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Family offices urged to review inheritance tax affairs during coronavirus crisis

By James Beech

The UK tax authority’s suspension of its Inheritance Tax investigations during the coronavirus crisis gives family offices the opportunity to get their affairs in order, family lawyers say.

According to Pinsent Masons, Her Majesty’s Revenue and Customs (HMRC) launched 5,347 UK Inheritance Tax (IHT) investigations last year, generating £259 million ($328 million) in extra tax. Some 27,283 IHT investigations have been launched in the last five years, with a total yield of £1.3 billion ($1.6 billion).

The global law firm warned the suspension of tax investigations was only temporary and HMRC was likely to be more aggressive once its compliance work resumes. HMRC will be looking for ways to increase its compliance revenues to cover rising coronavirus-driven public spending, the firm said.

HMRC increased the number of tax investigations it opened in the aftermath of the 2008 financial crisis as it tried to close the gap in the public finances. Investigations that are more likely to result in HMRC collecting a large amount of extra tax will be top of its list, such as investigations into Inheritance Tax and high net worths, Pinsent Masons said.

CampdenFBasked Steven Porter (pictured), partner, and Josie Hills (pictured), senior tax manager at Pinsent Masons, what family offices need to consider.

Josie Hills, senior tax manager at Pinsent MasonsHow has the looming HMRC inheritance tax investigation changed succession planning among UHNW family offices, if at all?

The fundamentals of succession planning for those whose personal wealth may have a UK inheritance tax exposure on their death have remained broadly similar for many years ranging from simple gifts to far more complex planning to pass wealth down the generations.

With the threat of losing almost half of your entire personal wealth to HMRC on death, succession planning remains a balancing act between keeping enough to fund the rest of their lives comfortably versus providing enough of the family’s wealth to benefit the next generation.

However, HMRC’s increased interest in Family Investment Companies may deter some family offices from using them if there is any suggestion of a perverse result coming from the investigations such as the introduction of a brand new tax in some form (e.g. the ATED imposed on residential property).

What are the common mistakes that ultra-high net worth (UHNW) family offices make which trigger HMRC’s attention?

The main mistake made by those exposed to UK inheritance tax is not seeking proper advice early enough in their lifetime. Succession planning should be looked at for those with material wealth in their early 40s, at the latest. For those who become exposed to UK Inheritance Tax for the first time (e.g. someone moving to the UK for the first time), the main mistake is not seeking advice before they arrive or, at the latest, before they become ‘deemed’ UK domiciled after 15 years.

This lack of proper advice means that gifts are often made without the correct structure or timing and inappropriate vehicles are used, for example where a US citizen uses a trust as basic US planning but has not considered the UK position carefully.

The exposure to UK Inheritance Tax broadly revolves around two factors: 1) the domicile of the donor and beneficiary and 2) the situs of the assets being gifted. The most complex scenarios involve a non-UK domiciled donor and a mix of UK and non-UK situated assets. This is likely to be a factor when HMRC select cases for enquiry.

What should UHNW family offices do in the first instance to check their compliance?

Family offices can seek a tax risk review for their family members, which will assist them in identifying any irregularities that may have already taken place as well as provide a prompt to prevent any arising at the time of a ‘chargeable event’. In lieu of this, a full UK Inheritance Tax and succession planning review should be undertaken at the earliest time with suitable Wills being in place for all family members and regular reviews of those Wills.

Has Pinsent Masons helped solve an UHNW family office’s issue with inheritance tax and HMRC in particular?

A non-UK resident trust settled by a non-UK domiciled individual with no other UK connection owned an investment portfolio, which at various points held UK situated investments. In such circumstances, if the trust holds UK investments on any 10 year anniversary of the trust being created, it is exposed to UK inheritance tax on the value of those UK investments. Unfortunately neither the investment manager nor the trustees were aware of this potential exposure (given their lack of any other connection to the UK) so nothing had been reported or paid to HMRC. Pinsent Masons identified the best route for a full and transparent disclosure to HMRC resulting in a fair and manageable IHT liability to settle the historic position and, most importantly, extinguished the penalties that HMRC could otherwise have imposed.

Given the billions spent by the UK government to keep the economy afloat during the pandemic, is it likely HMRC will return to investigating family offices to yield lucrative tax returns later this year?

HMRC will always risk assess where they should target their investigations. If there is a perceived abuse in a particular area, they will target those who may use it. UHNW individuals and trusts will always be a target for investigations because tax planning is often undertaken, with some being more aggressive than others. Therefore, there is unlikely to be a change in HMRC’s approach in focussing on those with the highest incomes, capital gains or estates once their attention has been drawn back from the measures they’ve all had to implement ‘all hands on deck’ to manage the country through this crisis.

The mistake will be if HMRC think blanket, untargeted enquiries will yield more tax revenue. This approach could indeed encourage high net worth individuals to leave the country as they may feel persecuted.

Is the inheritance tax investigation likely to mobilise UK family offices out of the country and/or deter family offices from setting up in the UK?

A family office doesn’t always base itself where the centre of vital interests is for the main part of the family, so given the favourable corporate environment with access to financial services and other key services provided to wealthy families, an inheritance tax investigation is unlikely to change where the actual family office is set up. However, if the inheritance tax environment becomes unfriendly, then given how internationally mobile many UHNW family members are and will only become increasingly so, there is a genuine risk that attempting to squeeze ‘until the pips squeak’ could result in an exodus, especially with so many other jurisdictions looking to encourage UHNW family members into their countries. Therefore, watch for two things: overzealous HMRC inspectors and overreaching UK tax legislation.