Vulnerable Beneficiaries After Finance Bill 2013

 In Tax, Trusts

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vulnerable beneficiariesWhere are the changes?

The proposed new provisions can be found is in Schedule 42 of the draft Finance (No.2) Bill.

What are the purposes of the changes?

  • To align income and capital requirements imposed by the income tax, capital gains tax and IHT codes for vulnerable beneficiaries to ensure that the trust does not fall into the relevant property regime for IHT; and that the trustees can elect for their income tax and capital gains tax treatment to be calculated in broad terms by reference to the circumstances of the beneficiary.
  • To include in the definition of ‘disabled person’ those who are receiving the new Personal Independence Payment (which is to replace Disability Living Allowance).

Which trusts are affected by the changes?

  • Trusts for bereaved minors – s.71A IHTA 1984
  • Age 18-25 trusts – s.71D IHTA 1984
  • Trusts for disabled persons – s.89 IHTA 1984
  • Self-settled trusts by those with conditions expected to lead to disability – s.89A IHTA 1984
  • Protective trusts under s.33 Trustee Act 1925 arising in respect of income under a 18-15 trust, a s.89A trust or a s.89B trust.
  • Actual interest in possession trusts created by anyone during the lifetime of the settlor on or after 22 March 2006 for the benefit of a disabled person – s.89B(1)(c) IHTA 1984
  • Self-settlement on an interest in possession trust by a settlor who expects to become disabled – s.89B(1)(d) IHTA 1984.

A summary of the changes

  • For all the trusts, except the s.89B trusts, the rules will be aligned so that if any income arising from the settled property is applied for the benefit of a beneficiary, it must be applied for the benefit of the vulnerable beneficiary (for example, the bereaved minor in a S.71A IHTA 1984 trust; the disabled person in the various disabled person’s interest trusts)
    • EXCEPT that in any tax year the trustees may apply the “annual limit” which is the lesser of £3000 and 3% of the settled property (whether income or capital) for the benefit of another person

    One wonders who, apart from the vulnerable beneficiary, could benefit from the trust. Is this saying that if the trustees wish to pay the guardian some kind of expenses or even a retainer for caring for the child this would be so limited? Is it directed to a school that might be paid school fees?

  • If the trustees of a bereaved minors trust or an 18-25 trust make a disposition which exceeds the annual limit and does not benefit the vulnerable beneficiary (and cannot benefit from any of the current exemptions) an IHT charge only arises on the amount exceeding the annual limit.
  • S.89 trusts must provide that not only the income but the capital will be wholly applied for the benefit of the vulnerable person i.e. the disabled person, subject again to the exception for the lesser of £3000 or 3% of the settled property being applied for the benefit of another person during each tax year (whereas currently only half the capital must be given to the disabled person). In future only £3,000 or 3% of the settled property can be disbursed out of income or capital for someone other than the disabled person. This has implications for families where, say, the parents wish to provide for all three of their children, one of whom is disabled, and hope that the non-disabled siblings can benefit from any income and up to 50% of capital as well during the disabled person’s lifetime. The changes will mean that only modest sums can be diverted away from the disabled person during their lifetime.
  • The definition of “disabled person” will be extended for all the four forms of disabled person’s trusts to include:
    • People in receipt of personal independence payment (“PIP”)
    • People in receipt of constant attendance allowance or armed forces independent payment
  • The changes generally take effect for property transferred into settlement on or after 8 April 2013. There will be grandfathering provisions for existing trusts. For the income tax and capital gains tax regimes in FA 2005 and the application of the annual exempt amount under Schedule 1 TCGA 1992, the changes take effect from the tax year starting 6 April 2013 but only in respect of trusts created on or after 8 April 2013. As far as pre-8 April 2013 trusts are concerned, the current rules apply without alteration unless amendments are made to the trust on or after 8 April 2013.
  • Trusts arising under Wills executed before 8 April 2013 will also be grandfathered providing that the Will is not altered on or after 8 April 2013.
  • For Capital Gains Tax purposes, in order to obtain the full Annual Exempt Amount and to use the Finance Act 2005 computation system for vulnerable beneficiaries, bereaved minor’s trusts and disabled person’s trusts need to provide for all the capital and income to be applied for the benefit of the vulnerable beneficiary with the same £3000/3% exemption as for inheritance tax. The same changes track through in S169D TCGA 1992 (the provisions which exempt disabled persons interest trusts from the settlor interested charges ins.169B and s.169C TCGA 1992). Similarly the Finance Act 2005 provisions will have the same changes introduced (s. 34 FA 2005)
  • Age 18-25 trusts – No changes will be made to the CGT treatment of these trusts. They do not currently fall within the FA 2005 rules for dealing with vulnerable beneficiaries or the annual exempt amount rules.

Practice Points

  • These changes are not yet in force. There may still be changes during the passage of the Bill.
  • The Treasury has power to alter the £3000/3% limits for payments to persons who are not vulnerable beneficiaries by statutory instrument and/or to make different rules for different cases.
  • The provisions do not deal with the complexities of applying the income tax rules to the trusts (such as tax pooling) or the lack of CGT uplift on the death of a disabled beneficiary for deemed interest in possession trusts.
  • The new PIP system is not yet in place, but it is expected that there will be many fewer people receiving PIP than DLA.
  • Awards of PIPs are to be reviewed much more regularly than DLA. This means that a person may be in receipt of PIP one year and not the next. For IHT this will be of less concern as the time at which IHT is an issue is the time at which the property was transferred into the trust unless further funds are settled. However, for income tax and capital gains tax purposes the position is more complex:
    • Income tax – the income for the tax year in which the trust ceased to be a vulnerable beneficiary trust would be apportioned subject to any exemption application;
    • Capital Gains Tax – the FA 2005 regime does not apply to any disposals of trust assets after the trust ceases to qualify and the full Annual Exempt Amount will cease to apply from the tax year in which the tax status changed.

    This is no different to the position now but it may be more of a problem if people are more likely to cease to qualify for PIP.

  • Previously the trust for a disabled person could be set up with a wide class of beneficiaries, for example, to include the siblings or spouse, widow or children of the disabled person and obtain the IHT advantages of not being relevant property but this will not be the case for trusts created on or after 8 April 2013. In order to take advantage of the wider class of beneficiaries the trust needs to be created before 8 April 2013 and not altered thereafter.
  • The changes will enable small amounts to be spent by trustees on such things as respite care without concern that the amounts benefit someone other than the vulnerable beneficiary, i.e. in that case the carer. However, the £3000/3% amounts cannot be rolled forward from year to year if they are unused.
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