My Article- Shariah Tax Planning In The UK by Riyazi Farook
Shariah Tax Planning in the UK
26th January 2007 (Vol. 4, Issue 4)
In the UK, a 40% inheritance tax (IHT) is imposed on certain assets in excess of £285,000
(US$564,860) of a deceased person’s estate for the tax year 2006/2007. This individual
allowance, which is revised annually, is known as the nil rate band (NRB). There are ways
to substantially reduce or even eliminate any IHT liability, if arranged prior to death.
Whilst there are many exemptions and reliefs available, the following provides a summary
of the most relevant principles.
Gifts of any value made by the deceased to the surviving spouse, before or on death, are
exempt from IHT. However, these gifts may be liable to IHT on the death of the surviving
spouse. English law does not recognize the Islamic Nikkah (solemnization) ceremony if
undertaken in the UK, with the exception that the ceremony is used to obtain a civil
marriage certificate. If the surviving spouse is not UK domiciled, the inter-spouse
exemption is limited to £55,000 (US$109,023). A popular use of this exemption is to
ensure that on death all assets in excess of the NRB are passed to the surviving spouse.
Gifts of any value made to a registered UK charity are exempt from inheritance tax (IHT).
Gifts of any value are deemed to be exempt from IHT if made seven or more years prior to
death. Otherwise, IHT is payable in full on gifts made less than three years prior to death,
and on a sliding scale if made between three and seven years prior to death. Gifts in which
the donor retains some beneficial interest, such as a house in which the donor continues to
reside rent-free, are considered to be “gifts with reservation” and are liable to full IHT.
Business property relief
The transfer of shares owned for two or more years by the deceased in an ongoing
business concern is exempt from IHT. This is crucial for business owners, as the vast
majority of trading companies and partnerships qualify for this relief. Investment
companies or properties – both commercial and residential – generating rental income
normally do not qualify for business property relief.
A single gift of £3,000 (US$5,947) per annum can be made which is exempt from IHT. Any
unused annual exemption can be carried forward one tax year, enabling a maximum of
£6,000 (US$11,894) to be gifted.
Deeds of variation
The beneficiaries of an estate are able to retrospectively revise a will after death, usually
for religious, family or tax reasons. In order for a deed of variation to be accepted by the
Inland Revenue, all beneficiaries must be over 18 and sane, and give their written consent
within two years of death. Deeds of variations are typically very costly and time-
Advanced inheritance tax planning
Where a client’s assets are considerable, the above rules will need to be augmented to
ensure tax is mitigated. Listed below are some of the more popular advanced techniques
which typically apply to those whose assets are valued in excess of £1 million (US$1.966
million). Quite often these methods involve some form of capital gains tax (CGT) planning.
The following are merely simplified solutions – more complex solutions need to be
discussed with professional tax planners.
DT and IIP
Assets can be transferred into a discretionary trust (DT) on death. A DT also allows assets
up to the NRB (£285,000 (US$564,860)) to be exempt from paying inheritance tax.
Anything over this amount owned by the deceased is placed into another type of trust
called an interest in possession (IIP) trust, which also allows for tax mitigation. Technically
the assets in the IIP trust are held for the benefit of the spouse, although the trustees will
only give the spouse what is due to her under Shariah rules. Consequently, once the
trustees distribute the assets from the IIP, a potentially exempt transfer lasting for seven
years is created on the spouse. The DT can also be used to reduce the assets of someone
who pro-actively wishes to reduce the value of their estate during their lifetime. Typically,
in this scenario one is discouraged from making gifts, as gifts made to any person apart
from the spouse will automatically trigger a CGT charge. The value of a DT is that the CGT
charge can be deferred by placing assets into the trust.
Declaration of trust
Ownership of an asset to be deemed as shared by a group of individuals, rather than just
the legal owner (or indeed just one individual other than the legal owner) is allowed under
declaration of trust. This is crucial for married couples, as it allows both NRBs to be applied
to the value of the family home if it was initially purchased in a single name. For example if
the husband initially purchased a house now valued at £500,000 (US$991,082), this would
exceed his NRB by some £215,000 (US$426,171). By completing a deed of trust (DoT) on
this property, and allowing half the property to be owned by his wife, the two sets of NRB
can be offset against the value of the property. These would be worth £570,000 (US$1.12
million), which is greater than the value of the property at £500,000 (US$991,082),
thereby eliminating any tax charge.
Principally, offshore planning is the ability to hold assets in an environment where they are
exempt from both inheritance and CGT, and relies on one obtaining a non-domicile status.
