Post Finance Act 2006 - Trusts in IHT Planning
The Finance Act 2006 introduced fundamental changes to the tax treatment of trusts with consequent implications to the WAY Inheritor Plans. Whilst the construction of the existing plans will remain unaltered, new brochures and supporting literature will shortly be available to reflect the legislative changes, the main detail of which is detailed below:-
New Trusts for IHT Mitigation
Since the availability of limitless PETs into trust has now been removed in favour of working within each investor's Nil Rate Band, taxpayers will be forced to commence their planning earlier to maximise the number of 7 year Nil Rate Band periods they can use. This being the case ongoing flexibility will continue to be key to the construction of suitable trusts and this is where the WAY Flexible Inheritor can play a major role.
• WAY will continue to offer its existing schemes using Interest-in-Possession Trusts to enable settlors, as previously, to direct trust income and capital to named beneficiaries in stated proportions. Any future changes to beneficiaries interests will have no personal taxation impact on them (PETs will no longer be forced on anyone) whilst appointments of assets, to whomever, will be subject to exit charge rules - but may often be at nil charge (see below).
• If no other chargeable transfers have been made in the past 7 years, each investor may utilise his/her Nil Rate Band (currently £285,000) plus this year's and last year's unused annual gift allowances (£3,000 per annum) for making gifts into trust, such as the WAY Inheritor Plans. Previous PETs, including previous WAY Inheritor plans, were not chargeable and therefore are not included in the calculation. This means that a couple can remove £0.5+ million out of their estate every 7 years – with no IHT charges for at least 10 years and quite probably no charges thereafter.
• This means that after 14 years a couple could have removed well over £1million from their taxable estates and still have their 'returned' Nil Rate Bands available to cover residual assets.
• When establishing trusts at or near the Nil Rate Band, investors might consider splitting their gifts so that each trust may subsequently have its own Nil Rate Band. In this case trusts should not be established on the same days and it may be prudent to have slightly different beneficiaries (e.g. one for son, one for daughter and one for combined - in each case with full appointed class flexibility) – this is due to a quirk in the tax charges legislation which is currently being disputed in the Courts by HM Revenue & Customs (of course, depending on the outcome of this case this benefit could be removed in the future).
• Discounted plans may well offer the opportunity of removing larger gifts from one’s estate since the IHT transfer value is normally discounted from the full invested value. However, lives should undergo a full Medical Examiners Report – a facility which WAY can provide.
• Ten year periodic and/or exit charges could in future become payable as a result of the growth of trust assets and/or in relation to discounted plans where discounts narrow with time. We now revert to our previous position where we indicated that there might be the opportunity to keep any FLEXIBLE trust within the nil rate band on a permanent basis (and therefore nil charging) by means of special reversions before each ten year anniversary. We would also suggest that donors should consider establishing more than one trust so that each is more likely to remain within its own nil rate band.
• Remember, however, even where periodic charges do apply (on that element of the trust value in excess of the nil rate band) they will be at a maximum rate of 6% every 10 years, based on trust values at each 10 year anniversary which one would hope might be covered by the underlying out-performance of the trust assets.
• Note that completion of the Revenue form IHT100 is compulsory where transfers in any year exceed £10,000 or in any 10 years exceeds £40,000.
Conclusion:
We believe that the WAY Flexible Inheritor Plan, operated within each settlor's Nil Rate Band, with further deployment of new Nil Rate Bands after each 7 years, is the way forward. If the settlor wishes to utilise all or most of his Nil Rate Band on each occasion then two or more smaller trusts settled on different days would be advisable. The use of more modest sized trusts and the employment of special reversions should ensure that periodic or exit charges are largely avoided for the duration of the Plans. WAY is determined to continue to assist advisers and their clients to benefit from the most contemporary Inheritance Tax mitigation schemes currently available in the market place.
Existing WAY Inheritor Plans (i.e. those created on or before 21st March 2006)
The charges mentioned in the appendix, below, will not apply to Existing Trusts so long as there are no changes of beneficial interest.
• It is extremely important that there are no changes to the Interest In Possession beneficiaries, or in their respective shares, within pre-existing trusts as this may bring trust assets into the new charging structure. There is a transitional period between 22nd March 2006 and 5th April 2008 when no IHT charges will be made on pre-existing trusts and during which time any larger trusts may seek to reconstitute themselves in the light of the new regulations. WAY intends to work with the trustees of large trusts to consider the options available. Naturally this consultation will not be appropriate until after the passage of the Bill into law.
