The Residence Nil Band Rate in the countryside
From 6th April 2017 the agricultural advisor will need to be concerned with a new inheritance tax allowance available to their clients, subject to certain conditions. In considering the availability of the new allowance there are three definitions that are relevant for our purposes.
The first is “Residence Nil Rate Band”. The RNRB works in the same way as the conventional Nil Rate Band (“NRB”), as a threshold below which IHT is charged at 0% rather than the normal rate of 40%. It can be claimed in addition to the NRB. The RNRB is being phased in over three tax years, beginning at £100,000 and reaching the full £175,000 in the 2020/21 tax year, thereafter being indexed to the CPI.
This means personal representatives will be able to claim each in parallel to the other, thus increasing the ‘effective’ threshold below which IHT is charged at 0% to £500,000 for an individual (£325,000 NRB plus £175,000 RNRB) and therefore up to £1m for married couples and civil partners. Unused RNRB is transferable to a surviving spouse in a similar manner to unused NRB.
The second key definition is “Qualifying Residential Interest”. A QRI is an interest in a dwelling of the deceased and is either the only such interest in the estate, or if there are several such interests, the one nominated by the personal representatives.
If the deceased has downsized (and assuming Finance Bill 2016 makes it into law) some allowance is also made for previously owned QRIs if the full RNRB cannot be claimed, but would have been available earlier in the deceased’s lifetime. Sadly, and predictably, the current draft legislation is a masterpiece of Byzantine obscurity and thus largely beyond the current paper, which attempts to focus on agricultural matters.
From an agricultural perspective or at least a rural one, it is interesting to note that a QRI includes any land “occupied and enjoyed with [a dwelling] as its garden or grounds. It is not yet clear whether HMRC or the Valuation Office will attempt to apply any limit to what is reasonably considered ’grounds’. It might seem sensible for them to adopt the same policy as is applied in relation to the relief from Capital Gains Tax on the disposal of the principal private residence, but strictly there would be no statutory basis for such a policy.
Indeed, an argument could be made that since in the Capital Gains Tax legislation ‘permitted area’ is restricted by statutory provision then absent such a provision in the Inheritance Tax Act 1984 no such restrictions should apply to the new allowance. This would be particularly relevant to small holders and other rural folk with modest houses sitting on generous plots, perhaps with greenhouses, orchards and outbuildings that may or may not strictly qualify as agricultural property for the purposes of inheritance tax relief (e.g. the ‘orchard’ in Dixon).
There also seems to be nothing preventing a claim to APR over the farmhouse being made in conjunction with a claim to the RNRB in respect of any non-agricultural value in that dwelling, or in the buildings or potential barn conversions in the ‘grounds’.
Example 1 (Part 1)
Mrs Currie has retired from farming and lives in a former farm cottage in Lincolnshire, worth £150,000. This value excludes the value of a pair of large sheds that sit at the end of what is now her garden and that were retained by Mrs Currie and her late husband when they gifted the rest of farm to their son several years ago. These buildings are accessed via a side gate to Mrs Currie’s garden and are used for the storage of agricultural machinery and chemicals by the farm. The local planning officer has given strong indications that he would look favourably on an application to demolish and replace them with up to three dwellings.
APR will be claimed over the agricultural value of the sheds due to the nexus of common occupation between them and the farm (following Hanson), but could Mrs Currie’s remaining RNRB, including her husband’s transferable RNRB, rightly be claimed in respect of their obvious hope value? As they are currently part of Mrs Currie’s ‘garden or grounds’, it would seem so, though this is hardly in line with the declared intentions of the relief.
The final key definition is ‘closely inherited. The QRI must be inherited by a spouse, child or other lineal descendant, with step, adopted, foster and also children in law all being treated as ‘children of the deceased’.
Inherited here also means inherited either outright or subject only to an Immediate Post Death Interest (“IPDI”), Disabled Person’s Interest, Bereaved Minor’s Trust or 1825 trust. All of the latter three types of trust are mentioned for completeness but like much else, are beyond the scope of this discussion.
Inherited here can also mean passing to a beneficiary directly from a qualifying life interest, where property is deemed to be part of the deceased’s. It should be noted however that where that trust creates a following life interest this will not be an IPDI and thus the property should for preference be inherited absolutely on the termination of the life interest in order to qualify as being ‘closely inherited’.
Having established that they own a QRI and that it is to be closely inherited, farmers may be optimistic about their prospects for receiving the benefit of the RNRB: unfortunately, they are likely to be disappointed. The principal problem confronting an agricultural client in claiming the RNRB is the existence of a taper threshold, meaning that estates over a certain value gradually lose their entitlement to the RNRB until it is removed entirely.
