Proposals will restrict trust’s nil rate band, says Peter Shand
For the past two years, the government and the taxman have been reviewing and proposing changes to the tax treatment of trusts in the UK. Earlier this year, the government published its latest proposals and we will find out in the Chancellor’s autumn statement, on Wednesday this week, whether those proposals will become law.
Trusts are set up in the UK for a variety of reasons. Grandparents set up trusts for their grandchildren. Parents set up trusts to purchase flats for their children at university. Families set up trusts to help pass assets down the generations. Trusts feature regularly nowadays when people make their Will to avoid assets being inherited by immature beneficiaries. And trusts are commonly used to accommodate the proceeds of life assurance policies. The reasons are often not tax-driven. But there are tax implications nonetheless, which are likely to change this week.
The taxation of trusts was last overhauled more than eight years ago. As it stands, the vast majority of trusts that were set up after 22 March 2006 are caught by special inheritance tax rules. Those rules include a mechanism which can trigger a charge to inheritance tax on each ten year anniversary after a trust is set up, and whenever a lump sum of capital is withdrawn from the trust.
Calculating the amount of the inheritance tax charge is not for the faint-hearted. The complex formula takes into account the value of the trust and whether or not it exceeds the “nil rate band” which is the threshold beneath which the trust might escape any ten year charges.
The latest proposals, which are likely to be ratified on Wednesday, would simplify some aspects of the tax calculation but, critically, they will restrict the nil rate band that is available to any trust created after 6 June 2014.
The restriction in the proposals arises from the “simplifying” provisions in the detail of the rules. Up until now, it has long been accepted that an individual may set up more than one trust over his or her lifetime, or in his or her Will and, with careful planning, each trust enjoyed its own nil rate band. Traditionally this has afforded a way of multiplying the tax free threshold for individuals who have more than one trust.
The new proposals would restrict that practice and mean that there will now be only one single nil rate band which must be shared among all trusts established by an individual after 6 June 2014. To make matters more complicated, if an individual adds cash or assets to an old trust which was set up under the old rules, those additions will be treated as the creation of a new trust and caught by the new rules. In other words, the old trust fund will be subject to the old rules and the new additions will be subject to the new rules.
The changes mean that, going forward, when someone sets up a trust, for whatever reason, he or she must confirm, in writing, what percentage (up to 100 per cent) of their own nil rate band should be enjoyed by that trust. Similarly, on someone’s death, the executors will need to allocate any nil rate band among any trusts that have been created by the deceased during his or her lifetime or under his or her Will.
The changes could have a big impact on life insurance trusts. When putting life insurance in place it is common to gift the policy death benefits to a trust. Indeed, the insurance company often encourages this by providing a template form which can be completed to enable a gift to be made into a trust.
Under the existing rules, life insurance trusts rarely have to consider inheritance tax. However, the new rules mean that inheritance tax will be a key consideration for the financial services sector, and the existence of such trusts may affect the inheritance tax treatment of other trusts established by the same person.
The final say on the detail of the rules will be announced on Wednesday and, in all likelihood, changes will be triggered from April next year. Whilst the use of trusts during lifetime, and on death, will still form an integral part of all financial planning, the tax consequences need to be handled with care. • Peter Shand is a partner with Edinburgh law firm, Murray Beith Murray