Ashfords Solicitors - Budget 2006

In December 2003 the Inland Revenue (now known as HM Revenue & Customs) announced their approach to the reform of taxation of trusts which was to create a level playing field between assets held in trust and assets held personally by individuals.

Unfortunately, despite the 'consultation' process, various measures now announced as part of the 2006 Budget on 22 March in relation to inheritance tax completely contradict HM Revenue & Customs's so called objective.

The full impact of the changes is not yet known and it is likely that further information will not be available for some weeks, until the draft legislation for the Finance Bill 2006 becomes available. Although substantial criticism has been levelled at the government already, and there will a great deal of lobbying for changes to the proposals or, at least, a deferral of the introduction of the rules, it is not expected that the government will alter its plan. For this reason we recommend extreme caution as the measures announced on 22 March 2006 are retrospective in their scope and actually incorporate some very significant changes to the existing trust rules this will have far reaching effects for those actively planning to mitigate the impact of inheritance tax.

What will Ashfords do?

We will continue to monitor guidance available from HM Revenue & Customs and will act on instructions to provide specific advice.

In the meantime we set out below some advice that we hope you will find helpful.

--------------------------------------------------------------------------

ALIGNMENT OF THE INHERITANCE TAX TREATMENT FOR TRUSTS

The New Rules

With effect from 22 March 2006, transfers of assets into Interest in Possession Trusts (IIP) or into Accumulation and Maintenance Trusts (A&M) will no longer be treated as potentially exempt transfers for IHT. The treatment for such trusts will now be aligned with that applicable to discretionary trusts, which is unaltered.

Accordingly, where a transfer or the combined total of transfers during the last 7 years exceeds the nil rate band for IHT purposes (£285,000 in the tax year 2006/07) the excess amount will be subject to a lifetime tax charge of 20%.

There will be a potential tax charge of 6% of the trust fund value on each 10 year anniversary of the settlement and if funds are removed from the trusts between anniversary dates a proportionate tax charge will apply.

As with the lifetime tax charge (of 20%), the periodic charge only applies to trust assets in excess of the nil rate band. Even if there is no charge to IHT (because the value concerned is within the nil rate band) the trustees still have an obligation to return details of the event to HM Revenue & Customs.

For these purposes the term 'relevant property' is used to mean trust assets that are now caught by the new rules as well as assets within discretionary trusts.

Exemptions to the New Rules

There are exemptions which will still apply in limited circumstances namely:-

Trusts created on the death of a parent for the benefit of a minor child, who will become fully entitled to the assets at age 18.
Trusts created on death for the benefit of one specified life tenant, where the interest of that individual cannot be replaced.
Trusts created during the lifetime of the person creating the trust ('the Settlor') or in the event of their death, where the benefit is for a disabled person.

These trusts will not be subject to the 20% lifetime tax charge or the periodic 6% charge on 10 year anniversaries.

Transitional Provisions

There is going to be a transitional period (ending 6 April 2008) for existing trusts to be amended to comply with the exceptions detailed above. In summary:

A & M Trusts

Existing A&M trusts will retain the preferential treatment they enjoyed up until 22 March 2006 as long as the terms are modified prior to 6 April 2008 so that the assets within the trust will pass absolutely to a specified beneficiary when they attain 18 years of age.
Trusts not meeting these terms will become 'relevant property' on 6 April 2008 and the periodic tax charge will apply on the 10th anniversary of the original settlement. A proportional reduction to the charge will be applied to reflect the fact that the trust assets have not been 'relevant property' during the full 10 years.

Existing IIP Trusts

The situation for these trusts is rather more complex.
They will continue with the existing tax treatment until such time as the interest in the property as at 22 March 2006 comes to an end.
At this stage there will be no IHT levied if someone takes absolute ownership of the trust fund. This will either be a transfer on death or a potentially exempt transfer.
Where assets remain in trust at the end of the interest, it will be assumed that these assets become 'relevant property' at that date. If the interest comes to an end during the lifetime of the beneficiary, the transfer will become immediately chargeable as if a new trust had been created at that date. Where the interest comes to an end in the event of death, the trust assets will be treated as part of the deceased's estate for IHT purposes and will be treated as 'relevant property' thereafter.
An exemption will apply if the assets are used for charitable purposes.
In addition if the interest under an existing trust comes to an end prior to 6 April 2008, then the assets will be treated under the rules that applied prior to 22 March 2006.

______________________________________________________________________________________

Should I take any action ?

At present it is not possible to advise you fully on the changes because HM Revenue & Customs have not yet published all relevant material.

If you are concerned about how these new measures impact on arrangements you have in place, please contact a member of our Tax Trust & Probate Team.

This Guidance Memorandum takes into account the tax law and practice as we understand it to be as at the 27 March 2006.

Ashfords is regulated by the Solicitors Regulation Authority. The information in this article is intended to be general information about English law only and not comprehensive. It is not to be relied on as legal advice nor as an alternative to taking professional advice relating to specific circumstances.

4th April 2006

Budget 2006 - Inheritance Tax

Introduction