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Paul Latham: How do you help clients hit by HMRC’s pilot trust U-turn?

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As U-turns go, this one was pretty brazen. Just a few weeks after saying it wouldn’t use the General Anti-Abuse Rule to target pilot trusts, HMRC issued a consultation document indicating very strongly that it would be putting a stop to them after all.

It would probably be a waste of time trying to convince the revenue to change its mind, so we’ll just have to accept that the relevant legislation is likely to come in at some point in the next two years.

How do pilot trusts work and what will change?

To see how much difference this is going to make, it’s worth reminding ourselves quickly how pilot trusts work. Generally, someone sets up a number of pilot trusts and puts a small amount in each one – perhaps as little as £10. Like the pilot light on a boiler, the trusts are just there in the background, not really doing anything till they’re needed.

They come into their own – firing up the boiler – when the person who set them up dies, and inheritance tax has been paid on their estate. Each of the trusts currently has its own nil-rate band of £325,000, so the remains of the estate are moved into them, keeping the amount in each one below this threshold. As a result, when the time comes for HMRC’s ten year anniversary charge of 6%, there’s nothing to pay. The High Court approved this use of pilot trusts – as long as the trusts were set up on different days – in a 2003 judgment in favour of Guernsey-based Rysaffe Trustees.

However, under the new rules, HMRC will start looking at the total amount in all the trusts created by the same person – rather than in each one individually – and impose the 6 per cent charge on anything above £325,000.

This change probably means it’s not worth setting up new pilot trusts or maintaining ones that have been set up but haven’t yet had significant amounts moved into them – it would make more sense simply to distribute what they they contain to the beneficiaries.

So, what alternatives are there?

Well, if someone is likely to live more than seven years, if they won’t need access to their money and if they’re happy to give up control over it, they could consider gifting their wealth as a Potentially Exempt Transfer. But those are three big IFs.

A more flexible option could be investments qualifying for business property relief, such as shares in some of the companies listed on AIM. These ensure the investor retains control of their wealth and has access to it at all times. Better still, the investments become fully exempt from inheritance tax after just two years.

Clients who want a say in what happens to their wealth after they die also have the option of moving any BPR investments that have qualified for inheritance tax exemption into a discretionary trust. There is no Chargeable Lifetime Transfer tax for doing this, and the trust can inherit any other investments that qualify for BPR.

Once the original investor dies, or the BPR investments have been held in a discretionary trust for seven years, it’s possible to transfer them into other types of assets without losing the exemption from inheritance tax.

The BPR route could even be worth considering for investments that have already been moved into a pilot trust after the original owner’s death – as long as there is at least two years to go until the tenth anniversary of the trust’s start date.

Paul Latham is managing director at Octopus Investments

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Comments

There are 3 comments at the moment, we would love to hear your opinion too.

  1. I don’t have any clients for whom this misuse if Pilot Trusts would have applied, so well done HMRC for looking to close this loophole. God news for Octopus & Stella AM as this will increase the use of BPR &Aim, which is legitimate and what the govt want to encourage.

  2. These rules won’t just affect Pilot Trusts. It will effectively mean that planning using the Rysaffe principal will become defunct.

  3. Close the Mage Bucks tax loopholes 6th August 2013 at 11:49 am

    @James

    Yes, that is the point. These proposals are designed precisely to get rid of the Rysaffe principal

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