Simplified trust charges: the reforms continue

Transcription

1 ADVISER FACTSHEET Tech Talk July 2014 Simplified trust charges: the reforms continue This Tech Talk considers the consultation document Inheritance Tax: A fairer way of calculating trust charges recently published by HMRC. It also looks at how the proposed new settlement nil rate band could impact future inheritance tax planning. The proposals will affect the inheritance tax calculations for relevant property trusts created after 6 June 2014 and will apply a flat 6% charge to all relevant property trusts regardless of the date of creation. Contents The new settlement nil rate band The new 6% rate Implications for certain trusts Worked examples For professional advisers only

2 Introduction HMRC has issued a third consultation paper Inheritance Tax: A fairer way of calculating trust charges, aimed at simplifying inheritance tax (IHT) ten year and exit charges on relevant property trusts. We considered the proposals (now superseded by the latest consultation) within HMRC s previous consultation paper in our Tech Talk of June 2013 entitled Simplified trust charges, but what s the catch? The responses to HMRC s consultation document last year raised a number of concerns, and HMRC has now amended its solutions to simplifying the IHT regime for relevant property trusts. The latest consultation proposes the introduction of a settlement nil rate band ( SNRB ), separate and unconnected from the settlor s own personal nil rate band. The rules will apply to the following: all trusts created after 6 June 2014; additional funds placed into existing trusts after 6 June 2014; and changes made to existing settlements after 6 June 2014, resulting in relevant property coming into being, for example where an interest in possession trust created before 22 March 2006 amends the terms of its trusts to become a relevant property trust. A flat rate of 6% for periodic and exit charges will apply to all trusts regardless of the date of settlement. The new regime will apply to relevant property charges that occur on or after 6 April The background Under the existing rules, relevant property trusts each have the benefit of their own nil rate band (subject to certain transfers made by a settlor within seven years of a trust s creation). This allows individuals to engage in Rysaffe planning, establishing settlements on different (often consecutive) days to take advantage of multiple nil rate bands. Case study 2 in our June 2013 Tech Talk considered how this could result in an IHT saving. To counter Rysaffe planning, HMRC proposes a new SNRB to be split across all new relevant property trusts created after 6 June These proposals mean that it will no longer be possible to create multiple trusts which can each benefit from a full nil rate band. Relevant property trusts are all trusts excluding: interest in possession trusts with assets that were settled before 22 March 2006; an immediate post-death interest trust; a transitional serial interest trust; a disabled person s interest trust; a trust for a bereaved minor; and an age 18 to 25 trust. 2

3 The new proposals in outline Under the proposals, the settlor would allocate a percentage of the SNRB to each settlement created. It is intended that the date of the election would be totally flexible for each separate settlement and could be amended or withdrawn up until the due date for payment of the first IHT charge (either an exit or periodic charge, whichever occurs first). At this point, the percentage previously allocated by the settlor would be locked to the trust for the remainder of its life. The SNRB would rise in line with the nil rate band available to individuals. Once the allocated SNRB has been used in the calculation of an exit or ten year anniversary charge, the allocation of the SNRB to the trust cannot be reduced. HMRC has also proposed simplification of the IHT calculations undertaken whenever an exit or periodic charge is due. A flat 6% will apply to taxable property within a relevant property trust whenever there is an exit or periodic charge. The new proposals in more detail Periodic and exit charge calculations are to be simplified. It will no longer be necessary to include the following information in what are often complex IHT calculations: the value of funds held in related settlements (trusts created by the same settlor on the same day); and cumulative totals of chargeable transfers made by the settlor within the seven year period before the creation of the trust. However, it will still be necessary to calculate the settlement rate. The 6% charge will remove some of the steps in the calculations currently undertaken, and there will no longer be a requirement to calculate the effective rate. The following example demonstrates how the simplified calculations would work. EXAMPLE 1 Colin gifted 400,000 (after lifetime annual exemptions) to a discretionary trust in December He allocates 100% of the SNRB to the trust. In December 2024, the trust fund is worth 500,000. Assume that the SNRB is 375,000. Value of settled property in ,000 Less allocated SNRB (100%) ( 375,000) Value subject to tax 125,000 Charge at 6% 7,500 Settlement rate 7,500/ 500, % The ten year charge of 500,000 at 1.5% = 7,500. In December 2026, a distribution of 100,000 is made to one of the beneficiaries. The exit charge is calculated as follows: Settlement rate from ten year anniversary 1.5% Charge on exit: 1.5% x 100,000 x 8/

