On December 11, 2003, the Inland Revenue published a consultation document entitled, Tax Treatment of Pre-Owned Assets, in which it outlined how an annual income tax charge will be levied from April 6, 2005 on the benefit that people enjoy when they have arranged free continuing use of major capital assets that they once owned.
The intention is to crack down on certain inheritance tax planning arrangements that are designed to enable a person to give away a major capital asset and yet still enjoy a future benefit from that asset without infringing the gift-with-reservation rules.
The consultation document referred to gifts of “major capital assets” with the tax charge being linked to the benefit enjoyed by the donor.
This benefit will be measured by reference to his enjoyment of the property (for example, rent-free occupation of a house) or where the benefit is the enjoyment of a chattel such as a picture or an antique, the benefit will be linked to the capital value of the asset in question and a notional rate of interest to be introduced by secondary legislation. It was thought initially that the new rules were to be introduced primarily (but not necessarily exclusively) as a means of neutralising the benefits of IHT mitigation schemes using the family home which enable the donor to continue in occupation of the property without paying a rent, such as the double trusts (“IOU”) scheme, and spousal interest trusts set up before June 20, 2003.
The precise application of the pre-owned assets tax rules depends on whether the asset in question is land, chattels or “intangible property”. Intang-ible property will include items such as life assurance policies and capital redemption policies.
As regards intangible property, in brief terms, paragraph 8(1)(a) of Schedule 15 of the Finance Bill provides that a tax charge can arise where any income arising under a settlement would be treated by virtue of section 660A of the Income & Corporation Taxes Act 1988 (income arising under a settlement where the settlor retains an interest) as income of the settlor.
The key word here appears to be settlement. If a settlement exists and the settlor retains an interest under that settlement there will be a prima facie tax charge. However, it would appear that a properly carved out right by the settlor could be argued not to be settled property for the purposes of the pre-owned assets rules.
At a meeting with the Association of British Insurers following publication of the Finance Bill, the Inland Revenue confirmed that the aim of the anti-avoidance legislation in Schedule 15 was to mirror the IHT code. It was not the aim of the legislation to impose a tax charge in addition to IHT for life policies.
They also stated that the new legislation was designed to stop planning such as the Eversden and double-trust arrangements.
Furthermore, the Inland Revenue confirmed that it was not the intention of Schedule 15 to tax discounted gift schemes, however structured. The Revenue also advised that it is not their intention to catch gift and loan schemes where the settlor's only interest under the trust is as a creditor.
Eversden type arrangements, if established prior to 20 June 2003, remain effective to avoid the IHT gift with reservation provisions but are vulnerable to the pre-owned assets legislation, as the settlor is a potential beneficiary of the whole trust fund. In these circumstances, the settlor appears to have several options:
Simply pay the tax charge from April 6, 2005. This may be particularly attractive for settlors in ill health.
Exclude himself from being a potential beneficiary under the trust.
Opt out of the pre-owned asset tax charge by electing to have the trust property treated as a gift with reservation and thus part of his taxable estate for IHT purposes.
Persuade the trustees to make an absolute appointment of the trust fund free of trust to the settlor and/or spouse in order that he/they can consider other types of IHT planning.
Finally, and somewhat bizarrely, it seems that even shareholder protection arrangements where shareholders effect reciprocal cover subject to a trust to enable fellow shareholders to purchase their shares on death may be caught by the proposed legislation as currently drafted.
It seems there are still plenty of issues to be resolved before the legislation takes effect from April 6, 2005.