This strategy is for the very wealthy whose assets exceed the £5 million (US$9.91 million)
Conversion to tenants in common
Couples who own their family home as joint tenants would have the house automatically
passed to the surviving spouse in the event of one partner’s death, regardless of any
provisions made in the will. This situation does not conform to Shariah law and would likely
lead to a tax charge when the surviving partner eventually dies. A couple owning a
£500,000 (US$991,082) home as joint tenants would have the house passed to the wife
upon the husband’s death, making her the sole owner. A tax charge would arise on her
death. Owning a home jointly as tenants in common allows for the half owned by one
partner to be included as an asset in their will on death, instead of passing to the surviving
spouse. This arrangement not only allows Shariah law to be applied to the half owned by
the deceased, but also avoids a tax charge on the death of the surviving partner, as their
share is now worth £250,000 (US$495,509), which is less than the NRB.
The Importance of Inheritance in Islam
Many can speculate as to why Islam has placed such an emphasis on the laws of
inheritance and making a will. One could argue that it prevents family conflict on death, or
that it represents a means via which needy relatives can benefit from a wealthy family
member. The Muslim law of inheritance has been praised all over the world, including from
western quarters, for its refined and elaborate set of rules on the transference of property.
The Hadith states: “A man may do good deeds for seventy years but if he acts unjustly
when he leaves his last testament, the wickedness of his deed will be sealed upon him,
and he will enter the Fire. If [on the other hand], a man acts wickedly for seventy years
but is just in his last will and testament, the goodness of his deed will be sealed upon him,
and he will enter the Garden.” (Ahmad and Ibn Majah).
With such compelling instructions in the Shariah, one would expect every adult Muslim to
give priority to making a will. Unfortunately this priority has to a large extent been
neglected. Muslims who reside in the UK are hit by a double whammy because of their
apathy. UK tax authorities have imposed a whopping 40% tax on assets over a certain
threshold held upon death. For the tax year 2006/2007, this amounts to £285,000
(US$564,860). In addition, English law dictates the “law of intestacy” on a person who
passes away without a valid will in place. This effectively distributes their assets in a pre-
determined, un-Islamic fashion, to the heirs. Invariably this predetermined distribution will
not be tax-efficient and often will be contrary to both the wishes of the family of the
deceased and contrary to Shariah. (There are also practical considerations concerning the
Islamic rites of burial such as janazah (funeral prayer), ghusl (ritual washing), kafn (burial
shroud), dafn (burial not cremation) along with any wasiyyah (bequests) such as avoiding
post mortem, and also fidya (compensation for missed fasts/prayers, etc) to consider.)
The preparation of a valid will is not just an obligation for Muslims, but is also vital to
mitigate tax, protect one’s assets, to ensure one’s wishes are followed after death and to
ensure potential family disputes are minimized.
Shariah law is very clear on debt settlement and the subsequent distribution of wealth.
Only after fully settling the deceased’s debts and burial costs can his wealth be distributed.
Shariah allows the deceased to bequeath up to a third of his estate to anyone other than a
recipient entitled to a share from the remaining two-thirds.
Heirs to the estate
After the distribution of up to a third of one’s assets, heirs to a Muslim’s estate as defined
in Shariah are the fixed share inheritors (wife or husband) and the residuary inheritors
(usually sons and daughters), whose exact percentage of inheritance is not fixed.
Shariah inheritance law is not recognized by UK law and so Muslims should prepare their
wills, incorporating trusts into which all their assets are placed automatically on death.
Legal and tax concerns
The laws of intestacy apply when a person dies without leaving a will. Essentially, the first
£125,000 (US$247,750) plus chattels are given to the wife, and half of the remainder of
the estate is placed in a trust giving the wife a right to income for life. On the wife’s death,
the assets pass to any children above 18 years of age. Otherwise, the remaining half is
held in a trust until they come of age. Evidently, this approach does not conform to the
Shariah, as the assets would be trapped under the trust for an uncertain amount of time,
often involving the Court of Protection’s consent when administering the child’s assets.
This rule also applies in the event of a dispute between inheritors, possibly leading to a
court battle. Mutual agreement between all heirs to share the assets could avoid such a
distressing situation. However, there is no certainty of this, particularly in cases involving
a considerable amount of assets.
Once death occurs, all authorities (such as banks and investment companies) will freeze
the deceased’s assets until a probate certificate is received by them. Accounts held jointly
escape this freeze and the surviving partner can continue using the account after the other
partner passes away.
The presence of a will enables the named executors to obtain a probate certificate.
Without a will, the spouse and children would need to get letters of administration. With
the certificate of probate, the executors are authorized to manage the assets of the
deceased with a view to transferring them to the ownership of the rightful heirs.
The process of probate can be completed within a few months if the assets of the
deceased are less than £150,000 (US$297,270) and if there are no inheritance tax
concerns. Otherwise, it can take years to conclude. A probate certificate will only be issued
once the inheritance tax liability is paid. There are ways to resolve this situation and
manage the probate process efficiently from an Islamic as well as a legal perspective.