Stick with tried and tested solutions

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Stick with tried and tested solutions

HM Revenue & Customs' latest efforts to beef up inheritance tax (IHT) avoidance measures should hold no fear for advisers or their clients provided they stick with tried and tested solutions.

Schemes regarded as an established practice which HMRC have indicated their acceptance of, such as discounted gift trusts, remain outside the need to report under the new rules. 

What is Dotas?

The disclosure of tax avoidance schemes (Dotas) requires promoters of new schemes which are set up to obtain a tax advantage, to disclose the main elements of the scheme to HMRC. As such, it acts as an early warning system allowing HMRC to challenge them if it is believed they are abusive.

Only a handful of new schemes have notified HMRC of their existence since the rules were extended to include IHT. As a result HMRC has strengthened the IHT Dotas rules to ensure that schemes are not slipping through the net undetected. 

Previously certain scheme promotors could rely on ‘grandfathering rules’ to escape the need to disclose their scheme details to HMRC. This was the case provided the new scheme was essentially the same or substantially similar to a scheme which was already in existence prior to April 2011.

What’s changed?

But all that has now changed. From 1 April this year the grandfathering rules ceased to apply and new IHT hallmarks were introduced. 

Under the new hallmark, a scheme will need have to be reported if it enables someone to obtain an IHT advantage and it involves one or more contrived steps in order to achieve it. Broadly this could be any of the following:

•    The avoidance or reduction of relevant property charges (entry/periodic or exit charges).

•    The avoidance or reduction of a gift with reservation (unless caught by pre-owned assets tax (POAT).

•    A reduction in someone’s estate which does not give rise to a potentially exempt transfer (PET) or chargeable lifetime transfer (CLT).

While there is no longer any grandfathering rules for existing estate planning schemes to rely on, the new rules do include an exemption for certain schemes. Any schemes which were established practice prior to 1 April 2018 will not need to report, provided HMRC has indicated their acceptance of these schemes. 

Why does it matter?

Having to report does not automatically mean that an arrangement is not effective. But the reporting process can still cause concern. There are no automatic reporting requirements for advisers; this falls upon the scheme promoter. 

Scheme promoters have to notify HMRC of their scheme to obtain a scheme reference number and have to provide HMRC with lists of clients who have used the scheme. 

The reference number has to be passed to any users of the scheme on the HMRC form AAG6. This form pulls no punches and leaves clients in no doubt that they may be involved in tax avoidance and the possible consequences of their actions. 

What does it mean for estate planning?

Straightforward gifts into absolute, flexible or discretionary trusts are not affected. There are no additional steps involved and there is no reduction in relevant property charges or potential gifts with reservation issues.

Similarly loan trusts (and gift and loan trusts) are established by lending money to the trust and do not fall foul of the new tests.

On the face of it the new tests appear to catch certain mainstream packaged IHT solutions such as discounted gift trusts and flexible reversionary trusts. 

However, there are some obvious examples of published HMRC guidance that demonstrates their acceptance of these schemes, which provide comfort that they remain effective and outside the need to report. 

Discounted gift trusts

Discounted gift trusts (DGTs) generally involve a gift into trust where the settlor retains a right to future payments from the trust. The value of these rights reduces the amount gifted for the purposes of IHT, ‘the discount’. 

This discount reduces the relevant property entry charge. In addition the settlor can continue to enjoy the retained payments without causing a ‘gift with reservation’. 

This tax result could not be achieved without taking steps to divide up the interests of the settlor (the retained payments) and the beneficiaries (the remaining fund after the settlor’s death).

Thankfully, there is plenty of HMRC guidance to give comfort that DGTs are established and accepted practice. HMRC IHT manual confirms that provided the settlor’s retained rights are clearly defined, there is no gift with reservation and they have also published guidance on how discounts should be calculated. 

Flexible reversionary trusts

These schemes are similar to discounted gift trusts in that there is a gift into trust and the settlor retains a right to future capital payments. The key difference is that the settlor can choose to either defer these payments or not take them at all. As a result there is no discount available on these schemes and the full amount paid in will be a gift for IHT.

Until now there has not been the same published guidance from HMRC on their acceptance of flexible reversionary trusts. However, they have now updated the HMRC IHT manual to reflect their acceptance that there is no gift with reservation provided the settlor’s rights are carved out separately from those which have been gifted. 

It is worth noting that ‘established and accepted practice’ is not a generic exemption which can be applied to all discounted gift trusts and flexible reversionary trusts. Instead it operates at each individual scheme level. This means any future development or innovation within these products will take place under the watchful gaze of HMRC and any providers who make changes to their scheme will need to notify HMRC.

Clients seeking clarity and certainty that the plans they have put in place to reduce their IHT liabilities need to stick with tried and tested mainstream solutions. New schemes offering bells and whistles are only likely to attract unwanted attention from HMRC.

Dave Downie is technical manager at Standard Life