4 EXAMPLE 2 Colin had previously gifted 300,000 to a discretionary trust in January Under the old rules, he would have needed to add this back as it was a cumulative transfer made within seven years, but under the new rules, this is left out of the calculation. The new rules also simplify the calculation by applying the flat 6% rate in place of applying the 30% rate to the effective rate of the trust. The following example shows the tax charges under the old rules. Value of settled property in ,000 Value of chargeable transfers made within seven years of 24/12/ ,000 Less NRB ( 375,000) Value subject to tax 425,000 Charge at 20% 85,000 Effective rate 85,000/ 500,000 = 17% Actual rate 17% x 30% = 5.1% Rate of ten year anniversary charge: 500,000 x 5.1% 25,500 Exit charge Actual rate from ten year anniversary = 5.1% Charge on exit: 5.1% x 100,000 x 8/40 1,020 The new rules will place the onus upon the settlor to keep records of how the SNRB has been allocated and to notify trustees of each settlement of the allocation for that trust. The election must be made in writing by the settlor on a form prescribed by HMRC and the settlor must provide a copy to the trustees. By signing the election form, the settlor is declaring that the SNRB percentage allocated to the trust is within the maximum allowable. Where an existing trust receives further funds after 6 June 2014, the trustees will need to operate both the old and new regimes; the old regime will continue in respect of the pre-7 June 2014 funds and the new regime will apply to the post 6 June 2014 funds. The following points should be noted: A settlor will not be required to allocate a percentage of the SNRB at the date of creation of the trust. The allocated percentage can be altered at any time until the first IHT charge due date (six months after the end of the month an exit or periodic charge arises). A settlor can allocate additional SNRB (if available) on the gift of further assets into an existing trust. On the settlor s death, the executors will have two years to allocate any unused SNRB. They could allocate unused SNRB to trusts created either during lifetime or in the Will. 4

5 Advantages The new rules will give settlors a clean slate chargeable transfers made in the seven years prior to new (post 6 June 2014) trusts and related settlements will not be required to be included in IHT calculations going forward. The rules also allow the settlor flexibility to re-allocate any available SNRB if circumstances change. For example, if a trust is wound up during the settlor s lifetime, the SNRB allocated to the trust is available to be allocated to another trust. The application of the flat 6% removes some of the complexity of the calculations currently undertaken. Anti-avoidance measures HMRC announced that companies will not have the use of the new SNRB. This means that it will not be possible to benefit from multiple SNRBs by setting up companies as a vehicle for gifting. The consultation also announces that sanctions will be enforced against any settlor who attempts to allocate over 100% of the SNRB and against trustees who overstate or over-claim the SNRB based on carelessness or deliberate actions. Retrospective effect HMRC does not intend for the SNRB rules to apply retrospectively. This means that trusts created before 7 June 2014 will still come under the existing rules, except for the application of the new 6% charge. Implications for relevant property trusts to hold a member s death benefits When a pension arrangement is created under a trust based pension scheme, the date that the pension arrangement started is the reference date used when calculating periodic and exit charges on subsequent chargeable events. While the funds are held within the pension arrangement, they benefit from a specific exemption from an IHT charge. However, following the member s death, if the death benefits are transferred to a bypass trust, either a carve out trust or a pilot trust, the funds will no longer be exempt and will incur exit and periodic charges to the extent that the value of the funds exceeds the nil rate band. This is because section 81 IHTA 1984 applies and treats the death benefits as still deriving from the original settlement within the pension trust. 5

