Editor’s foreword: The Budget 2006

The Chancellor of the Exchequer excelled himself in the Budget of 22 March. The abolition of inheritance tax and the biggest give-away budget in a century was a masterstroke. It assured him of the sincere approbation of middle England and the PM could only look on in awe at his likely successor. Never has there been so much rejoicing as a result of single man’s hard work and originality. Share prices soared, the birds sang on until well after dark and despite it being a rather chilly night, we were all comforted as we settled down to sleep with a warm emotional glow. I do so love happy endings. Now wouldn’t that have made a change?

Instead, in reality: The Dark Lord of the Nasty Surprises, in his speech, merely confirmed implementation of the increase in the inheritance-tax threshold from £275,000 in the tax year 2005/2006 to £285,000 for the 2006/2007 tax year. It will then rise to £300,000 in 2007/8, £312,000 in 2008/9 and in 2009/ 2010 it will be £325,000. Given increases in house prices, this was not very generous, but at least it did not fill every private-client lawyer with a gloom sufficient to cause some stalwart tax planners to take a trip straight out to ‘Lovers Leap’.

I quite agree with John Riches, chair of the STEP UK Technical Committee. The HMRC Budget press release BN 25, which was entitled ‘Aligning the Inheritance Tax Treatment For Trusts’ should more accurately be described as ‘Penalising Families For Using Trusts To Hold Their Assets’.

HMRC can be proud of itself in that it has spent years consulting with the various professional bodies over trust-related income and capital-gains-tax reforms. But as far as inheritance tax is concerned, consultation appears to be a dirty word. No pre-budget proposals; no consultation; no chance of stopping clients accidentally giving themselves whopping great inheritance-tax liabilities. The changes are apparently set to be applicable on and after 22 March, to new trusts, including those in the wills of people inconsiderate enough to die before reviewing them.

Currently lifetime ‘non-interest in possession’ trusts (namely discretionary trusts) do not suffer inheritance tax on amounts paid into them of less than £275,000 (2005/2006). Over that, there is an immediate ‘entry’ charge of 20 per cent, the lifetime rate to inheritance tax, on the additional value transferred. There is a ‘periodic’ tax charge of up to six per cent on the value of trust assets over the then inheritance-tax threshold once every ten years. There is also an ‘exit’ charge proportionate to the periodic charge of six per cent when funds are taken out of a trust between ten-year anniversaries.

Until 22 March, this regime did not apply to accumulation and maintenance trusts (broadly trusts for grandchildren) or interest in possession trusts (broadly life interests). Lifetime transfers into those trusts were exempted from inheritance tax if the settlor retained no benefit and survived by seven years. They were also not subjected to the periodic or exit charge. This ancient regime will now only apply to such trusts (lifetime and will trusts) founded up to midnight on Budget day.

The Finance Bill apparently proposes to limit the application of the former inheritance tax rules, which the press release inaccurately describes as ‘special rules’. That expression implies some terribly good tax advantage whereas, in fact, the rules are just the same as the rules applying to outright gifts. They both amounted to ‘potentially exempt transfers’. Now only outright gifts and the following gifts into trust will be such ‘PETs’.

The old rules will henceforth only apply:

1. Where an interest in possession (such as a life interest trust) is created on death by a parent for a minor child who will be fully entitled to the assets in trust at age 18. So we should forget commonsense telling us that any perfectly reasonable 18 year old might want to blow the lot on fast cars and high living. I have said it before that we are now considered to be mere ‘consumer units’ by our government. Is there now any doubt? Prudence be damned; live for the day and fuel the economy while you’re at it;

2. Where an interest in possession is: ‘Created on death for the benefit of one life tenant in order of time who’s interest cannot be replaced [whatever that means] (more than one such trust may be created on death as long as the trust capital vests absolutely when the interest comes to an end).’ This is an apparent attack on the flexible life interest trust of the residuary estate arising at the time of the first death in a married-couple/civil-partnership situation. The usefulness of the (spouse exempt) survivor then being able to make a deemed potentially exempt transfer is lost. But so is the tremendously flexible family protective security of such a provision. Has the chancellor not heard of ‘second marriage situations’? It seems that for people who die with such a will after 22 March their estate may potentially be liable to the full 40 per cent weight of an inheritance-tax charge on amounts above the tax-free band. It is not at all clear whether or not the spousal exemption will be applicable on foundation of that will trust whatever the ongoing tax treatment might now be. It may be that outright appointments from the life interest trust fund to the survivor, within two years of the first death, might be necessary to make use of the spousal exemption assuming that those particular ‘writing back’ rules are not also being changed;

3. Where an interest in possession is: ‘Created in the settlor’s lifetime or on death for a disabled person, within the terms of Section 89(4) IHTA 1984.’ The provisions of the Inheritance Tax Act 1984 are hopelessly inadequate to meet the demands of all relevant situations involving vulnerable people. What of vulnerable people who are not mentally incapable or who do not fulfil the other prerequisites of such trusts such as receipt of Disability Living Allowance? It is also not clear that bare trusts used by both the Court of Protection and the High Court to protect the awards of vulnerable people will be exempt from these rules. Sometimes they contain millions in personal injury awards. My view is that they should not suffer because there is no transfer of value upon which the new rules might bite. That is despite the fact that such trusts are strictly interest in possession trusts. The ultimate bare trust is of course the co-owned family home. A supertax on high value purchases? Surely not a consequence of the changes. But this just shows the lack of thought given when conjuring the new rules out of thin air.

No mention was made in BN25 of settlor interested interest in possession trusts. Will new lifetime trusts with the elderly in mind be safe from the depredations of immediate charges to inheritance tax over the nil rate band? However flexible they might be, the settlor would still be taxed on the value in the trust at death (assuming their estate and trust fund combined exceeds the current inheritance tax free threshold) through having retained a benefit.

I am sure I am not the only person who is feeling aggrieved that the chancellor has apparently created some arbitrary traps for a large proportion of the population who have been carrying out prudent inheritance tax efficient planning, including will planning, on a basis that has been perfectly acceptable, it appeared, since the introduction of the Inheritance Tax Act in 1984. In my opinion, this is all part of the plan to hide away a significant change, creating a big increase in inheritance tax liabilities, without affecting the headline rate of taxation. I am sure that the readers of this magazine will feel similarly.

I have yet to find any serious justification for it other than as a cynical tax-raising measure. It is certainly not simply ‘Aligning the Inheritance Tax Treatment For Trusts’. As potentially exempt transfers into trust have now mostly bitten the dust, are we to expect potentially exempt transfers generally to fall in the next Budget? For the will-writing enthusiast this is an opportunity to be deluged with ‘corrective’ work. Actually perhaps it’s just a way of compensating lawyers for the introduction of Home Information Packs, which will lead to the loss of loyal clients by way of unscrupulous estate agents… There are a lot of lawyers in government after all.

David Coldrick
Editor
david.coldrick@wrigleys.co.uk

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