The taper threshold reduces the RNRB by 50p for every £1 by which an estate exceeds £2million. Critically for the agricultural client, this value is the value before the application of exemptions and reliefs including APR and BPR, which has some rather harsh consequences.
Example 2 (Part 1)
Mr Black, a divorcee, rents out Blackacre, his family farm of 280 acres, on a short term FBT having become too infirm to farm it himself. He lives in a modest farm bungalow and has built up a stocks and shares ISA over the years that represents his ‘nest egg’ for retirement.
The value of his estate is as follows:
280 acres farmland £2,200,000
Farm Bungalow £150,000
Mr Black is intestate, and his entire estate will pass to his only child, a son who currently works as a contractor, but intends to return and farm the family holding. Mr Black dies on the 8th April 2017.
Mr Black’s chargeable estate is £425,000 due to a successful claim to APR over the farmland. In these circumstances however, the value of Mr Black’s estate for the purposes of the RNRB will be £2,625,000 meaning that he exceeds the taper threshold by £625,000 and that all of the RNRB will be entirely lost. His estate will pay £40,000 IHT.
Farmers and their advisors then, can no longer ignore the underlying value of farmland when IHT planning. There may, however, be a loophole for farmers. Absolute lifetime gifts, even if they fall within 7 years of death, are not part of a person’s ‘estate’ as defined in the Inheritance Tax Act 198412 . Rather are taxed as separate chargeable transfers that may reduce or eliminate the nil rate band available on death or be taxed in their own right as though they were made in lifetime (but taxed at death rates). As such, if Mr Black were willing and able to make a deathbed gift of his farmland (subject, presumably to a holdover claim for Capital Gains Tax purposes) he could bring his estate beneath the taper threshold, and save his heirs a significant amount of IHT.
In cases where the farmer’s taxable estate after reliefs exceeds the available NRB this raises the question of whether lifetime gifts of the farming estate should now be more seriously considered, especially if this brings the farmer beneath the tapering threshold and makes the RNRB available. In this way a married couple might potentially save their heirs up to £140,000 by qualifying for their RNRBs after 2020.
Example 2 (Part 2)
Taking up the facts of the previous example, Mr Black signs a deed of gift from his hospital bed that transfers the farmland to his son. He dies the next day and his executors claim both the NRB and RNRB taking the estate out of tax altogether.
This leads us to downsizing.
The downsizing provisions, as already mentioned, are an obfuscatory horror, but might nevertheless present some planning opportunities for farmers. If the claim to APR over the main farmhouse is secure but there are other properties that do not qualify for relief, then a claim to the RNRB might be established over these as a way of passing additional assets free of tax to the next generation.
If the deceased vacates the main farmhouse whilst ensuring its continued occupation for the purposes of agriculture, for example by having the farming successor move in, she can then move into a cottage or smaller property that does not qualify for APR, but instead is covered by the RNRB.
Example 1 (Part 2)
The houses at the bottom of Mrs Currie’s garden are now built. She moves into one, finding it better suited to her needs than her slightly draughty cottage, which is used to provide accommodation for the new farm manager. Her executors can now claim APR over the cottage and the RNRB over her new dwelling.
Finally, having considered the availability of the RNRB, we must consider whether it should be relied upon by agricultural clients, even if it can be.
From a strategic perspective the conditions attached to the RNRB are quite limiting, most particularly in the requirement that assets be closely inherited. The logic here seems to be that these measures are intended for ‘normal’ taxpayers meaning, in Westminster and HMRC, taxpayers whose assets are left simply and directly to their children, unencumbered by such esoterica as trusts!
The reasons why a farming family might wish to settle a dwelling into a discretionary trust are many and various: safeguarding the family wealth against the current dire economic conditions in farming; Issues over succession; A troublesome spouse or inheritance tax issues of the beneficiary’s own. Also, in small family farms of the sort given in our example above, the following generation may be unwilling or indeed unable to continue farming, raising questions of equalisation between farming and non-farming siblings that might be addressed with a discretionary trust structure. Unfortunately however, if the RNRB is to be claimed we are constrained to the rather limiting Immediate Post Death Interest or to an attempt to crystal ball gaze on an absolute division of assets.
Example 1 (Part 3)
After a disastrous series of potato harvests, Mrs Curie’s son is at the point of declaring bankruptcy, and his wife has moved in with the now redundant farm manager and is asking for a divorce. Rather than see her son lose the assets in one direction or another Mrs Currie changes her will to settle her whole estate into a discretionary trust with instructions to the trustees to keep the assets in trust for the foreseeable future and thus provide some protecting from her son’s spouse and creditors. This prevents them from being ‘closely inherited’ and therefore prevents the RNRB from being claimed.
We must therefore ask not only if the RNRB can be claimed, but in each case whether it should be.