New inheritance tax rules for trusts relaxed – but is this the thin edge of the wedge?
IN THE June 9 edition of The Resident, I outlined some of the problems facing trustees, following Gordon Brown’s amendments to inheritance tax rules. Since then, and as a result of intensive lobbying from tax and trust practitioners, certain modifications to his original proposals have been agreed. Let me start with a recap on the amendments outlined in the Budget.
New rules, applying from March 22, 2006, affect the inheritance tax (IHT) treatment of Accumulation and Maintenance (A&M) trusts as well as interest in possession (IIP) trusts. The rules align the IHT treatment of the majority of such trusts, with the treatment of discretionary trusts.
An A&M trust is one where the purpose is to benefit children or grandchildren of the settler. The income of the trust may be accumulated annually, or payments made for the education and maintenance of the beneficiary. The child has a right to become the absolute beneficiary by the age of 25, at the latest.
An IIP trust is one where specified individual(s) have a fixed entitlement (often called a life interest or interest in possession) to the income of the trust. For example, a man may arrange that, on his death, a sum of money be set aside in trust for his children, but his wife will enjoy the interest from the investment throughout her lifetime. The trustees would have power to change the beneficiaries to reflect changing circumstances.
New A&M and IIP trusts set up from March 22, 2006, and additions to existing trusts, will incur an immediate 20 per cent inheritance tax charge on assets transferred in excess of the nil rate band (currently 285,000 pounds sterling). A further periodic six per cent will be charged on the value of the fund every 10 years. An “exit” charge will also be incurred and calculated as a proportion of the rate applicable at the last 10 year periodic charge.
One of the major criticisms of the Bill was that a large percentage of all wills would need to be reviewed, as they often include a “Will Trust” (IIP trust), created on the death of the testator, which provides for a spouse to have a lifetime interest on the estate. It has now been proposed that full inheritance tax exemption will continue to be available, where wills provide for assets to be held in life interest trusts for the spouse or civil partner of the deceased, even where that life interest can be altered by the trustees. However, the downside is, that if trustees do exercise their powers, there will be an IHT charge and the trust will fall into the “relevant property” regime and become subject to periodic and exit charges.
Another major concern of the measures announced in the Budget was the effect they would have on Accumulation and Maintenance Trusts established in a will for young dependents. The original amendments meant that only A&M trusts, created on the death of a parent, where the minor became absolutely entitled to the assets of the trust at 18-years-old would be exempt from the new charges. The lobbyists declared that 18-year- olds are not generally considered to be responsible or mature enough to become absolute beneficiaries of large sums of money or property. However, if the absolute entitlement was set at an age above 18, the full effect of the new charges would apply.
The Government has now proposed that, where beneficiaries get capital outright, on or before attaining age 25, the periodic charge will not apply to the trust, until the beneficiary attains age 18. The charge will then apply during the seven year period between age 18 and 25. Therefore, the maximum IHT periodic charge, assuming the beneficiary does not get capital before age 25 will be 4.2 per cent.
In the Budget Notes, it was already established that trusts created for disabled persons would be exempt from the new rules. However, the government has now proposed that this exemption will also apply to trusts established by disabled people. Nevertheless, the definition of “disabled” is likely to be restrictive.
A “Deed of Variation” is where the beneficiaries and executors of a will agree to amend the content of it. This is allowed within a two year period after the death of the testator. It has now been proposed that, where Will trusts have been varied within the two year statutory period, the “relevant property” regime will not apply to new trusts, where the conditions for the old regime are otherwise met.
Transitional rules will apply, and should allow a period of time in which existing trusts can be amended to minimise the effects of the new regime.
These proposals do not mean an end to the uncertainty. It is likely to be the end of July before all the amendments are finalised and the Bill has made its way through parliament. However, we can be certain that this Government is determined to maintain its stance on the matter.
Some experts warn this Finance Bill is just the beginning of the Government’s attack on trusts, and possibly the forerunner to a much larger development: a wealth tax for individuals.
The good news is that although it’s getting tougher, there are still some ways in which UK tax residents can mitigate inheritance tax liability.
Please remember that IHT is charged on “worldwide” assets.