If you have a Will containing trusts or two or more lifetime trusts, you may be affected by some proposed changes to the taxation of relevant property trusts.
HMRC has recently put forward some proposed changes to the way relevant property trusts will be taxed, which could impact on both new and existing trusts. If you have the type of trust which is affected, you need to be aware of these potential changes. Although the rules are not yet finalised and the detail will not be clear until they are implemented, you may want to start managing your trust now in a way that will minimise the impact of these changes should they be implemented.
Which trusts are affected?
Trusts are commonly used for tax planning purposes, to reduce the amount of tax payable on death.
The tax changes apply to relevant property trusts which are created, or added to, after 6 June 2014. Virtually all new gifts to lifetime trusts (except those for the benefit of disabled beneficiaries) will be affected, as well as will trusts created by a Will.
A relevant property trust is typically a discretionary trust created in lifetime or by Will at any time in the past and most other forms of trust created on or after 22 March 2006. Many investment products are written in trust and you may have created relevant property trusts as part of the investment process. If in doubt about the arrangements you have you should seek professional advice.
The current position
Under the current rules relating to the taxation of relevant property trusts there are potential charges to inheritance tax (“IHT”):
- on creation of the trust – a maximum rate of 20% of the value added to the trust above the IHT nil rate band;
- when property leaves the trust – a maximum rate of 6% of the value leaving the trust; and
- on every 10 year anniversary of the trust’s creation – a maximum rate of 6% of the value in the trust on the anniversary date.
In broad terms, each trust has its own IHT nil rate band (currently £325,000), which is deducted before calculating the tax payable. Only the excess value over the nil rate band is chargeable to tax. The calculation can be more complicated though if you have made lifetime gifts or set up more than one trust on the same day.
Provided those trusts are not added to after 6 June 2014 and there is no change in the trust structure (for example, the death of a life tenant with on-going trusts) they should retain their nil rate bands.
The proposed changes for post 6 June 2014 relevant property trusts
All relevant property trusts created or added to after 6 June 2014 will fall within the proposed new rules, including trusts created by or added to by Will.
The new rules introduce a new concept: a ‘Settlement Nil Rate Band’ (SNRB). This is a single nil rate band, unaffected by gifts made by the Settlor, to be shared by all relevant property trusts created by the Settlor which fall under the new rules. The Settlor (or his personal representatives within two years of his death) can determine by election to HMRC what proportion of the SNRB will be allocated to each of the trusts.
The rate of IHT payable under the new rules will be:
- on creation of trust – a maximum rate of 20% of the value added to the trust above the IHT nil rate band;
- on every 10 year anniversary of the trust’s creation – a flat rate of 6% on the value of the trust assets at that date less the SNRB allocated to that trust; and
- on transfers out of the trust – the maximum charge will be 6% of the value leaving the trust.
Mary, a widow, has made a Will leaving her estate equally between two discretionary trusts created before she signed her Will, one for each of her children and their families.
On Mary’s death, shortly after the trusts were created, £350,000 goes into each trust. Ten years after the trusts were set up this has increased in value to £500,000 in each trust and no distributions have been made.
If Mary died before 6 June 2014 the old rules will apply. On the ten year anniversary the tax payable by each trust will be £10,500 (if the nil rate band is then £325,000) as each of the two trusts will benefit from a nil rate band (£500,000 – £325,000 x 6%).
By comparison, if Mary dies after 6 June 2014 the new rules will apply. The IHT payable on the ten year anniversary will depend on the SNRB that each trust enjoys. So if Mary, as Settlor, made an election to split the SNRB equally between each trust, assuming that the SNRB is £325,000, the IHT payable will be £20,250 for each trust (£500,000 – £162,500 x 6%). So the effect of the new rules is to almost double the amount of IHT payable.
If Mary (or her executors within two years of her death) does not elect to allocate any SNRB each trust will pay 6% of the value in the trust at the 10 year anniversary and so will be liable for £30,000 per trust.
However if Mary did not use trusts but had left her estate directly to be divided equally between her two children, each family would be liable for up to £200,000 of IHT if, at the date of death of the child, the value of the inheritance had increased to £500,000.
Practical effects of the proposed changes
- If your estate planning has involved the creation of more than one relevant property trust before 6 June 2014 then adding more assets to these trusts should be avoided as the new gift will then fall within the new rules, potentially increasing the IHT charges significantly and making the calculation of tax more complicated.
- Trusts created to receive money or assets left by Will (as in Mary’s case) will be affected.
- Similarly, trusts created to receive death benefits under pension schemes may be caught by the new rules once a death triggers the payment of benefits to the trust. This will only be a disadvantage if more than one trust has been created.
- If you have a Loan Plan and have given the outstanding loan to the loan plan trustees in your Will then this may need to be reconsidered, as the gift of the loan will be regarded as adding property to the trust, so bringing the value of the loan within the new rules.
- You should keep records of your trust arrangements so that it can be determined how much of the SNRB is available to any particular trust. The election allocating how much of the SNRB is applied to each trust should be considered carefully as part of overall estate planning.
This article is based on the content of the consultation paper. There may well be further changes after the consultation closes on 29 August 2014 in the effect of the rules that may alter our understanding of the impact of the proposed new regime.
If you are affected by this change, or are unsure as to whether you are affected, you should seek professional advice. Please do not hesitate to contact to any member of our Private Client team for further information.