellor of the Exchequer did however say that he would in future increase the nil rate band not just to reflect the Retail Price Index but also to reflect any increase in house prices.  It is only in those circumstances that a nil rate band trust is likely to result in less tax being paid and against that must be set the administrative inconvenience and complexity of setting up and maintaining a nil rate band trust. 

Nil rate band discretionary trusts do have other benefits as well as the inheritance tax savings. They can protect the amount of the nil rate band in the event that the surviving spouse remarries as the new spouse will not be a beneficiary and the children's interest will be protected. Also if the surviving spouse has to go into residential accommodation the nil rate band trust set up under the will of the first to die would be protecetd against a claim for care home fees.

We have put nil rate band discretionary trusts in place for many clients who will wish guidance on what they should now do.  The first point to mention is that the announcement has not yet passed into law and the detailed legislation is likely to be contained in next years Finance Act which, if it follows the normal timetable will not become law until August 2008.  It is therefore safer to keep the nil rate band discretionary trust wills in place until this happens.  It is very easy if someone dies leaving a nil rate band discretionary trust will for the whole of the amount of the trust to be appointed in favour of the surviving spouse or civil partner provided that this is done more than three months but less than two years after the death.  That would mean that the will would be treated as if the whole estate had been left to the surviving spouse and the whole of the nil rate band of the first to die would be available on the second death. 

As part of setting up nil rate band discretionary trusts many couples will have created a tenancy in common of their house so that on the first death a half share would pass into the discretionary trust and not automatically to the survivor.  Again this share can easily be passed to the survivor either by will or through the discretionary trust and there is therefore no need to reverse the severance of the joint tenancy.