Inheritance Tax – a consultation on a fairer way of calculating trust charges or an unfair way of changing the law?
Most of you will be aware that when Inheritance Tax trust taxation changed in March 2006 a practical problem arose of calculating the periodic and exit charges in relevant property trusts where there was no background information about the settlor e.g. in old accumulation and maintenance trusts.
Apart from the cost of investigating the settlor’s position there was also the valuation issues again involving the cost of obtaining historic valuations. These costs were particularly unpleasant for taxpayers when the outcome may have resulted in any event in little or no charge to IHT as a result of applying the formulae in the IHTA 1984.
So it was that HMRC embarked on trying to offer ways in which the calculations made be made easier and less costly but at the same time preserve the amount of tax taken overall. At the moment the third consultation on this topic has recently closed (29 August 2014) and we await the outcome.
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The first two consultations were broadly seem as achieving the aim of simplification and some of the changes to legislation were brought in by the Finance Act 2014 (alignment of payment and filing dates and the treatment of accumulated income).
The third consultation – Inheritance Tax: A fairer way of calculating trust charges – is much more controversial and in my opinion goes beyond being a true consultation because it has already changed the law with effect from 7 June 2014.
The proposed changes
HMRC believe that the following changes would remove some remaining difficulties:
- If the settlor’s previous lifetime transfers were ignored in determining the available NRB for the purposes of the calculation of the hypothetical transfer on exit charges and periodic charges this will avoid the problems & associated costs of having to obtain historic records & valuations
- If non-relevant property was also ignored for the purpose of calculating the exit and periodic charges the trustees would only be required to know information regarding exits from the trust and other trusts in the last 10 years rather than old information
- If the NRB is split by the number of relevant property settlements created by the settlor this will alleviate the risk that settlors might seek to fragment the ownership of property across a number of trusts to maximise the availability of reliefs or exempt amounts. There would be no need for the related settlement rule.
- A single rate of 6% of the chargeable transfer be used in the calculations rather than the lengthy calculations of effective and settlement rate
HMRC suggest that an individual, as well as having their personal nil rate band will be given a settlement nil rate band (SNRB); however, this SNRB will not be renewable every seven years. Instead, it will have to last not only a lifetime but also on death too as far as relevant property trusts are concerned.
The settlement nil rate band (SNRB)
On 6 June 2014 the revised proposals for consultation were announced in which it was said that any changes would be incorporated in the Finance Act 2015 and apply from 6 April 2015; however, the impact of some proposals operates from 6 June 2014.
In chapter 3 of this latest consultation document HMRC says it would introduce a statutory obligation on settlors requiring them to make an election that sets out how they wish this SNRB to be allocated between the settlements they have created. It would have to be made in writing on a form to be prepared by HMRC by the settlor before any SNRB allocation to a settlement. It will be in the form of a percentage rather than an amount to accommodate future changes in the value of the SNRB.
There will be a system for electing parts of the SNRB to additions to trusts and making amendments or withdrawing the election up to the point of the first 10 year charge on the trust following which the allocation cannot be reduced.
The settlor will be responsible for notifying his trustees of the percentage of the SNRB allocated to a particular trust. If no allocation is made or details notified to the trustees then the trustees have to calculate the relevant property regime charges on the basis that the trust has no SNRB.
PRs of a deceased settlor will have two years from death to make an election to either allocate SNRB to relevant property settlements created by Will or to make sure that the deceased’s SNRB has been fully allocated between relevant property settlements made during their lifetime and on death. Penalties may be applied where the settlor or his PRs over claim SNRB.
The SNRB will be separate from the individual’s personal nil rate band, which means that a client who has already used his personal nil rate band by setting up a discretionary trust with £325,000 in 2013 will be effectively given a new SNRB from 7 June 2014 and could make a new trust which he can elect has 100% of his new SNRB.
The election process is however not straightforward because if the settlor intends to have relevant property trusts in his Will e.g. a nil rate band settlement or a discretionary trust for grandchildren; then some of the SNRB will need to be ‘saved’ to be allocated to that or else it will not benefit from any nil rate band.
It will be possible to reallocate the SNRB but only if a trust created during the settlor’s lifetime is wholly wound up during the settlor’s lifetime. If a trust terminates after the settlor’s death any SNRB allocated to it will not be available for re-allocation; instead, it will be lost.
If the trust ceases to be in the relevant property regime e.g. because the assets become part of a charitable trust or a ‘vulnerable beneficiary’ obtains an interest in possession; then this will be treated the same as if the trust had been wound up so that the SNRB allocated to it can be re-allocated.
