Tech talk
Budget 2006 - Trust Changes - TT25/06
Tech Talks 16/06, 17/06 and 18/06 considered the impact of
the Budget and the subsequent Finance (No. 2) Bill 2006 proposals
published on 7 April 2006. As explained in TT18/06, ongoing
discussions between the professional bodies and HMRC on some
aspects of the new rules meant that changes could arise on
the Bill as it progresses through Parliament. The good news
is that changes to the Bill have indeed been tabled as outlined
below. This Tech Talk therefore updates earlier bulletins.
Bereaved Minors Trust
To recap, the Budget ended the possibility of creating new
Accumulation & Maintenance (A&M) trusts by parents/grandparents
during their lifetime. Instead, the concept of Bereaved Minors
Trusts was introduced.
The original Finance Bill proposals stated that from 22 March
2006, a trust created on death by a parent for a minor child
would fall into the mainstream discretionary trust ('relevant
property') regime unless the child became fully entitled to
the trust assets at age 18. In other words if the child was
not to become fully entitled by age 18 (and assuming the child
was not disabled) then the trust would be subject to periodic
and exit charges from the date of death of the parent. Accordingly,
the tax favoured rules for Bereaved Minors trusts were only
available in very restrictive cases.
Amendment
Favoured trust status can now apply to trusts continuing beyond
age 18, so long as the beneficiary will take the trust assets
absolutely no later than age 25. Assuming this is the case
then:
- Trust assets will be exempt from periodic charges while
the beneficiary is under 18
- Periodic charges will then only start to apply if trust
continues beyond age 18
- If trust continues for a maximum 7 more years to age 25,
then the capital leaving the trust will be subject to 7 years
worth of charge on exit , i.e. 7/10 x 6% = 4.2% max
- If beneficiary became absolutely entitled at (say) age
20, then the maximum exit charge would be 2/10 x 6% = 1.2%
If however the will trust is fully flexible with no certainty
as to when the child will receive his/her share, then the
discretionary trust regime (i.e. the 6% regime) will apply
from date of death.
How does the amendment affects existing A&M trusts
The original Finance Bill proposals stated that if an A&M trust was established before 22 March 2006, then the trust
assets will fall within the periodic and exit charge regime
from 6 April 2008 unless the trust provides that the beneficiary
will become absolutely entitled at 18 - or the trust terms
are modified before 6 April 2008 to provide for this.
The amendments therefore also apply to the existing A&M trusts in the sense that these trusts should be modified prior
to 6 April 2008 to reflect the 18 - 25 provisions. Assuming
that is the case, then where the beneficiary is under age
18 at the end of the transitional period on 6 April 2008,
the 6% regime will not apply until the beneficiary attains
age 18 (it must then come to an end by age 25 at the latest).
Surviving Spouses
The Finance Bill introduced the concept of an "Immediate
post-death interest" (IPDI).
For deaths on or after Budget day, a will trust (or one arising
under intestacy) is subject to the discretionary trust regime
unless an IPDI is created. Broadly this required an interest
to arise immediately on death:
- Which could only be terminated in the life tenants
favour or with their consent
- Which will end with the trust property passing into
absolute ownership, or onto trusts for a minor child, a disabled
person or charity
Under the original proposals therefore a very simple will
trust with income payable to surviving spouse/civil partner
for life and remainder to children absolutely would qualify
as an IPDI (and avoid the discretionary trust charges). If
however the remainder interest continued in trust for children
(rather than passing to them absolutely on death of the life
tenant), then it would not qualify. Similarly, the existence
of a standard power of appointment exercisable by the trustees
in favour of a range of beneficiaries also breached the qualifying
condition.
To appreciate why it is desirable to create an IPDI, consider
a will trust creating an IPDI with the life tenant being surviving
spouse/civil partner. If so, the gift into trust on death
qualifies for the IHT inter spouse exemption. If however the
trust does not qualify as an IPDI then it would be taxed as
a discretionary trust with no inter-spouse exemption available.
