There has been much press coverage recently of changes announced by the Chancellor in the 2006 Budget in relation to the way in which trusts and settlements are treated for Inheritance Tax (IHT) purposes.
BackgroundAt present trusts fall broadly into three categories:-
| a) | Interest in Possession Trusts - Where one or more beneficiaries have an immediate right to the income but not to the capital;
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| b) | Accumulation and Maintenance Trusts - Where the beneficiaries will acquire the right to income at an age not exceeding 25:
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| c) | Discretionary Trusts – Where no beneficiary has an automatic right to income.
Trusts within a) and b) have hitherto enjoyed favourable treatment for IHT purposes as compared with discretionary trusts.
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Proposed ChangesSubject to some transitional rules for trusts in existence at 22 March 2006 and subject also to a very limited class of exceptions, interest in possession trusts and accumulation and maintenance trusts will from April 2008 be subject to the same IHT regime as discretionary trusts. 1) Any payments made into such trusts will be chargeable transfers for IHT purposes, (rather than, as previously, Potentially Exempt Transfers) although if they fall within the settlors’ available nil rate band there will be no IHT liability on the making of the transfer, and 2) the assets of the trust will be subject to a 10 year charge to IHT at a rate of 6%, subject to any available nil rate band, on each 10 year anniversary. 3) Payments out of the trust will be liable to a proportionate charge to IHT, again subject to any available nil rate band.
Action RequiredA significant aspect of the new rules, which requires urgent action, relates to wills which create interest in possession trusts for the surviving spouse, or civil partner. Until Budget day such trusts qualified for spouse exemption from IHT on the death of the first spouse. Since Budget day almost all such trusts will not qualify for spouse exemption. This could cause considerable hardship in cases where the assets of the first spouse to die exceed the nil rate band and the assets are left in an interest in possession trust for the benefit of the surviving spouse.
If you have included a provision in your will under which assets are left to an interest in possession trust for your spouse we recommend that you should consult your solicitor as soon as possible to take immediate action to modify the terms of your will. If you have an estate worth say £500,000 which you were planning to leave entirely in trust for your wife for her lifetime with the remainder passing to your children following the death of your wife, under the previous regime no IHT would have been paid until the death of the second spouse to die. Under the new rules, IHT of £86,000 would be immediately payable on the death of the first spouse leaving a correspondingly lower sum available for the benefit of the survivor.
There has been no change to the IHT regime relating to discretionary trusts and if you have already created one of these or have made provision for one in your will then the tax position remains unchanged.
However if you already have in existence an interest in possession settlement or an accumulation and maintenance settlement we recommend that a review should be conducted to establish whether any action is required prior to April 2008. Although these new provisions will not become law until the Finance Act has been passed, and may, of course, be subject to amendment in the interim, Nunn Hayward will be carrying out a review of all Trust clients in the coming weeks.
A further change introduced by the Budget relates to settlor interested trusts. It has been the case for some years that the capital gains of any trust from which the settlor can or may benefit (known as “settlor interested”) are assessable on the settlor rather than on the trustees. With effect from 6th April 2006 the definition of a settlor interested trust is extended to include any settlement where a child or step child of the settlor can benefit from the settlement whilst under the age of 18. If you are the settlor of a trust from which your minor child can benefit we recommend that, if there is any possibility of the trustees realising gains within the settlement, you should take advice as soon as possible.
There is, at present, considerable uncertainty as to the effect these new provisions will have on Life Assurance policies written in Trust. It is understood that the Life Assurance Industry is making representations to The Treasury in this respect.
If you have any queries regarding this article please do not hesitate to contact Carolyn Spencer, Tax Manager at
Carolyn@nunn-hayward.com or call 01753 888211.