6 EXAMPLE 3 Dave made his first pension contribution to his trust based pension scheme in June He created a bypass trust in October 2016 and on its creation, assigned the rights to the death benefits from his pension to the trust. He dies in June 2030 and the trustees of the pension scheme transfer the death benefits, worth 600,000, into the bypass trust. The bypass trust still holds these funds in The funds did not incur a ten year periodic charge in June 2024 as the rights to the death benefits were of negligible value. In June 2034, the bypass trust will incur a periodic charge as follows (assuming that the nil rate band is 350,000): Value of settled property in ,000 Less NRB ( 350,000) Value subject to tax 250,000 Charge at 6% 15,000 Settlement rate 15,000/ 600, % The ten year charge of 600,000 at 2.5% x 16/40 = 6,000. The proposed new rules will not affect members who commenced trust based pension arrangements on or before 6 June 2014, even if the bypass trust to which death benefits will be paid is completed after 6 June What is unclear from the consultation document is whether any SNRB will need to be allocated to trust based pension schemes entered into after 6 June 2014 which are subject to a bypass trust or whether the decision can be delayed until the member s death. Pensions transferred between providers could be caught by the new rules where additional contributions are made to the new provider after 6 June The additional contributions may be deemed to be post 6 June 2014 settlements which fall within the new SNRB regime. Hopefully, the draft legislation, when available, will clarify the position. Implications for discounted gift trusts held on relevant property trusts SNRB will need to be allocated to discounted gift trusts settled after 6 June 2014 if they are to avoid IHT on ten yearly and exit charges. The SNRB allocated should reflect the value of the gift within the trust (i.e. the total value of the assets less the right to income retained by the settlor). Existing trusts will benefit from the simplified 6% rate and simplified calculations. 6

7 Implications for loan trusts held on relevant property trusts SNRB will need to be allocated to loan trusts settled after 6 June 2014 if they are to avoid IHT on ten yearly and exit charges. The proportion of SNRB allocated prior to a periodic or exit charge should take into account the value of the relevant property (the value of the assets in the trust less the value of the outstanding loan) at the first IHT charge. Existing trusts will benefit from the simplified 6% rate and simplified calculations. Implications for relevant property trusts holding life policies Trusts created after 6 June 2014 to hold life policies will fall within the new rules. It is unclear whether additional sums added to trusts created prior to 7 June 2014 to meet the premiums will be deemed to be additional settlements which bring these payments into the new regime. Hopefully there will be a specific exemption from the SNRB regime for additional premiums paid to policies held under trusts created prior to 7 June Existing trusts will benefit from the simplified 6% rate and simplified calculations. Potential pitfall There is no legal requirement that a settlor retains any role in any individual settlement after its creation. In practice, a settlor may wish to appoint themselves as a trustee while they are capable of acting, but there may well be instances where a settlor is not able to act. This could mean that trustees inadvertently lock the allocated SNRB to the trust, for example by advancing capital, without the settlor s knowledge, meaning that he cannot reduce the allocated SNRB to benefit a trust created at a later date. 7

8 EXAMPLE 4 Trustees locking in a high allocation of the SNRB Bill is a wealthy businessman. He settles 110,000 on each of three discretionary trusts in August 2015, paying any IHT due, the principal beneficiary of each trust being one of his three grandchildren. He does not appoint himself as a trustee as he spends a lot of time travelling for business and makes an election that each trust should get the benefit of 1/3 of the SNRB of 325,000. In September 2018, a fourth grandchild is born. Bill gifts 110,000 to a fourth trust. However, as funds have been withdrawn from Trusts 1 and 2 and the IHT payment dates have passed, the only allocation of the SNRB which can be altered is that of Trust 3. This might not be what Bill intended to happen. EXAMPLE 5 Trustees locking in no SNRB Ben, a widower, retires in August 2015 and at that time creates a discretionary trust for his grandchildren by placing 325,000 into the trust. He does not allocate any of the SNRB at the trust s creation and appoints a trust corporation to be sole trustee as he plans to travel the world and will not be available to carry out any duties as trustee while he is absent. In June 2017, the trustees decide to make a payment to one of the beneficiaries. Under the proposed SNRB rules, they are to assume that no SNRB has been allocated. The continued involvement of the settlor in allocating his SNRB to each trust suggests that he may need to have an ongoing input in trustees discussions of exit planning. What is the duty on the trustees in the above examples? Should they contact the settlor to confirm the allocated SNRB? If no SNRB is allocated, should they approach the settlor before making any distributions to ask if available SNRB can be allocated? If SNRB has been allocated, should they approach the settlor to confirm that the allocation will not be reduced before the due payment of IHT? What would happen if the SNRB was reduced between the date of payment of capital and the due date of payment? Who would be liable for any IHT due? 8

