With the Revenue, it's a matter of trust exactly what your children will inherit

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The Independent Online

As families gather for Christmas, parents may wonder how to ensure, after they die, their children and grandchildren benefit from the full value of their home.

But the Chancellor has a message for them which will not help the turkey go down. His Pre-Budget Report last week may have suddenly made it a lot more difficult and expensive to avoid inheritance tax (IHT) on the family home.

At one point, IHT was an issue only for the very rich. It is payable at 40 per cent on an estate worth £255,000 or more, except for assets given to a spouse or charity. With the average price of a home in the South-east of England now almost £200,000, IHT has become a concern for most families in some parts of the country.

Until now, many tax advisers have suggested to clients that they avoid IHT by gifting the family home to a trust and continue to live in it, with the value of the home passing to family members upon death.

But a technical notice from the Treasury after Gordon Brown's Pre-Budget Report has raised the prospect of this giving rise to an income tax liability from the 2005 tax year forward on the nominal rental value of the property, to be paid by those who continue to live in the home after giving it away. But there is much confusion over exactly what the Treasury intends to do.

Mike Warburton, senior tax partner at the accountancy firm Grant Thornton, believes the Treasury is simply trying to eliminate the so-called Eversden trusts, which are properly called defeasible life interest trusts. Under these, spouse A gifts his or her share of the home to a trust where spouse B has an interest for life.

After a short period, the life interest is cut down by the trustees and replaced by discretionary trusts for the couple and their children. Spouse A can carry on living in the property without it being taxed in his or her estate on death. As long as spouse B lives for seven years, IHT is avoided altogether. Discretionary life interest trusts were ruled legal in the Court of Appeal last year, to the great frustration of the Treasury. Rush measures were included in the last Budget and Finance Act to put an end to these trusts.

But, Mr Warburton says, they were not sufficiently well drafted and advisers have since been selling a modified version of the discretionary life interest trust. Mr Warburton says all the Treasury is now trying to do is to put an end to these trusts.

Stephen Pallister, a tax lawyer with Charles Russell and a member of the Law Society's wills and equity committee, says the so-called "home loan plan" is also caught by the proposed rules.

These schemes involve a couple selling their home to a trust in which they are the beneficiaries, the cost of the sale being settled by an IOU. The couple gift that IOU to a second trust, in which their children are the beneficiaries. Until now, this has been regarded as a potentially IHT-exempt gift, but the Treasury is unhappy with such devices.

But Mr Warburton, recognised as another of the country's leading tax professionals, takes a different interpretation. He believes home loan schemes will not be covered by the Treasury's new rules.

The Treasury itself appeared to side with Mr Pallister's interpretation. A spokeswoman said: "Our measures are for where people are using artificial structures to avoid IHT: for example, where you get an IOU and put an IOU into another trust."

Mr Warburton shares the view that will trusts, which may suit Frank Rawcliffe (see panel), are outside the scope of what the Treasury is doing. Mr Pallister agrees, but says it is impossible to be certain with the lack of detail provided so far by the Treasury.

But John Whiting, tax partner at the accountant PricewaterhouseCoopers, believes that even will trusts might be caught by the new rules. The Treasury spokeswoman did not want to provide any clear guidance on which schemes will be covered and which not. "We don't go into much detail on tax avoidance matters," she said.

That lack of detail is irritating many tax professionals. Mr Pallister says: "The consultation document is extraordinarily brief. I don't know how you can call it a consultation document when it is unclear what is being consulted on." He believes there are between 25,000 and 30,000 households who have drafted home loan plan arrangements and various forms of trusts to avoid or minimise IHT and may be affected.

It is unclear what action they should take, at least until the rules are published and clear. Some people will be best off paying the new income tax liability. Mr Pallister's advice for the moment, to those who have set up a trust, or are thinking of doing so, is simple: "Do nothing. Sit tight and wait and see."

Mr Whiting adds: "Do we really know what the Inland Revenue and the Treasury are proposing? Not really. Anybody who is going into an arrangement at this stage needs to be aware that everything might change. Don't rush into any changes now. Book an appointment with your adviser around Budget time next year."

'I prefer to spend my own money'

Frank Rawcliffe, 70, of Stourbridge, is one of many who is concerned at the prospect of his estate paying a large IHT bill. "I don't see why we should keep giving money to the Chancellor," he says. "I'd much prefer to spend my own money." He wrote to The Independent seeking advice on how to ensure that his estate gets full benefit from the family home without it having to pay IHT.

Simon Higginbotham, of HR Estate Planning Services, is certain the use of an IOU in a will trust is unaffected by the proposed new rules and is ideal for people in Mr Rawcliffe's situation. Mr Higginbotham proposes that two lifetime discretionary trusts are established, enabling trustees to make loans to beneficiaries.

After the death of the first spouse, all their assets pass to the survivor, including their part-share in the family home. The surviving spouse gives the executors an IOU equal to the lower of the value of the assets transferred or the nil rate band, which the executors transfer into the deceased's discretionary trust.

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