Tech talk

Attack on Potentially Exempt Transfers (PETs) and discounted PETs - TT16/06

Introduction

Prior to the Chancellor's Budget announcement, it was possible to create a PET by setting up an Accumulation & Maintenance (A&M) trust for children/grandchildren, or an Interest in Possession (IIP) trust.

For trusts established on or after 22 March 2006 (and additions of new assets to existing trusts), then this will only continue to be the case where the trust created in the settlor's lifetime is established for a disabled person.

The concept of a Discounted PET trust will therefore no longer exist for new trusts where the beneficiary is not disabled.

In view of the fact that we offer lifetime IIP trusts, but not A&M trusts, then the remainder of this bulletin will concentrate on the implication for our trusts.

Proposal

For trusts created on or after 22 March 2006 (or additions of new assets to existing trusts) then they will come under the same IHT regime as Discretionary Trusts. This regime is called the "relevant property" regime. It combines:

• An immediate "entry" charge of 20% on lifetime transfers that exceed the IHT threshold
  
• A "periodic tax charge of 6% on the value of trust assets over the IHT threshold every ten years
  
• An "exit" charge proportionate to the periodic charge when funds are taken out of a trust between ten year anniversaries

Implications for our trust range

SPILA Estate Planning Trust (Discounted Gift Trust)

Where set up on or after 22 March 2006

If set up for a disabled person then previous rules still apply

If not set up for a disabled person, then discount will still apply but the discounted gift will not be a PET but rather a chargeable transfer. If the value of this when added to the settlor's chargeable cumulative total is within the Nil Rate Band then no lifetime charge to IHT will arise. If however the Nil Rate Band is breached then the excess will be subject to an entry charge at 20%.

If a beneficiary dies, then his/her interest under the trust will not form part of that person's estate for IHT purposes (as it would have done previously). Similarly, if the beneficiaries are changed then this will not now be regarded as a PET by the "outgoing" beneficiary on the value of their interest under the trust.

Completion of form IHT100 is necessary for a settlor to inform HMRC regarding gifts which give rise to an immediate charge to IHT. This is required within one year of making the gift (it is not necessary to inform HMRC of PETs when they are made). Form IHT100 is only not required when the value of the gift plus other chargeable transfers in the same tax year do not exceed £10,000 and the gift and other chargeable transfers made by the individual in the previous ten years does not exceed £40,000.

The fact that a discount is merely suggested and not cast in stone therefore opens up the possibility of either the IHT100 form being completed with an incorrect valuation or IHT being underpaid when the chargeable transfer turns out to exceed the Nil Rate Band due to the discount being wrongly overstated.

There is an upside however in that if HMRC will now have to agree the value of the discount when the trust is created as opposed to when the settlor dies.

Existing SPILA Estate Planning Trusts (and existing SMI IHT Plan trusts)

The discounted PET previously made will be unaffected (though any addition of new assets will be subject to the new rules)

If a beneficiary dies their interest under the trust will continue to form part of their estate for IHT purposes

If the named beneficiaries are changed, then this will continue to be regarded as a PET by the "outgoing" beneficiary on the value of their interest under the trust

Other Trusts

1. Investments

The other trusts that we currently offer for investment bonds are as follows:

• Gift trusts (flexible and absolute)
• Family Inheritance Trust
• Gift & Loan Trust
• Nil Rate Band Trust
• Probate Trust

It is only the Gift Trusts and the Family Inheritance Trust which involve the creation of a PET. Therefore, for these trusts established on or after today then the initial investment will constitute a chargeable transfer with IHT at 20% payable on lifetime transfers in excess of the Nil Rate Band. Thereafter periodic and exit charges will apply as appropriate. As detailed earlier the trust fund will not form part of any beneficiary's estate as would have happened previously. The value of the initial transfer should be known with accuracy allowing for correct completion of form IHT100.

For those Gift Trusts & Family Inheritance Trusts already in existence then they will remain unaffected providing no new additions to the trust are made.

The "Gift & Loan" trust which we offer is in fact purely a loan arrangement with no gift now involved. Therefore, no PET was made. On the basis therefore that no initial transfer of value is included then it would appear that the creation of this trust will remain unaffected by the new regime. However , the beneficiaries will no longer have the growth as part of their estates for IHT purposes, therefore the trust could be subject to periodic and exit charges at some point in the future depending on the value of the trust fund. This will be clearer once the legislation is published.

The Nil Rate Band Trust & the Probate Trust both include the settlor as beneficiary during his/her lifetime. Transfers into these trusts do not therefore become exempt if the settlor survives for seven years. We are currently looking into how the new regime will affect these trusts.

2. Protection

The trusts currently offered for protection policies are as follows:

• Gift Trusts (flexible & absolute)
• Split Trust
• Business Trust
• Probate Trust

The Gift Trusts & the Split Trust are designed to ensure that any death benefit (which includes terminal illness benefit) is outside the settlor's estate on death for IHT purposes.

Payment of premiums by the settlor are typically exempt from IHT under the annual exemption or normal expenditure out of income exemption. If this is the case, then no "entry" charge implication should arise on new trusts. The fact that the new rules will also apply to additions of new assets to existing trusts should mean that trusts previously established for regular premium life policies will automatically fall within the new regime (i.e. trusts set up prior to budget day but premiums payable after). Although the settlor is unlikely to be affected by the new regime due to the exemptions mentioned above, the trust fund may in future be subject to the 'periodic' and 'exit' charges depending on the value of the trust fund.

A business trust set up under a proper commercial business arrangement should be unaffected where no transfers of value arise due to the reciprocal nature of events.

As detailed under the investments section, probate should be unaffected.

3. Pensions

We only offer discretionary trusts for pension purposes and therefore they will be unaffected

Conclusion

Although these proposals shall have to pass through Parliamentary Committee stages before being ratified under the Finance Act, it must be assumed that they will apply as intended. On this basis, advisors must bear in mind that an outright gift of an asset still constitutes a PET, but if done through the medium of an A&M or IIP trust then this will no longer apply where the beneficiary is not disabled.

For those individuals proposing to carry out lump sum IHT planning with one of our trusts, then (unless the beneficiary is disabled) the gift is going to give rise to a chargeable transfer - on which IHT may or may not be payable - as detailed earlier. Even if IHT is not payable, such a transfer is not as attractive as a PET as it can remain in the settlor's IHT cumulation for up to 14 years! The periodic and exit charges thereafter can be negligible but the calculations themselves are often complex. We will cover these aspects in future bulletins.

We will revise all our literature once the Finance Act has been passed, but in the meantime caution should be exercised when trust based solutions are being proposed.

Finally, please bear in mind that these are our very early thoughts, and we will give greater consideration to these matters in the coming weeks.

Graeme/Neil/Liz - March 2006