RSS feedsHave potential exempt transfers (PETs) been abolished?
No, but the list of lifetime transfers that qualify as PETs has been severely shortened. Previously, outright gifts, gifts to interest in possession (IIP) trusts, gifts into accumulation and maintenance (A&M) trusts, and gifts to disabled trusts all qualified. From now on, only outright gifts and gifts to disabled trusts will be PETs. Gifts to IIP or A&M trusts will be chargeable to inheritance tax at a rate of 20% to the extent that the value of the gift exceeds the transferor’s inheritance tax ‘nil rate band’.
Will this be the only tax charge?
No, if the value in these trusts exceeds the then ‘nil rate band’ at the ten-yearly anniversary of the trust, there will be a charge of up to 6% on the excess value. Likewise, when assets leave these trusts there can be a proportionate ‘exit’ charge. Essentially, new IIP and A&M trusts will be taxed in the same way that discretionary trusts have been taxed to date.
What about existing trusts?
Trusts already in place on Budget day will not be immediately subject to the new charges. Existing IIP trusts will avoid the ten-yearly and exit charges for as long as the existing life tenant’s interest continues. Existing A&M trusts will avoid these charges until at least 6 April 2008. After that date, if the terms of the A&M trust provide for capital to be paid to a beneficiary at 18, they will continue to avoid the charges. Otherwise – for example, in the very common case where a beneficiary receives a right to income at 25 – the charges will start to apply from 6 April 2008 and in such a case there would then be an ‘exit’ charge when the beneficiary reached 25.
What happens when an existing IIP trust comes to an end?
Because existing IIP trusts are taxed under the old rules, it will depend upon whether this happens on the current life tenant’s death or during their lifetime. If it happens on death, the assets of the trust will be treated as forming part of the life tenant’s estate. If this happens during the life tenant’s lifetime, the life tenant will be treated as making an inheritance tax ‘transfer of value’, which would ordinarily qualify as a PET only if the trust assets passed outright to someone or if a disabled trust arose.
There are special rules, however, that would also treat this event as a PET if another interest in possession trust arises on the termination of the original IIP before 6 April 2008. Where an existing IIP terminates in favour of the life tenant’s spouse, the inheritance tax exemption will apply at any time if the spouse gets an absolute interest and will also apply if the spouse gets a life interest before 6 April 2008, but not after that date.
Will spouse exemption be available when someone leaves assets to a spouse under a will?
If the spouse gets an absolute interest, yes it will. If the spouse takes a life interest, however, it will depend upon the precise terms of the life interest trust. If it is a simple trust for the wife for life with remainder to adult children, spouse exemption should be available. If, however, the spouse’s interest can be terminated in favour of other beneficiaries without the spouse consenting or being a party to the decision, it will not be.
Likewise, if the trust provides for the children to get interests in possession at the end of the spouse’s life interest, relief will also not be available. This is one of the most controversial and also the most technical aspects of the new legislation and the rules in this area may change before the finance bill receives royal assent.
Where gifts are held in trust for a testator’s child under a will, is such a trust liable to a 6% charge?
If the terms of the trust are that the child gets the trust fund at 18 and before that time nobody other than the child can receive any of the trust income – either as of right or at the discretion of the trustees – then the 6% charge will be avoided. If the child receives the assets at a later age, or if such a trust arises under a grandparent’s will – for example, for a grandchild who’s own parents had died – then if the trust fund is large enough, a 6% charge could arise.
Is there any good news in all these changes?
Yes. The introduction of a 6% ongoing charge for IIP trusts applies only if the value of those trusts exceeds the nil rate band. However, whether or not the value of the trust fund exceeds the nil rate band, the assets of such trusts will no longer be taxed as part of the life tenant’s estate. In effect, a potential 40% inheritance tax will be avoided with no alternative tax cost replacing it if the value of the trust assets are below the nil rate band.
To this extent there may be a kamikaze element to these changes if the overall intention was to collect more tax overall. If, however, the intention was to make it more difficult for the very rich to plan, in theory the changes will block a lot of planning that we have been used to using, but, in practise, alternative ways of 'skinning the cat' are likely to arise.
Ian Maston is a director of estate planning at Chiltern plc or mastoni@chilternplc.com
