Over the past two weeks I have been looking at the background to the latest (third)consultation document on the taxation of relevant property trusts – basically all private (non-charitable) trusts other than bare trusts and certain trusts for disabled people.
While the simplification proposed in the second consultation document was generally welcome, representative bodies expressed significant concerns. The most recent revised proposals take account of these concerns which were summarised in my last article. While the updated HMRC model is based on the same broad principles as the earlier version (insofar as a simple rate of 6 per cent of the chargeable transfer should be used in the calculation of trust charges and a single nil-rate band will be available for all the trusts created by a single settlor), a notable change is that the new rules, which will take effect in relation to IHT charges occurring on or after 6 April 2015, will now only apply to:
- New trusts made after 6 June 2014
- Additions of property/funds to existing trusts made after 6 June 2014; and
- A trust that is changed after 6 June 2014 with the result that relevant property comes into being – for example, an interest in possession trust created before 22 March 2006 which has its terms amended so that it become a relevant property trust.
It is therefore necessary to distinguish between new and existing trusts for the purpose of considering the new rules in detail and the potential impact of the new rules in relation to the trust-based planning that might typically be carried out by advisers.
I will look first at new trusts.
For new trusts (that is, primarily those created after 6 June 2014 or existing trusts that are added to after that date), the main difference between the new proposals and the original proposals is the introduction of a settlement nil-rate band.
The SNRB would be separate and distinct from the settlor’s personal nil rate band but would be set at the same level (so currently £325,000) and increase in line with the personal IHT nil rate band. Where a trust is created by joint settlors, this will be treated as two distinct trusts for IHT purposes with each created by one of the joint settlors.
Further, instead of being applied equally across all trusts created by the settlor, the SNRB would be applied to each new trust created by the settlor in such proportions as the settlor so elects. Each trust’s allocation would be in percentage terms so any future rise or fall in the IHT nil-rate band automatically feeds through. This is a key change as it avoids a large part of an individual’s nil rate band being wasted on a small settlement that would be unlikely to incur charges in any event.
The percentage of the SNRB allocated to a settlement can be increased, reduced or withdrawn altogether until the first payment point of the trust in question but cannot be reduced after that point. This first payment point will be the first 10-year anniversary of the trust or the occasion of an earlier exit. If property is later added to the trust, a further election (increasing the allocation) can be made provided the settlor has some SNRB available. The settlor will be responsible for making the election (prescribed) and for providing the trustees with a copy so that they can accurately calculate any IHT that becomes due.
Where no election has been made in respect of a trust, then the trustees must calculate the charge on the basis that no SNRB is available.
If the settlor should die, the personal representatives would have two years to make an election to either allocate the SNRB to trusts created by a will or to make sure that the deceased’s SNRB has been fully allocated between trusts made during their lifetime and on death.
The following simple example of how the revised model might work in practice for a single trust established after 6 June 2014 is given in the consultation document:
Mr Smith allocates 50 per cent of his SNRB to a settlement created in 2016 (that is, after the introduction of the new rules). Assuming the nil-rate band remains at the current level, the 10-year anniversary charge would be calculated as follows:
Value of settled property in 2026 – £500,000
Less allocated SNRB (50 per cent) – £162,500
Value subject to tax – £337,500
Charge at 6 per cent – £20,250
Settlement rate (20,250/500,000) – 4.05 per cent
Five years later, the trustees decide to pay £50,000 to one of the beneficiaries of Mr Smith’s settlement. The exit charge is calculated broadly along the same lines as it is now, that is, the “settlement rate” that applied at the last anniversary is apportioned according to the number of quarters that have since elapsed:
Settlement rate from 10-year anniversary – 4.05 per cent
Number of quarters elapsed since then – 20
Charge on exit (£50,000 x 4.05 per cent) x 20/40 – £1,012.50
Not all scenarios will be so simple.
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Tony Wickenden is joint managing director of Technical Connection