HM Revenue & Customs has put forward new rules which will allow individuals to decide how they split their £325,000 inheritance tax allowance between multiple trusts.
Under current rules, an individual can establish several trusts and as long as they are set up on different days each has its own £325,000 nil rate band.
HMRC first consulted last August on changing the rules relating to so-called “pilot” trusts so that the £325,000 nil-rate inheritance tax allowance is split between the trusts rather than each trust having its own £325,000 allowance.
An updated consultation on the proposed rules, published last week, says respondents to the August consultation found the arbitrary split between trusts put forward by HMRC “unacceptable”.
HMRC has now proposed to allow those using multiple trusts to divide the nil rate band between them as they see fit, while married couples will be handed control over how they allocate their £650,000 allowance.
Technical Connection joint managing director Tony Wickenden says: “It is a big change, because after all what is the point of having part of your nil rate band allocated arbitrarily to a trust with not very much in it?
“It was put to HMRC that a new nil rate band becomes available every seven years, just as you get when you give gifts. But HMRC has said no. It is one for life.”
The new rules are due to come into force from April 2015, although once in place they will be applied from 6 June 2014. This is to avoid people taking advantage of the current rules to set up multiple trusts with their own nil rate bands before the new rules come in.
Trusts established before 6 June will continue to operate under the current rules. IHT is charged at a marginal rate of 40 per cent above the nil-rate threshold.
Amounts above the threshold that are put into trusts are subject to a 20 per cent entry charge, plus a 6 per cent charge every 10 years. Exit charges also apply when the assets are taken out of the trust.
The HMRC consultation on the latest reforms closes on 29 August.
Colin Jelley, managing director, Landmark Financial Solutions
HMRC is not only keen to reduce the complexity and admin burden of the current methodology but also remove the advantage that estate planning with trusts has over planning with wills. Since the Court of Appeal judgment in the Rysaffe case, there has been judicial authority for most trusts each to have an IHT nil rate band while an estate passing by will is generally only entitled to a single nil rate band.
The proposals seem to be close to a sensible compromise as they introduce simplicity of calculation for new trusts while broadly protecting pre-existing trusts and address the tax loss incurred by the fragmentation of large estates across multiple trusts in the future.
However, the allocation of only one nil rate band to all future trusts now tilts the balances slightly in favour of estates passing by will rather than by trust. It seems in future large estates will continue to combine wills and estates just as before but with somewhat fewer trusts being created.
It has taken 10 years for the obvious IHT advantage of multiple fragmented trusts to be addressed and the surprise is only in the time that it has taken to get here.