What is a Tax Efficient Islamic Will?

Inheritance tax can be a significant issue for Muslims, particularly as the usual planning routes such as spousal exemption are not fully available. This article discusses alternative options.

29 April 2019

Read Time:  3 mins   |         

Tasbiah Shoaib


What is a Tax Efficient Islamic Will?

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Inheritance tax can be a significant issue for Muslims, particularly as the usual planning routes such as spousal exemption are not fully available. This article discusses alternative options.

“The main aspect of this type of Will is that the surviving spouse is the ‘life tenant’ of the trust fund and the income is automatically payable to them, resulting in the spousal exemption applying to all assets.”

Inheritance tax (“IHT”) is charged at 40% on all assets that exceed £325,000 (“the nil-rate band”). There is also an additional allowance of £150,000 (“the residence nil-rate band”) as at 2019-20, and there are certain conditions to claim this. Assuming those conditions are met, a total of £475,000 is potentially exempt from IHT.

Further, if an individual’s estate exceeds this threshold, there may still be no inheritance tax payable if the estate is exempt. The estate may be exempt due to spousal exemption, i.e. if the entire estate passes to the surviving spouse (assuming the marriage is registered in the UK or took place abroad and is legally recognised in that country)).

The Issue

Under the Shariah, there is a fixed distribution depending on the family circumstances (see this post for more information). The provisions for distribution are largely detailed within Surah An-Nisa verses 11,12 and 176. We have created an app which calculates the Islamic inheritance based on an individual’s family circumstances. You can find more information on our Islamic Will App page as well as download the app.

TS tax efficient blog imageCalculating the IHT implications of your Will is an important step – often overlooked

 

A typical scenario is as follows:

  • Advising a married couple with a son and two daughters
  • Both sets of parents are alive
  • Husband’s estate is worth £1.2m
  • Wife’s estate is worth £900k.

In accordance with Surah An-Nisa, the distribution of the husband’s estate would be as follows:

  • 1/8th to wife (£150k);
  • 1/6th to father (£200k);
  • 1/6th to mother (£200k); and
  • Balance to children in a 2:1 proportion (£650,000).

 

In accordance with Surah An-Nisa, the distribution of the wife’s estate would be as follows:

  • 1/4 to husband (£225k)
  • 1/6th to father (£150k)
  • 1/6th to mother (£150k); and
  • Balance to children in a 2:1 proportion (£375k).

Should the husband then pass away with a ‘Simple’ Islamic Will, this would result in the beneficiaries being automatically entitled to their respective shares (subject to attaining the age of 18). In the above example, assuming that the husband dies first, the tax position would be as follows:

 

Tax Position                                    

Estate Value                        £1,200,000

LESS Allowances

Nil Rate Band                         £325,000

Residence Nil Rate Band      £150,000

Spousal Exemption                £150,000

 

Chargeable Estate                  £575,000

Tax at 40%                               £230,000

 

In the above scenario therefore, an IHT bill of £230,000 results from having an Islamic Will without considering the tax implications. However, this does not have to be the case.

 

The Solution – A Tax Efficient Islamic Will

A tax efficient Islamic Will means that the assets owned by the deceased at the time of their death transfer into a trust fund written within the Will. For a married couple, as is the case in our example above, the Trust fund would be called a ‘Flexible Life Interest Trust’. The main aspect of this type of Will is that the surviving spouse is the ‘life tenant’ of the Trust fund and the income is automatically payable to them, resulting in the spousal exemption applying to all assets. Therefore, the estate on first death is free from IHT.

Further, the trust fund is managed by Trustees who are appointed in the Will. The Trustees are guided by a side Letter of Wishes which is prepared to stipulate the Islamic shares of the beneficiaries and any additional wishes. The Trustees have discretion as to how and when the beneficiaries receive their Islamic entitlement and have a wide range of powers to facilitate this.

One of the advantages of this structure is that the nil rate band allowance and residence nil rate band allowance can be combined and claimed on second death (subject to certain conditions being met, for which advice should be taken on first death). This would result in a total IHT allowance of £950,000. Additionally, after first death, tax planning could be considered to mitigate any tax liability payable on second death.

If you would like to discuss preparing a tax efficient Islamic Will, please contact us via the following link: https://www.iwillsolicitors.com/contact-us/ or call us on 0121 603 0077.

About The Author

Tasbiah Shoaib
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