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When the Poat comes in

How do the pre-owned assets tax rules apply to business insurance?

Insufficient business insurance is put in place, partly because of its perceived difficulty. That the pre-owned assets tax could apply to policies held in business trusts does not help as it adds another layer of confusion and potentially another reason to procrastinate.

HM Revenue & Customs originally made the following statement with regard to business trusts in its guidance notes on Poat:

“A partner in a business effects a life insurance policy subject to a business trust. The partner is a potential beneficiary.

“Provided the arrangement is commercial, it is not a gift with reservation for inheritance tax. However, the trust is a settlement for inheritance tax purposes and a charge to tax will arise under paragraph 8 of this schedule.”

This was then superseded by the following guidance released on the HMRC website on April 4, 2005:

“In some cases, policies are taken out on each partner’s life solely for the purposes of providing funds to enable their fellow partners to purchase his/her share from the partner’s beneficiaries on their death. The partner is not a potential beneficiary of his/her own policy. In such circumstances, a charge to tax under paragraph 8 of this schedule [that is, schedule 15, FA 2004] will not arise.

“However, in many cases, the partner retains a benefit for themselves, for example, they can cash in the policy during their lifetime for their own benefit.

“In such cases, even if the arrangement is on commercial terms so that it is not a gift with reservation for inheritance tax, the trust is a settlement for inheritance tax purposes and a charge to tax under paragraph 8 will arise.”

Life policies will typically be effected subject to these trusts, with the main objective being to enable cash to be placed in the hands of the co-business owners on the death of a business owner. While HMRC talks in terms of partners, these arrangements are also frequently set up by shareholders in a private limited company.

Under the terms of a typical trust, only business owners who are participating in the overall arrangement will be able to benefit. Spouses and family members who are not also participating business owners should be excluded.

However, in order to provide flexibility should the settlor leave the business, the settlor will be a beneficiary, either as a member of a discretionary class to whom appointments can be made or as a beneficiary who will benefit on leaving the business when benefits revert to him or her automatically under the trust. Some trusts may incorporate both provisions.

As indicated above, HMRC has expressed the view that, provided the arrangement is a commercial transaction, that is, only participating business owners can benefit and each business owner pays an amount commensurate with his or her expected benefit under the arrangement, so that the arrangement is demonstrably on arm’s-length terms, there will be no donative intent and no transfer of value. Therefore, in reliance on the exemption in section 10 IHTA 1984 (exemption for dispositions not intended to confer a gratuitous benefit), no gift with reservation issues arise.

In this respect, so-called equalisation arrangements ensuring that the total cost of premiums is born equitably will be extremely helpful. The main driver for these will be commercial but they will also deliver a valuable tax benefit. As the April 2005 statement by HMRC indicates, however, the official view is that, despite commerciality, the trust is a settlement and, as the settlor can benefit and the gift with reservation rules do not apply, the Poat rules could apply.

Of course, the Poat rules can only apply if the settlor can benefit under the trust. So a business trust under which the settlor is excluded from all benefit will not give rise to any Poat problems. Where the settlor can benefit, it will be in two possible ways. The first is where the settlor is one of the potential beneficiaries to whom the trustees can make an appointment of benefits, perhaps if he or she leaves the business. After the appointment, which would be exempt from inheritance tax, the trustees could then advance the policy to the settlor in satisfaction of his or her absolute beneficial interest. The beneficial and legal ownership of the policy would then converge in the hands of the settlor. Care wouldneed to be taken so that a subsequent capital gains tax charge did not arise on the payment of policy benefits.

If, subject to the CGT warning immediately above, the policy were assigned by the settlor into a trust for his or her family, care should also be exercised over the amount of the transfer of value for IHT. Provided the life assured were in good health and there was no surrender value in the policy, then if the policy was a term insurance policy, there would be no transfer of value. If the policy were other than a term policy, then the transfer of value would be equal to the surrender value or premiums paid if greater.

However, even with a life policy and a life assured in good health, the ascertained benefit is likely to be significantly below the de minimis limit for the Poat charge to apply. This is because unless the policy value is currently greater than 100,000, the ascertained benefit will not exceed the de minimis limit of 5,000.

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