Effect on existing trusts
In a departure from the previous proposals the consultation says that settlements established before 7 June 2014 will not be affected by the changes in treatment of the nil rate band. By implication therefore the proposals will apply to any new trust created on or after 7 June 2014 (even though we do not yet know for sure the terms of the legislation!)
This means that any fully constituted trusts (including some pilot trusts) set up before 7 June 2014 will not be taken into account for the purposes of using a proportion of the new SNRB. However, should any additional property be added to such a trust, the addition will be treated for these purposes as a new settlement and will be affected by these new rules.
Existing pilot trusts will therefore continue to benefit from separate nil rate bands and will not be affected by the new rules provided the trusts are fully funded and no further assets are added after 6 June 2014.
Jemma set up a pilot trust in June 2015 to receive the death benefit under her pension policy. Her pension scheme was set up under a discretionary trust so if she set up the pension in 2000 it is already subject to the trusts of the pension scheme.
S.81 IHTA 1984 provides that property transferred from one relevant property trust to another is treated as remaining comprised in the original trust, hence when we calculate the periodic charge dates on pension by-pass trusts like this we always use as the start date the date upon which the member joined their scheme.
As a result, it follows that when Jemma dies and the pension scheme trustees pay from their discretionary trust a sum of money to the pilot trust, even though it was created post 6 June 2014 it will be deemed by s.81 IHTA 1984 as in the 2000 discretionary trust of the pension scheme and so be outside the new rules for SNRB allocation.
However, arrangements which only apply on death under a Will whereby a proportion of an estate is paid to a pilot trust set-up before death will be adversely affected by the changes since the legacy will be an addition to the pilot trust and bring the new regime into play. Equally, pension schemes not set up under a discretionary trust but say a Deed Poll will also not be able to utilise the s.81 IHTA 1984 treatment.
Consider too the impact on existing Will trusts – if the deceased gave his estate to his widow for life and the remainder on discretionary trust to his children and grandchildren the effect of this was to create an IPDI for the widow and on her death it would become a discretionary trust in the relevant property regime. Instead of this being a chargeable transfer by the deceased s.80 IHTA 1984 permits s.18 IHTA 1984 exemption to apply on the deceased’s death but then regards the conversion to a relevant property regime trust on the widow’s death to be a chargeable transfer by her and she is to be regarded as the settlor of the trust.
This means, that the surviving spouse’s PRs will have to consider allocating her SNRB to what was a trust created originally by her late husband but of which she is deemed to be the settlor by virtue of s.80.
The consultation suggests it is not for the testator to allocate any SNRB to the trusts under his Will; this will be something for his PRs. However, presumably a testator would wish to give some indication to his PRs (by letter of wishes) as to how he might wish to allocate his available SNRB, particularly if the s.80 situation arises, between more than one affected trust.
The SNRB will not be applicable to IHT due on death; only against the periodic and exit charges. The individual’s personal NRB will be the relevant NRB for the purposes of calculating the IHT on death.
Impact on advice
By stating that the proposals in the 3rd consultation would apply from 6 June 2014 it means that straight away we should:
- Encourage clients to avoid adding assets to pre-7 June 2014 trusts until we know what the law actually is – i.e. we have a draft Finance Bill 2015 following the Autumn Statement – always assuming it ever gets Royal Assent given there is an election in May 2015.
- This means advising clients of the potentially pointless nature of creating new pilot trusts to receive added property at a later date unless it is in transfer from a pre-existing relevant property settlement.
- Discuss with clients intending to create new relevant property trusts either inter vivos or in their Wills from 7 June 2014 the impact of the SNRB regime might have so that they can indicate how much of the SNRB he or she would wish to allocate to any new trusts.
The risks to practitioners of acting negligently in ignorance of these changes at the present time must be high given the lack of publicity provided to consultation documents compared to the media interest in a Budget. It is in my humble opinion wrong to change a law like this where we do not have the detailed legislation; we cannot advise clients appropriately as to what the law currently is and clients are unable to organise their affairs on death properly and may become incompetent to do so before the law is clarified.
Pilot trusts are clearly the target of HMRC here – they do not like the fact that multiple nil rate bands have been created and used in this way to save tax – but since the creation of such trusts was acknowledged as acceptable practice in the GAAR Guidance and the DOTAS guidance it is wrong to create uncertainty around them through a consultation document. In the profession we all accept the law can change overnight in a case or more likely in a Budget but to bring in the principle of a change months before the law is clear and within a consultation document seems underhand.
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