BN 25 - Aligning The Inheritance Tax Treatment For Trusts

Who is likely to be affected?

1. People who have set up, or have an interest in, “accumulation & maintenance” trusts (A&Ms) and/or “interest in possession” trusts (IIPs) that do not meet new inheritance tax (IHT) rules about their terms and the circumstances in which they are created.

General description of the measure

2. This measure refines the current IHT rules for A&Ms and IIPs. Trusts of this type that currently receive special treatment but do not qualify under the new rules will come within the mainstream IHT regime for “relevant property” trusts. This change will apply also to existing A&Ms and IIPs, subject to the transitional rules described below.

Operative date

3. The new rules will apply on and after 22 March 2006 to new trusts, additions of new assets to existing trusts and, subject to transitional provisions, to other IHT-relevant events in relation to existing trusts. Transitional rules will provide for a period of adjustment for certain existing trusts up to 6 April 2008, and for continuing exclusion from the “relevant property” charges if they satisfy conditions for ongoing protection.

Current law and proposed revisions

4. Part III, Chapter III Inheritance Tax Act 1984 (IHTA) provides a specific regime for “relevant property” trusts – broadly, those trusts in which no person has an interest in possession. It combines:

  • an immediate “entry” tax charge of 20% on lifetime transfers that exceed the IHT threshold into “relevant property” trusts;
  • a “periodic” tax charge of 6% on the value of trust assets over the IHT threshold once every ten years; and
  • an “exit” charge proportionate to the periodic charge when funds are taken out of a trust between ten-year anniversaries.

5. There are special rules for A&M trusts (section 71 IHTA) and IIP trusts (Part III, Chapter II IHTA). Lifetime transfers into these trusts are exempt from IHT if the settlor survives seven years, and the trusts are not subject to the periodic or exit charges.

6. Legislation in the Finance Bill will limit these special rules to trusts that:

  • are created on death by a parent for a minor child who will be fully entitled to the assets in the trust at age 18; or
  • are created on death for the benefit of one life tenant in order of time whose interest cannot be replaced (more than one such trust may be created on death as long as the trust capital vests absolutely when the life interest comes to an end); or
  • are created either in the settlor’s lifetime or on death for a disabled person (see section 89(4) IHTA).

Any other trusts will fall into the mainstream IHT rules for “relevant property” trusts.

New trusts

7. In the case of trusts created on and after 22 March 2006, this means that lifetime transfers into trusts are no longer eligible for special treatment unless they are set up for a disabled person. All other transfers will be immediately chargeable. Trusts that do not qualify for special treatment – whether they are created in life or on death – will be liable to the periodic and exit charges applying to “relevant property” trusts.

Existing A&M trusts

8. Where existing A&M trusts provide that the assets in trust will go to a beneficiary absolutely at 18 – or where the terms on which they are held are modified before 6 April 2008 to provide this – their current IHT treatment will continue.

9. Where they do not, the trust assets will become “relevant property” from 6 April 2008 and the periodic and exit charges will apply. Ten-yearly anniversaries will arise by reference to the original date of settlement. For the first ten years after 6 April 2008, the rate of charge will reflect the fact that the property has not been “relevant property” throughout a full tenyear period. For example, if the first ten-yearly anniversary falls in November 2008, it will be one twentieth of the normal charge.

Existing IIP trusts

10. The current rules for existing IIP trusts will run on until the interest in the trust property at 22 March 2006 comes to an end. If someone then takes absolute ownership, this will be a transfer by the person with the interest in the property – either a transfer on death or a “potentially exempt transfer” if they are still living – and will receive the same IHT treatment as now. The trust will have no further IHT consequences.

11. If the interest comes to an end so that the property remains on trust, this will be treated as the creation of new settled property;

  • if it comes to an end during the lifetime of the person beneficially entitled to it, this will be a transfer creating “relevant property” (unless the new trusts are for charitable purposes) and will therefore be immediately chargeable; and
  • if the interest comes to an end on death, it will form part of the person’s IHT estate as now and the settled property will then become “relevant property” (unless the charity exemption applies).

In both cases, the periodic and exit charges will apply.

12. However, any new IIP that arises when an IIP created before 22 March 2006 comes to an end before 6 April 2008 – whether on death or otherwise – will be treated as an IIP that was in place on 22 March 2006.

Gifts with reservation

13. Where an individual is beneficially entitled to an interest in settled property, and continues to be treated for IHT purposes as owning the property, a termination of the interest in the individual’s lifetime on or after 22 March 2006 will be treated as a gift for purposes of the IHT “gift with reservation” rules. So if they retain the use of the settled property after their interest in it ends, it will remain chargeable in their hands in the same way as if they had formerly owned it outright.

Capital gains tax consequentials

14. Changes to the IHT treatment of trusts will have a number of implications for CGT:

  • transfers into and out of trusts that will now come within the “relevant property” rules will automatically be eligible for hold-over relief under Section 260(2)(a) Taxation of Chargeable Gains Act 1992 (TCGA);
  • hold-over relief under Section 260(2)(d) TCGA will be restricted to trusts that meet the new IHT rules for trusts for minor children;
  • the special rules in Section 72 and Section 73 TCGA relating to the death of a person entitled to an IIP will be restricted to assets that are subject to an IIP which meets the new IHT rules.

Further advice

15. If you have any questions about the changes, please contact the Probate/IHT Helpline on 0845 3020 900.