Feature

posted 14 Dec 2006 in Volume 12 Issue 1

What The Finance Act really means

“The trouble is that it’s all new law, and frankly not very good law, and we don’t know how the Revenue will interpret it all, yet.” Sound like one of your internal seminars? Read on for the weary solicitor’s guide to the Finance Act, by Andrew Jones.

Alice opened the training session at Dazed and Confused (Solicitors). “I’m pleased to say that Brian has been looking into the complexities of the new inheritance tax rules in this year’s Finance Act. We’ve all got a photocopy of Schedule 20. Brian?”

“Ah, yes, now, Transitional Serial Interests...”

“Er, Brian,” piped up Christine, “I wonder... before we get into the detail, I always find it’s easier to understand things if you could explain to me what the principle is.”

“The principle?”

“Yes, you know, the principle, the policy. Government said to itself so-and-so is wrong with society so we should legislate to achieve such-and-such.”

“Ah...”

“Rather in the way that the income tax exists to finance artillery for the Napoleonic Wars,” suggested David, the senior partner.

“That kind of thing, yes,” agreed Christine.

Brian gave this some thought. “I’m sorry, I don’t think the new legislation has anything like that. Now, Transitional Serial Interests...”

Alice had something else on her mind. “Brian, I think the legislation originally said that parents had to give all their money to children at 18 – which most of our clients hated, of course – but then there was some kind of climb down. How does that work?”

Brian agreed, up to a point. “Yes. The new rule is that there are no new accumulation and maintenance trusts, and there are transitional rules for existing ones. Let’s do this on a flip-chart.” Brian chatted through the possibilities until his flip-chart looked like this:

Accumulation & Maintenance Trusts

No new A&Ms:

New trusts of that kind now: mainstream.

Transitional rule for existing A&Ms:

If not changed by April 2008: mainstream;
If changed by April 2008: similar to “18 to 25” below.

Christine interrupted: “That’s fine, but I see two terms I don’t understand. First, what kind of ‘change’ is required? Secondly, what’s ‘mainstream’?”

“‘Changed’ means ‘changed so that the kids are absolutely entitled before age 25’, and ‘mainstream’ is the government’s new buzzword for what we used to call the non-interest-in-possession tax treatment.

Some lawyers started looking nervously around the room in response to this statement, each fearful they might be the only one who did not understand it. David, the senior partner, was robust enough to say:

“Brian, perhaps you could do another flipchart on ‘mainstream’ for us?”

“Happy to,” said Brian, “but first let’s complete this chart on trusts for children”:

In parents’ wills

If children absolutely entitled at 18:

“Bereaved Minors’ Trust”;
No IHT (except on the death).

If children absolutely entitled between 18 and 25

“18 to 25 Trust”;
Mainstream rules start running from ate 18;
Maximum possible ‘Exit Charge’ 4.2%.

In other people’s wills

· Mainstream.

“Before we move on,” said Alice, “am I right to think that the treatments in parents’ wills are more generous than ‘mainstream’?” Brian nodded. “So,” continued Alice, “are we saying that gifts made by other people, such as grandparents, in their wills are mainstream in any event? If so, maybe that wasn’t such a big climb down. Is there anything we can do about that?”

“We think that possibly bare trusts, by virtue of being absolute entitlements, don’t fall within these rules,” Brian replied. “In practice, that would be very similar to a trust with a contingency age of 18 – since the child couldn’t give a receipt for her money until she reached that age. One problem with that idea is that you cannot delay entitlement to an older age, like 21 or 25. The real trouble is that it’s all new law, and frankly not very good law, and we don’t know how the Revenue will interpret it all, yet. There’s a lot of debate in the learned press about the planning possibilities – but I think it will be another year before there’s a clear consensus in the profession about what works and what doesn’t. For what it’s worth, where minorities are concerned I’m advising clients to reflect their actual wishes in their wills, and to take the new taxes on the chin.”

“...But we might be saying something different in three months or six months time when the new law has bedded in?” suggested David.

“That’s right,” Brian agreed. “Now, Transitional Serial Interests...”

“I think,” said Alice, “that you had promised us a flipchart on ‘mainstream’.” Brian stood up, and drew:

Mainstream

· Tax in the normal way on death if created on death;

· Tax at half the death rate (20% on value over the nil rate band) if created in life;

· Tax above recalculated as a PET if death in seven years (but no refunds);

· “Ten year charge” each tenth anniversary: (6% on value over the nil rate band);

· “Exit charge” on money leaving the trust: (x/40ths of 6% on value over nil band, where x is the

number of quarters elapsed since the last ten years charge.

“I’m simplifying a bit, especially towards the end”, Brian pointed out, hoping that no-one would ask him to demonstrate an exit charge calculation, which nobody did. “Now,” he continued, “Transitional Serial Interests...”

“I think there was a huge hullabaloo about the Spouse Exemption after the budget,” said David. “Do I remember something about a climb down there, too? How did that pan out?”

“Well,” said Brian patiently, seeing his chances of reading his paper on Transitional Serial Interests slipping away. “It’s time for another flipchart, I think. Much simplified, the rules are:”

(Almost) All new lifetime trusts are mainstream;
Existing interest-in-possession trusts continue their interest-in-possession treatment until the present interest-in-possession comes to an end;
Most new will trusts are mainstream;
IPDIs get the interest-in-possession treatment.

Brian read the last item out loud, pronouncing the first acronym as if it was spelled ‘ippdy’. Alice realised she was going to spend the rest of the day humming ‘IPDI-doo-dah’.

“An IPDI is an ‘immediate-post-death-interest,’” explained Brian, “basically any interest-in-possession which arises straight away, under a will.”

“Just remind me,” said Christine, “the interest-in-possession treatment...”

“That’s attribution to the beneficiary.” said Brian. “An interest-in-possession means the right to current income: for example a life interest. However just to confuse things (as my flipchart shows) not all trusts with interests-in-possession now get the interest-in-possession treatment. Some of them have gone mainstream.

However, where you do have the interest-in-possession treatment, the trust is taxed in tandem with the affairs of the beneficiary with the interest-in-possession. If she dies, the trust aggregates with her estate to calculate the inheritance tax; if the interest comes to an end in her lifetime, it is taxed as if she had made a PET.

All of this is potentially good news where the surviving spouse gets an IPDI, because it will always be spouse exempt on the first death. The government backed down on that one. Another piece of good news, by the way, is that Nil-Band Discretionary Trusts work exactly as they did before. No real changes, there.”

“Well, that was all most interesting...” said Alice with somewhat forced sincerity.

“What a shame that none of this legislation has been drafted in a clear and logical way, so that we have had to waste hundreds of chargeable hours at the expense of our clients, just working out what the law actually is,” opined Edith, who until then had been in a silent state of contemplation. The comment was met by stunned silence, and rumour has it Edith was invited to leave the partnership the next morning.

“So,” said Brian, “there’s one more item for that last flipchart.” He wrote:

“Right, thank you, everyone,” said Alice. “Same time next month.”

Any similarity between Dazed and Confused (Solicitors) and any real firm is entirely coincidental. n

Andrew Jones is an associate solicitor with Cheltenham firm, Rickerbys. He can be contacted on andrew.jones@rickerbys.com