Picking Out Key Facts from CII AF1 Case Studies

In this article we review Question 2 of Section B of the CII’s AF1 September 2021 paper, picking out some of the key facts from the case studies that students needed to identify in order to arrive at the correct answers to the questions asked.

THIS ARTICLE IS RELEVANT TO EXAMINABLE TAX YEAR 2021/22.

(a) Calculate, showing all your workings, the Inheritance Tax liability on Alberto’s estate.

Alberto’s estate is valued at £740,000 as follows:

As the property was owned jointly, half its value is included in Alberto’s estate. Note that, unlike EISs, SEISs, and AIM investments, Venture Capital Trusts do not benefit from business relief after 2 years and are therefore included in the estate. The term assurance policy is included because it is not written in trust.

From the gross estate, we need to deduct the charitable gift to arrive at the estate potentially subject to inheritance tax:

From the total estate potentially subject to inheritance tax, we need to deduct the available nil rate band. There is no spousal exemption to apply as Alberto was not married to Marina. He had never been married before, so there is not a transferable nil rate band to set against his estate. As there’s no mention of any previous lifetime gifts, we assume a full nil rate band of £325,000 is available:

To determine whether the 36% rate will apply, we need to find out if at least 10% of the net estate has been left to charity. Net estate in this instance is defined as the estate remaining after deducting exemptions (but excluding the charitable gift), reliefs and the nil rate band.

The net estate is therefore £370,000 plus the charitable gift of £45,000 = £415,000. 10% of this is £41,500. The £45,000 bequest exceeds this and so IHT is charged at 36%.

£370,000 @ 36% gives an IHT bill of £133,200.

(b) Explain how, and on what grounds, Enrique and Sonia could claim for reasonable financial provision under Alberto’s Will.

The legislation regarding this is quite a specific piece of knowledge, so it’s not too surprising that the examiner saw short and vague answers to this question. In terms of technique, it’s also important to note that there are two parts to this question: how the children could claim and on what grounds.

In terms of the ‘how’, the children could challenge the Will under the Inheritance (Provisions for Family and Dependents) Act 1975 by making an application to the court within 6 months of the Grant of Probate being issued.

In terms of the ‘grounds’: they are his children, they lived in the same household as him and were dependant on him and the Will did not make reasonable financial provision for them.

(c) (i) Explain how the Accumulation and Maintenance Trust created by Alberto’s mother in 2004 is treated for IHT.

When answering a question relating to the IHT treatment of a trust for IHT purposes, you need to think about its treatment at outset and then throughout the trust’s lifetime. This is normally quite straightforward, with the initial gift being a PET or a CLT and then, if it’s a CLT, we can add in periodic and exit charges.

However, A&M Trusts are a little different because their tax treatment changed as a result of the 2006 Finance Act. So, while the gift would have been a PET at outset, as no changes were made, the trust became relevant property from 6 April 2008 and subsequently periodic and exit charges could apply. Any periodic charge would apply with reference to the original settlement date of 2004.

(c) (ii) Describe briefly how the trust could have been amended prior to 6 April 2008 and the effect this would have had on the IHT position.

Again, note there are two parts to this question – firstly, how the trust could be amended and secondly the effect this would have on the IHT position.

There are two ways in which the trust could have been amended prior to 6 April 2008.

Firstly, so that the beneficiaries became absolutely entitled to the trust property at 18. The effect this would have had on the IHT position would have been no periodic or exit charges.

Alternatively, it could have been amended so that the beneficiary became absolutely entitled at 25. There would then be an exit charge when the beneficiary becomes entitled to capital. This would be based on the number of quarters between their 18^th birthday and age 25. However, there would be no periodic charge.

A&M Trusts aren’t tested very often, but when they are there isn’t that much that can be asked about them, so they are well worth revising.

(d) Calculate, showing all your workings, the exit charge payable on the distribution of £50,000 from the discretionary trust set up by Marina.

Where a discretionary trust distributes capital in the first 10 years, the effective rate is based on 30% of the lifetime rate (20%) that would have been charged on a hypothetical transfer by the settlor using their cumulative total of gifts in the 7 years prior to the trust.

In this instance, the CLT was valued at £425,000 (no exemptions as we’re told Marina has made use of her annual gift exemptions every year). From this we can deduct Marina’s nil rate band of £325,000, leaving £100,000. £100,000 x 30% x 20% = £6,000. This gives an effective rate of £6,000 / £425,000 = 1.41%.

Only x/40 of the full tax is charged, with x being the number of quarters since outset that the capital distribution takes place. In this instance, that’s 5 years and 6 months, which is the equivalent of 22 quarters (there are 20 quarters in 5 years and 2 in 6 months).

The exit charge is therefore £50,000 x 22/40 x 1.41% = £387.75.

(e) Describe the impact of pre-owned asset tax in the event Marina moves into the property purchased by Sonia.

POAT often crops up in AF1 and is a topic many students struggle with. It’s not an especially tricky concept, but because it is often positioned alongside gifts with reservation it can be hard to unravel the two.

POAT is an income tax charge that sometimes applies when a person receives a benefit from an asset they have given away. In this instance, Marina will be living in a property rent-free that has been purchased with money she gifted to her daughter. Unless Marina pays full market rent or elects for the cash gift to be treated as a gift with reservation, the market value of the rent will be added to her income for each year she lives with Sonia and she will pay income tax on it.  This assumes the value will be above the £5,000 de minimis limit. If it is not, there will be no income tax to pay.

In conclusion, like all Level 6 exams, with AF1 the marks are in the detail. Future students should remember to relate their answers to the case study and give enough detail for the marks on offer.

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