By making gifts during your lifetime, you can help your children avoid inheritance tax. If you do not have sufficient liquid assets to give your children cash, you can structure your gift(s) in the form of an acknowledgement of debt. For this tax strategy to work effectively, you must ensure you pay the interest diligently every year.
Acknowledgement of guilt
An admission of liability is also referred to as a “deed of gift“. You declare to your children that you owe them a debt. To provide proof of this, you set out this declaration in writing. As you stipulate that you will only settle this debt after your death, the declaration must be drawn up by a notary. An acknowledgement of debt that is not contained in a notarial deed will be disregarded by the tax authorities when calculating inheritance tax on your estate.
Interest
You also stipulate that you must pay your children interest on the amount stated in the acknowledgement of debt. This interest is usually payable once a year, and very often towards the end of the year. You don’t need to think too long about the interest rate. It amounts to, on an annual basis: 6%.
If you compare the interest your bank pays on your savings account with the current mortgage interest rates, you will see that this is a very high rate. However, if you apply a lower rate, the Inheritance Tax authorities will assume that, until your death, you continued to derive (at least partial) benefit from the debt owed to your children. The tax authorities will then include that benefit in the amount on which your children are liable to pay inheritance tax on your estate.
Actually paying interest
Given the purpose of your acknowledgement of debt (to save on inheritance tax by transferring assets during your lifetime), a substantial rate of interest is often not a problem. This is because you actually have to pay the interest to your children each year. A higher interest rate means a greater transfer of assets.
If you do not actually pay the interest on your acknowledgement of debt to your children each year, the tax authorities will determine, following your death, that you have in fact retained the benefit of your acknowledgement of debt. Your children will then have to pay inheritance tax on it.
The burden of proof that you actually paid the interest rests with your children following your death. You should therefore always pay the interest via the bank. And, in view of the burden of proof, keep your bank statements.
180 days
If you have failed to pay the interest on your acknowledgement of debt in the past, you can rectify this. You must then pay all outstanding interest amounts and calculate and pay interest on those amounts. Should you die within 180 days of making this rectification payment, your attempt to rectify the situation will be disregarded when calculating the inheritance tax on your estate.
Box 3
Your debt to your children forms part of the tax base for your income from savings and investments (Box 3). If you have a positive tax base in Box 3, acknowledging the debt will result in you paying less income tax in Box 3.
For your children, their claim against you also forms part of their income in Box 3. As a result, your children may have to pay income tax. However, they can do so using the interest they receive from you. The maximum tax in Box 3 is: 1,61% of the tax base (for tax assessed in 2017), so that the 6% interest you pay is more than sufficient.
Transfer of assets
Of course, there are other ways to transfer your assets to your children in a tax-efficient manner. Please contact the consultants at VWGNijhof for advice tailored to your financial situation.