The Autumn Statement proposed a new simplification of relevant property trust taxation. This replaces the proposed settlement nil-rate band and is due to be incorporated into Finance Act 2015.
The new proposals are targeting ‘pilot’ trusts (typically where a trust is initially constituted with a nominal amount such as £10 in order to receive larger sums later) that receive legacies on death. This is achieved by amending the circumstances under which trusts are deemed to be ‘related’ to other trusts. Such trusts may now incur significant additional charges.
Background
The government has been consulting on how to simplify the rules surrounding inheritance tax on relevant property trusts for some years. This latest change replaces the planned settlement nil-rate band which would have impacted other lifetime trusts as well as will trusts, with which the industry has been uncomfortable in their complexity and administration.
The settlement nil-rate band would have increased the incidence of tax on lifetime gifting with the probable effect that many clients would have delayed or even foregone planning with trusts. This latest change effectively reverts to a version of the current rules for lifetime trust planning. However, clients who have set up a number of pilot trusts in their will may want to consider amending these provisions as these trusts will no longer do what they were intended to do.
Proposed changes
The basic tenet is that, for lifetime-relevant property trusts, we will have a very similar regime to today but, unlike today, without the need to take failed potentially exempt transfers (PETs) into account.
As today, relevant property trusts will each retain their own nil-rate band for calculating periodic and exit charges. The value of chargeable transfers made in the seven years prior to the trust in charge being set up will also still be considered.
In brief, the periodic and exit charges on the new definition of ‘related trusts’ will be increased, while the periodic and exit charges on non-related trusts will not be increased.
The new proposals also change the calculation of periodic and exit charges. Only gifts made to relevant property trusts will be considered.
Overall, the proposed changes are much kinder to typical lifetime planning using trusts than the settlement nil-rate band and are a slightly more generous version of the current rules. The changes only affect periodic and exit charges.
Related trusts
Under current rules, trusts are only ‘related’ when they are set up on the same day by the same settlor, regardless of any later top-ups to those trusts.
Where trusts are not related the current value of the trust hitting the charge is added to the initial value of chargeable transfers made in the seven years ending with the date the trust in charge was set up.
Where trusts are related and one hits a periodic or exit charge, the historic value of all related trusts is considered in the calculations in addition to the initial value of chargeable lifetime transfers made in the seven years prior.
Under the new proposals, adding funds to more than one trust on the same day at any point will result in those trusts being related. The most common scenario would be where funds are added to discretionary trusts and pilot trusts on death.
Calculating charges under the new rules
When a trust reaches a periodic charge, add up the current value of that trust; the historic value of any related settlement including same day additions; and the historic value of any relevant property settled in the seven years prior to the trust.
The excess over the standard nil-rate band at the date of the charge will be charged at 6 per cent.
The examples outlined in Box 1 and Box 2 demonstrate how the changes target pilot trusts rather than lifetime gifting by comparing the charges due under the current and proposed regime. They are based on our understanding of the draft Autumn Statement provisions and assume that the nil-rate band remains at £325,000.
Order of gifting
Failed PETs will no longer affect charges on trusts set up in the seven years following the PET. This removes the requirement to make chargeable lifetime transfers before PETs.
Order of gifting is still relevant where multiple chargeable lifetime transfers are made to reduce the impact of each on periodic and exit charges. For example, discretionary loan trusts (where there is no transfer of value) should still be set up before gift trusts. This avoids the historic value of the gift trust being taken into account when calculating periodic and exit charges on the loan trust.
Specific trusts
Spousal bypass trusts are normally pilot trusts and, when considered with the new pensions flexibility rules, now appear largely redundant.
Regular premiums to insurance policies held in trust are specifically excluded when considering whether a trust is a related trust. The premiums must be due at least annually.
Most relevant property trusts set up prior to 10 December 2014 are protected unless they are added to on the same day as another relevant property trust.
There is transitional relief to allow time for rewriting wills that currently utilise pilot trusts. Where the will was written before 10 December 2014 and the date of death is before 6 April 2016 the new definition of related trusts will not apply.
Victoria Harman is a chartered financial planner at Hargreaves Lansdown