9 Conclusions The simplification of the IHT regime in respect of relevant property trusts is welcome, and the proposed SNRB will tackle the issue of fairness between those engaging in lifetime IHT planning and those who only pass assets on after their death. If you would like to discuss the contents of this Tech Talk in more detail, please contact the Technical Support Unit. However, the mechanism for allocating a percentage of the SNRB using the method outlined in the consultation document adds a layer of administration for both trustees and settlors. Full details of the new SNRB will not be available until the draft legislation is published in the autumn and the full implications of the new regime, including any specific exemptions, will not be known until the legislation is finalised. It remains to be seen whether trusts created for certain purposes, such as trusts to hold life policies or the death benefits of pension funds, will be subject to bespoke rules. Further information Joanna Fergusson Technical Manager Tax and Trusts Please do not hesitate to contact the Technical Support Unit with any further queries on: Tax and Trust Technical Support: taxtrust.techsupport@jameshay.co.uk Please note that every care has been taken to ensure that the information provided in this article is correct and in accordance with our understanding of current law and HM Revenue & Customs practice. You should note however, that James Hay Partnership cannot take upon itself the role of an individual taxation adviser and independent confirmation should be obtained before acting or refraining from acting upon the information given. The law and HM Revenue Customs practice are subject to change. The tax treatment depends on the individual circumstances of each client. James Hay Partnership is the trading name of James Hay Insurance Company Limited (JHIC) (registered in Jersey number 77318); IPS Pensions Limited (IPS) (registered in England number ); James Hay Administration Company Limited (JHAC) (registered in England number ); James Hay Pension Trustees Limited (JHPT) (registered in England number ); James Hay Wrap Managers Limited (JHWM) (registered in England number ); James Hay Wrap Nominee Company Limited (JHWNC) (registered in England number ); PAL Trustees Limited (PAL) (registered in England number ); Santhouse Pensioneer Trustee Company Limited (SPTCL) (registered in England number ); Sarum Trustees Limited (SarumTL) (registered in England number ); Sealgrove Trustees Limited (STL) (registered in England number ); The IPS Partnership Plc (IPS Plc) (registered in England number ); Union Pension Trustees Limited (UPT) (registered in England number ) and Union Pensions Trustees (London) Limited (UPTL) (registered in England number ). JHIC has its registered office at 3rd Floor, 37 Esplanade, St Helier, Jersey, JE2 3QA. IPS, JHAC, JHPT, JHWM, JHWNC, SPTCL, SarumTL and IPS Plc have their registered office at Trinity House, Buckingway Business Park, Anderson Road, Swavesey, Cambs CB24 4UQ. PAL, STL, UPT and UPTL have their registered office at Dunn s House, St Paul s Road, Salisbury, SP2 7BF. JHIC is regulated by the Jersey Financial Services Commission and JHAC, JHWM, IPS and IPS Plc are authorised and regulated by the Financial Conduct Authority. The provision of Small Self Administered Schemes (SSAS) and trustee and/or administration services for SSAS are not regulated by the FCA. Therefore, IPS and IPS Plc are not regulated by the FCA in relation to these schemes or services.(01/14) JHSTT 02 JUL14 LD 69