This posed a major problem since many wills had already been
drafted comprising a nil rate band discretionary trust, and
residue then passing into a flexible interest in possession
(IIP) trust in favour of surviving spouse/civil partner. The
aim of these wills was clearly to avoid an IHT liability on
first death, yet if the Budget proposals were enacted then
an IHT liability would have arisen on estates above the nil
rate band.
Amendment
The requirement for there to be an absolute interest following
the life tenant's death has been dropped. In addition it will
no longer be necessary for the life tenant to consent to their
interest being ended. Therefore, a flexible will trust with
surviving spouse/civil partner being the life tenant, but
with powers for the trustees to appoint to a range of beneficiaries
(e.g. children, grandchildren); then this will qualify as
an IPDI, and therefore enjoy the benefit of the inter-spouse
exemption at time of first death.
S144 IHTA 1984
Many individuals when drafting wills are unsure how their
estate should be distributed on their death. If so, a common
solution is to leave the estate (or part of it) to be held
on discretionary trust. S144 allows distributions to be made
from discretionary trusts within two years of death as if
the gifts had been made by the deceased, and crucially without
any charge to IHT (as there would normally be for property
leaving a discretionary trust). The trustees therefore could,
within this two year period, distribute assets or declare
further trusts as they see appropriate, or perhaps act in
accordance with a letter of wishes drafted by the deceased.
Under original proposals, if S144 was used to create a life
interest for surviving spouse then this did not constitute
an IPDI (since it did not arise immediately on death). Consequently
the inter spouse exemption would not be available.
Amendment
If S144 is being used, then the amendment ensures that the
trustees can create a Bereaved Minor trust, an 18-25 trust,
or an IPDI as if they had been created in the will.
Life Policies in Trust (IIP or A&M) Prior to Budget Day
It was explained in TT18/06 that life assurance policies
entered into before Budget day would not be subject to the
new regime as a result of continuing premium payments made
after Budget day. This was not detailed in the Finance Bill
itself but instead arose from the fact that it was considered
that premium payments were a means of fulfilling a contractual
obligation with the life office rather than constituting "additions
of new assets to existing trusts". That was all well
and good, but it was unclear whether contractual changes to
increase premiums or options to increase premiums could change
this opinion.
Amendment
The Finance Bill has been amended to clarify that where a
life policy (a "contract of life insurance") was
settled on either an IIP or A&M trust before Budget day,
but premiums continue to be payable after that date, then
the whole value of the policy qualifies for transitional protection
as an asset of a pre-Budget settlement. That will apply to
cases where the policy terms are varied on or after Budget
day so long as the original terms of the policy provide for
this. The amended legislation terms this as an "allowed
variation" defined as "… a variation that takes
place by operation of, or as a result of exercise of rights
conferred by, provisions forming part of the contract immediately
before 22nd March 2006."
Life Policies in Existing IIP Trusts
The proposals originally stated that the existing rules for IIP trusts would continue until the interest in existence
at 22 March 2006 ("the prior interest") came to
an end. If the property remained on trust despite that interest
ending, then it would be treated as the creation of new settled
property. Therefore if the life tenant died and the trust
continued, it would form part of that person's IHT estate
(as before) but the trust fund would then become 'relevant
property' subject to periodic and exit charges. If however
the original life tenant dies before 6 April 2008 (or there
is a lifetime termination of their "prior interest")
before then, the new interest arising after that death will
be treated as if it was in place on 22 March 2006. This new
interest is called a Transitional Serial Interest (TSI).
Amendment
Whether the original life tenant dies before or after 6 April
2008, and following their death the property remains on trust,
then the trust fund will not then become subject to periodic
and exit charges. In addition, if the original life tenant
dies before 6 April 2008, and the interest passes to a new
life tenant who then has a TSI, then on that person's death
the trust fund will again not become subject to periodic and
exit charges.
Note however that a TSI can arise not only on death of the
person holding the "prior interest" before 6 April
2008, but also where that "prior interest" is the
subject of a lifetime termination before 6 April 2008. In
this latter case, the Finance Bill amendment has no effect
since it only applies where the original life tenant dies
before 6 April 2008.
Graeme Robb - July
2006