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I married an alien

Pre-owned asset tax Scottish Equitable International technical manager Margaret Jago warns on spouse-alienation plans

Pre-owned asset tax came into force on April 6 and affects some inheritance tax planning arrangements using investment bonds. This represents an opportunity for advisers as many people will not know how Poat affects them and may be considering taking steps to mitigate this tax. For some people, it will be possible to improve their tax liability for 2006/07 and, in some cases, it may even be possible to take action to avoid a 2005/06 liability.Poat is an income tax charge designed to counter IHT planning arrangements. The targeted arrangements are those where a person has given away assets but can still benefit from them in some way but the assets are no longer in their IHT estate or that of their spouse. Trusts currently on offer from life offices for use with investment bonds do not meet this definition or fall foul of Poat so investors who are planning now can be confident that this tax should not be an issue. But there were trusts in the market until June 2003, sometimes known as spouse alienation trusts, that do fall foul of Poat.To help you recognise the affected arrangements, they operated by the investor (the settlor) setting up a trust for his spouse. There would be a wide range of potential beneficiaries, including the settlor. At the outset, the trust fund was within the IHT estate of the spouse. However, trustees could change the beneficiaries of the trust. The spouse would then be treated as having made a potentially exempt transfer for IHT purposes and this would be IHT-free if she survived for seven years.There are two reasons why people with spouse-alienation trusts may not have taken action yet. First, the legislation allowing people to calculate their Poat liability was finalised just before the tax came into force which made planning in advance of the implemen-tation date very difficult. Second, they may not realise that they have a potential liability. Life companies will not be able to help here as they will not necessarily know what trust a plan is in.For those affected, the right solution will depend on the size of the trust fund, what access to the trust fund is required by the settlor and the settlors appetite for exposure to additional tax liabilities.Bear in mind the Poat de minimis limit, where no tax liability arises if the benefit from all arrangements is less than 5,000. This equates to a trust fund of 100,000 (at current rates)The settlors first course of action may be to do nothing as the idea of Poat tends to get a hostile reaction. In fact, when the sums are done, the tax liability may seem acceptable. For example, on an investment of 1m, the potential IHT saving as a result of having undertaken the planning is 400,000.The benefit taxed at the settlors marginal income tax rate under Poat is calculated by applying a prescribed rate (currently 5 per cent) to the value of the trust fund at the start of the year so if the trust fund remains at 1m in the above example, the annual tax will be 20,000, meaning that it will take over 20 years for the income tax cost to outweigh the IHT saving.For people who want to avoid the Poat liability and are prepared to sacrifice access to the fund, the solution may be simply to remove the settlor as a potential beneficiary from the trust. This means that the settlor cannot access the trust fund in future but will mean that there should be no Poat liability for years after 2005/06. Whether or not there is a liability for 2005/06 will depend on the size of the trust fund and the date on which the settlor is removed.For those who still need some access but want to minimise the Poat liability for years from 2006/07 onwards, the solution is to alter their arrangement so it is below the de minimis limit. There are two ways of doing this. First, the settlor can ask the trustees for part of the trust fund back. He could then use this for a different type of IHT arrangement or indeed simply hold it in his taxable estate. This will minimise the Poat liability but increase the potential IHT liability.The alternative is to distribute part of the trust fund out of the trust to other beneficiaries such as children or grandchildren. This mitigates the Poat liability without causing an IHT liability for the settlor but, of course, restricts his access to capital in future.The clock is ticking in respect of some planning activity, with the last date for removing a settlor from a 250,000 trust to take advantage of the de minimis limit and avoid the 2005/06 liability having passed on August 29. Many affected people will have to accept a tax liability for 2005/06 as the price of delaying their decision-making and so any clients affected should be contacted outside the normal review cycle.


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