The recent decline in the value of investments and property provides an additional burden on executors, not only to carefully manage their investments and property, but also to ensure that the estate they are administering pays the correct amount of inheritance tax (IHT).
This article is intended to be a reminder of the main IHT issues that an executor should consider when faced with declining asset values during the administration of an estate.
Under section 4 (1) of Inheritance Tax Act 1984 (IHTA 1984), IHT is payable as if immediately before his death the deceased had made a transfer of value equal to the value of his estate immediately before death.
Under section 5 (1) IHTA 1984, a person’s estate is defined broadly as the aggregate of all property to which he is beneficially entitled immediately before his death. The value of the property and assets in the estate is (subject to certain specific valuation requirements for certain assets) the price at which the property might reasonably be expected to fetch if sold on the open market at the time of death, provided that the value is not assumed to be reduced on the ground that the whole property is to be placed on the market at the same time (section 160 IHTA 1984). This open market value price is referred to in this article as the probate value.
The executor must therefore value the estate as at the date of death and pay any IHT on the total probate value within six months of the end of the month of death.
Often during the administration of an estate, an executor will sell or may consider selling assets comprised in the estate. Alternatively, assets which are not sold may simply decline in value before being transferred to beneficiaries. While tax is only one factor that he should take into account when considering a sale, in the current economic climate the question that will often arise is, if an asset has been sold for less than the probate value or simply declines in value, what relief (if any) can be claimed given that IHT will have been paid on the higher probate value?
General argument for lower probate value
If an asset is sold for less than its probate value, might the executor be able to successfully argue that the value submitted for IHT purposes was too high and should be replaced by the value the asset was sold for? In the case of property and quoted investments there are statutory reliefs outlined below, which, in the case of actual sales and subject to satisfying the relevant conditions, allow a substituted IHT value to be claimed.
However, in the case of assets that are not sold, but decline in value or where assets are sold at a loss, but are not within the scope of the specific reliefs mentioned below, then the executor is left to rely on making an argument to HMRC that the probate value of the assets is, in reality, less than was originally submitted.
The executor could do this and make a claim for a reduction in the value of the taxable estate when submitting their IHT corrective account. However, their chances of making a successful claim may be limited. They will often have (and in many cases should have) obtained a professional valuation of the assets to ascertain the probate value of the asset. The executor will have to argue that the probate valuation returned did not, in fact, reflect the open market value of the assets at the date of death. This may be a difficult and potentially costly argument to run.
The open market value test necessarily requires consideration of what the asset might reasonably be expected to fetch if sold on the open market between a hypothetical purchaser and vendor (assuming the hypothetical parties are reasonable and prudent). The hypothetical purchaser is assumed to make proper enquiries and he represents the state of demand at the relevant time (death). Valuations of assets will fluctuate through time and HMRC may be reluctant to accept an argument that because the value of an asset subsequently falls (such as with recent declines in the value of property), this necessarily means that the probate value returned was not appropriate unless there is significant evidence demonstrating that the probate value was too high.
In the case of two particular asset classes the IHTA 1984 provides a statutory framework that provides a form of IHT relief for certain assets sold for less than their probate value.
Sales of quoted investments
Under section 178-179 IHTA 1984, on a claim being made by an appropriate person (usually the executor, or the trustees of a settlement to which the deceased is treated as being beneficially entitled, being the persons responsible for paying the IHT), relief is given where the aggregate value of ‘qualifying investments’ sold within one year of the date of death is less than their aggregate value on death. No relief is given for shares that have fallen in value, but have not been sold during the 12-month period.
Qualifying investments are broadly quoted shares and securities, holdings in authorised unit trusts and shares in a common investment fund and for deaths after 16 October 2002 shares in an open ended investment company (OEIC). No relief is available on sales of unquoted shares or securities.
The relief provides the executor with an opportunity to, in effect, reduce the estate’s IHT liability where qualifying investments have been sold at an overall loss.
For capital gains tax (CGT) purposes, a claim for relief also has the effect of substituting the value of the investments sold for the original probate value for CGT-base cost purposes. This will prevent a loss arising for CGT purposes.
Care must be taken if the executor purchases qualifying investments within the period commencing on the date of death and ending two months after the date of sale of the last of the qualifying investments in respect of which a claim is made. The relief will be restricted or reduced by the proportion that the aggregate of the purchase price of the qualifying investments bought during that period bears to the aggregate of the sale price of the investments (see section 180 IHTA 1984).
Sales of land
Under sections 190-198 IHTA 1984, where an interest in land comprised in an estate is sold within four years immediately following the date of death and a claim is made by the appropriate person, the probate value of the land for the purposes of IHTA 1984 is deemed to be its gross sale value.
The gross sale value for the purpose of a claim does not take into account the expenses of sale. The sale value cannot be substituted for the probate value if the values differ by less than GBP1,000 or 5 per cent of the probate value, whichever is lower. The relief is also not available where there is a sale to a beneficiary or to a spouse, child or dependant of the beneficiary.
It should be noted that, unusually for tax purposes, in the case of this relief, ‘sold’ means that actual completion must have taken place and an exchange of contracts is not sufficient.
It should also be noted that all land sold within the four year period must be included in any claim made under these provisions. This is subject to the exception under section 197A IHTA 1984 that for sales that take place in the fourth year following the year of death, the sale is only taken into account where the gross proceeds of sale did not exceed the probate value. It will be the aggregate loss (or gain) taking into account all sales that will then be applied in recalculating the IHT liability. Careful consideration should be taken to whether, taking into account all sales, a claim will produce a lower tax liability.
A claim for the relief cannot be made where no IHT is payable. An executor may question whether they can make a claim in such a case, with a view to increasing the base cost of the land for CGT purposes. It is not, however, possible to make a claim unless there is an appropriate person to do so and an appropriate person is defined under section 191 of IHTA 1984 as ‘the person liable for IHT’ (if there is no IHT payable, there is no appropriate person to make the claim).
Nonetheless, there may be cases where making a claim would lead to increased IHT, but also a higher base cost for CGT purposes, which may be advantageous to the overall tax position of the estate if a reduced charge to CGT on sale was achieved.
Conclusion
An executor must always be careful to properly manage the property and investments of the estate that they are responsible for, and in particular in a declining market, ensure that appropriate professional advice is taken concerning the sale of investments. They must also be mindful of ensuring the estate pays only the correct amount of IHT and where investments have been sold at a loss, consider whether it is possible to recover any of the IHT paid on higher probate values.