Three-Dimensional Tax Planning With IHT BenefitsMake Text Bigger
This is a case study of how a couple with two daughters changed the structure of their property business to fund their girls’ through University tax free, and which changed their lives forever. An inspiring case study based on a true story.
Mr & Mrs Smith own their property portfolio jointly and each account for 50% of their income and profits on their self-assessment tax returns. This is what I would call two-dimensional accounting. It is very normal.
When their twin daughters were about to reach the age of 18 they approached a tax consultant to see whether their finances could be arranged more effectively. They wanted to help fund their daughters’ education in the most tax efficient way.
Their property portfolio consisted of 10 virtually identical flats worth £390,000 each (£3,900,000 in total). They had purchased them for £280,000 each some time ago, hence their capital gain stood at £1,100,000 each.
For their 18th Birthday the girls each received a gift of 1% of the beneficial interest in the properties via a Declaration of Trust. This required a severance of joint tenancy at HM Land Registry to make Mr & Mrs Smith Tenants in common. A Declaration of Trust was drawn up to show that beneficial ownership was 49% each for Mrs & Mrs Smith and 1% each for the girls. Form 17 was then filed to HMRC within the required 60 day period.
The value of each transfer was £3,900 which is less than the SDLT threshold.
A capital gain of £22,000 (i.e. 2% of the £1,100,000 actual gain) was crystallised. However, Mr & Mrs Smith were able set this against their £11,100 annual CGT exemption allowance, hence no tax became payable on that either.
The above was repeated annually whilst the girls were at University.
With this structure in place, a family partnership was formed to enable a three-dimensional approach to accounting for profits. This involved obtaining a unique tax reference number “UTR” from HMRC and submitting an annual partnership tax return in addition to self-assessment returns.
The benefit of this three-dimensional accounting approach was that profits could be allocated entirely at the discretion of the partners. This is because profit allocation does not have to be in accordance with partnership equity. This meant that all nil rate and basic rate tax bands could be utilised for tax purposes. Note that Mr & Mrs Smith are high rate tax-payers from their other professional careers.
Drawings from the partnership are not required to follow partnership equity or allocation of profits either. This meant that Mr & Mrs Smith could continue to draw the same amount of money as they had before and create an overdrawn capital account. On the other hand, the girls’ capital accounts grew nicely, as was their share of partnership equity.
Both girls went onto complete their MA’s in property related fields and left University with some excellent ideas to grow the family property business.
The business was incorporated with no CGT or Stamp Duty payable on the transfers into the company due to incorporation reliefs which had become available as a result of this structure.
Prior to incorporating, Mr & Mrs Smith borrowed £2,900,000 against the security of their property portfolio, which had previously been unencumbered. They put this money into their bank account but then loaned it back to the company post incorporation. The company then used this money to repay the £2,900,000 loans incorporated from the partnership, which had become a company liability. This structure left the company indebted to Mr & Mrs Smith to the tune of £2,900,000. The company is able to repay these loans out of future pre-tax profits without Mr & Mrs Smith having to incur any further personal taxation on the money whatsoever.
The girls now run the business and are building to rent. They started in an excellent position of having an unencumbered property portfolio on which to secure finance.
Mr & Mrs Smith continue to gift shares to their daughters annually. This creates Potentially Exempt Transfers “PET’s” which could be subject to IHT if they die within 7 years. However, they insure against this using a joint life, second death, decreasing term assurance policy which is written into trust. This is a special form of life insurance specifically designed for estate planning purposes. The premiums are surprisingly inexpensive.