Last week, I looked at the background to the introduction with effect from April 6, 2005 of the pre-owned asset rules. These impose an annual income tax charge on the benefit enjoyed by the donor of an asset, tangible or intangible, where the gift is not otherwise caught by the gift with reservation provisions.
Given that the new tax will be capable of application to an assortment of schemes carried out in the past but can be avoided by making an election for the transaction to be subject to inheritance tax, one issue that was discussed comprehensively during committee stage is how taxpayers are supposed to know whether they are within the charge to this tax.
Paymaster General Dawn Primarolo responded that she has “no doubt that financial advisers, accountants and tax planners, given their professionalism, will be keen to ensure that their clients understand the obligations that now impinge on them. It may well be that those advisers, accountants or tax planners encouraged them down that route in the first place and will feel an obligation to tell them.
“We are aware that many of the schemes were implemented with substantial health warnings about their effectiveness. It is also undoubtedly the case that advisers who promoted the schemes would have records of the clients who entered into such arrangements.”
Clearly, it will be essential for advisers and the providers of any IHT schemes that are likely to be caught by the provisions to contact their clients reasonably soon after the final version is available (when the Finance Bill 2004 is enacted) or even before then to discuss their options.
Life insurance single-premium investment bonds appear to have been singled out by Primarolo for particular criticism. This was in the context of an amendment proposed by the Conservatives which would effectively apply the charge only where the structure was generating income that was taxable on the settlor under the existing anti-avoidance provisions.
Primarolo responded that this was not the mischief the Government was trying to tax. She further said that “although many of the structures arrange their funds so that they do not generate any kind of taxable income, notably in the form of insurance bonds, that does not mean that they generate no benefit. The benefit comes from knowing that the taxpayer has substantial funds that are available to them if they want them and they will never have to pay the inheritance tax bill that normally goes with that level of wealth. The Government aims to tax that benefit.”
The Tories' amendments were criticised as attempting to “let certain people off scot-free so long as the people using such structures are careful to invest the contents in the right sort of assets”.
It is clear that schemes involving investment bonds have not made a good impression on Primarolo although it appears that many such schemes are saved from the new charge because they are based on reversionary interests, that is, the settlor's retained fixed rights under a trust, rather than being schemes where the settlor has access to funds simply by being one of the trust beneficiaries. The latter trusts are obviously caught by the new provisions.
Some amendments have been made to paragraph 8 of schedule 15 to clarify when the charge applies in respect of intangibles . In particular, there are amendments to ensure the charge does not apply when it was not intended to.
Paragraph 8, it was said, “is aimed at situations where a former owner has shifted intangible assets outside their taxable estate in such a way that he can still benefit from them”.
As originally drafted, the provisions could apply in situations where the former owner's control does not go quite as far as that. The example given was that of dividend waivers. If someone who owns a company puts some of their shares into a trust but retains the rest, they can manipulate the income of the trust by waiving the dividends on the shares they retain, even though they may put the capital value of the trust generally out of their reach. Such a situation would be caught by schedule 15 and the Government agreed it should be excluded.
The amended paragraph 8 will restrict the charge on assets in trust to cases where the former owner's interest in the trust assets arises only from the terms of the trust.
Sometimes a single settlement contains distinct sub-funds held on different trust terms. One sub-fund may be caught by the test in paragraph 8 while the other sub-funds may not. The amended paragraph 8 ensures that what is taxed are the assets in the sub-fund that is caught rather than all the assets of the settlement.
This point could be of importance to schemes such as discounted gift trusts, under which a part of the trust fund is held absolutely for the benefit of the settlor while the remainder (a clearly defined part) of the trust fund is held for other beneficiaries.
Without this amendment, the whole of the trust would be caught by paragraph 8. As things stand (and this has been clarified independently by the Inland Revenue) the fund held absolutely for the settlor is not caught by the charge.
Another amendment increases the de minimis limit in paragraph 13 – how large the value of the benefit enjoyed by the former owner must be before the tax charge arises – from £2,500 to £5,000 a year and this is very welcome.