Brown may close loophole after inheritance tax defeat

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Thousands of families may have the opportunity to save huge amounts of inheritance tax (IHT) after the Inland Revenue lost a test case yesterday in the Court of Appeal and has been denied leave to appeal to the House of Lords.

The case is IRC (Inland Revenue Commissioners) vs Eversden and another, in which a married couple avoided liability for IHT on their marital home by setting up a trust to own the bulk of the property.

This will come as welcome, if temporary, relief to many people who have seen the value of their home increase far more rapidly than the Chancellor, Gordon Brown, has increased the threshold for paying IHT. In last month's Budget he raised the threshold by just £5,000 to £255,000.

The Government line has for several years been that only 4 per cent of estates pay IHT, but Mr Brown admitted in his Budget speech that this has recently risen to 5 per cent, an increase of a quarter, as so-called "fiscal drag" begins to take effect. The proportion of estates being caught by IHT is expected to rise to 10 per cent in the next few years, on the death of more second partners whose estates provide for the family home to be sold or passed to children.

But anyone who wants to protect themselves must act quickly if they want to set up the sort of trust at the heart of IRC vs Eversden. Legal experts believe that Mr Brown could close the loophole by inserting a clause in the Finance Bill currently going through Parliament.

Owen Clutton, a partner in the solicitors Macfarlanes, said: "Although the Revenue has been denied leave to appeal, it could petition the House of Lords directly, or it could announce that the law was being changed with effect from today, subject to the approval of Parliament."

The background to the case is that Margaret Greenstock created what is known as a "defeasible life interest trust" which gave her husband a 95 per cent interest in their house for his life. She kept the other 5 per cent stake. After he died the trust gave Mrs Greenstock and others in the family the use of the house.

After Mr Greenstock died, Mrs Greenstock continued to live in the house until it was sold about a year later. The trustees then bought a new house and put what was left over into an investment bond.

When Mrs Greenstock died the Revenue argued that the 95 per cent interest owned by the trust should be included in Mrs Greenstock's estate for inheritance tax purposes, because she had benefited from the assets she had put into the trust.

Mrs Greenstock's executors won an appeal to the Special Commissioners, but the Revenue counter-appealed to the High Court.

Mr Clutton added: "I don't think we've heard the last of this. The Revenue perceives it to be avoidance, and it has wider implications, for insurance bonds and other assets. So it is too important to let go."