• Changes of beneficial interest will, of course, include the possibility of a beneficiary dying before the settlor. In this circumstance the value of that beneficiary's interest will, as before, form part of his IHT taxable estate. Under the new regime, however, that beneficiary's share of the trust will subsequently be considered 'settled property' and will be subject to the new rules. This means it will be subject to the new charging structure (potentially suffering periodic and exit charges but no further transfer charges).
Conclusion:
Existing WAY trusts will be unaffected by the changes and will not incur any IHT charges unless there are changes in beneficial interests. Trustees of large existing trusts who fear the impact of any future changes in beneficial interests have a two year transitional period in which to restructure. WAY will be contacting all such trustees after the passage of the 2006 Finance Bill into law, to assist in any further planning deemed necessary before April 2008.
Appendix - Summary of potential charges applying to IIP Trusts post 2006 Budget
WAY and its advisers have made a preliminary study of the proposed changes to the treatment of Interest-in-Possession (IIP) Trusts as far as Inheritance Tax is concerned. In future the treatment of gifts into IIP Trusts will mirror that of gifts into Discretionary Trusts, including:
• A lifetime transfer charge at inception
A charge will be incurred amounting to 20% of the amount transferred into the trust which is in excess of the Nil Rate Band reduced by the amount of lifetime chargeable transfers made in the previous 7 years, e.g. if a settlor has already made lifetime chargeable transfers of £100,000 in the past 7 years any amount transferred into a trust in excess of £185,000 will incur a charge of 20%.
• The imposition of regular 10 year periodic charges
A charge will be made on each 10th anniversary of the creation of the trust amounting to (currently) 6% of the value of the trust in excess of the Nil Rate Band applicable to the trust. This Nil Rate Band will be equal to the then current personal Nil Rate Band less the total of lifetime chargeable transfers made in the 7 years immediately preceding the creation of the trust and the value of chargeable appointments and reversions made out of the trust in the 10 years immediately preceding the 10th anniversary.
• Charges on any property leaving such trusts
Any amount taken out of the trust will be subject to a charge based on the marginal tax rate applicable to either the amount charged at inception or, if after the 10th anniversary, at the last 10th anniversary, e.g. if at inception the charge was, for example, £10,000 on an amount transferred into trust of £200,000 then any payment will be subject to a charge of 10,000/200,000 x 30% (1.5%), or if at the last 10th anniversary the charge was, for example, £15,000 on a trust asset value of £300,000 the payment will be subject to a charge of 15,000/300,000 x 100% (5%). However, this amount will be payable only for the complete number of quarters which have elapsed since creation of the trust or its last 10th anniversary pro-rata to the 40 quarters of the 10 year period.
Further, if new trusts are created (a) with an overall investment at or less than the Nil Rate Band (currently £285,000) [or less than that if prior lifetime chargeable transfers have been made] and (b) if the value of the assets within each trust, including chargeable transfers in the 7 years prior to the trust in question, at each 10th anniversary remain less than the Nil Rate Band applicable to each trust at that time, then (c) all of the above mentioned charges will be £nil.
This puts planners largely back in the position they were in with Capital Transfer Tax (pre-1986) when most strategies relied on the repeated use of the Nil Rate Band (each 7 years, after which it falls out of account and can be re-used).
With IHT planning, particularly where the 7 year inter vivos period is important to removing assets from one's chargeable estate, time is of the essence.
As we receive further clarity from the Revenue and/or Counsel we will continue to update this note accordingly.
IMPORTANT: The information contained above is based on WAY's understanding of current law and HM Revenue & Customs practice as at: 25 August 2006. The stated tax implications cannot be guaranteed. It should not be treated or relied upon as a statement of law (or proposed law). Proper legal or tax advice should be sought on any particular aspect. Donors should rely on their own tax advice.
Should you wish to discuss our current understanding of these issues, please don't hesitate to get in touch or send us any questions you might have.
Issued on: 25th August 2006. WAY Investment Services Limited is an appointed representative of WAY Fund Managers Limited which is authorised and regulated by the Financial Services Authority.
Press Release Date: 25th August 2006