Finance Act 2006 - Everyday Law Spring 2007

01 April 2007

22 March 2006 marks a very important moment in the history of Inheritance Tax (IHT). From this date, a new and widereaching taxation system for IHT applies to many trusts. The new legislation is found in the Finance Act 2006.

In proposing the new legislation, the Government’s view was that children should be trusted with absolute entitlement to assets from the age of 18. Many practitioners strongly disagree.

The new rules affect the tax treatment of trusts, whether set up for tax planning purposes or for non-tax reasons such as protecting a person’s wealth from their own unsuitable financial decisions or delaying receipt of funds until a later age. Trusts can be set up during lifetime, or on death under the terms of a Will or through application of the intestacy rules.

In general, most trusts set up after 22 March 2006 will incur an immediate charge to IHT on the value passing into trust which exceeds the nil rate band allowance available, at the tax rate of 20%. There will also be a charge to IHT on two events, namely:

• On every tenth anniversary of the trust; and
• Every time capital is paid out of the trust to or for the benefit of a beneficiary.

The maximum rate of tax which can apply is 6% of the value held in trust which exceeds the available nil rate band allowance (which is currently £285,000) at the time.

The new rules also affect some trusts which were already in existence on 22 March 2006.

How do the new IHT rules affect Wills?

We can check your Will for you and advise on any recommended changes. Even if you are not affected by the changes now may be an ideal opportunity to review your Will particularly if you have not done so for some years. Your Will may be affected if it includes any of the following:

• A gift to someone conditional upon them reaching an age of 18 or over (for example “to such of my children who shall be living at my death and reach the age of 25”);
• A life interest trust, particularly if included in your Will to make it more tax efficient;
• A life interest trust which is not set up immediately on your death (for example a life interest trust for children following a life interest trust for your spouse/Civil Partner);
• The transfer of any part of your estate to a trust already in existence (often referred to as a ‘Pilot Trust’);
• Provision for a beneficiary to receive an annuity;

There will be no need to change the terms of your Will for any of the following provisions:

• Outright gifts to people and charities;
• Outright gifts of the residue of your estate;
• A discretionary trust (known as the Family Trust Plan) which provides an IHT saving for your children of at least £114,000 – this is still effective IHT planning;
• A life interest trust to provide an immediate life interest for your spouse/ Civil Partner and on your death to ringfence your estate for your children of a previous relationship to inherit on your spouse/Civil Partner’s subsequent death.

How do the new rules affect trusts set up in lifetime?

Any new trust set up in your lifetime after 22 March 2006 will be taxable under the new discretionary trust regime as explained above. This means that there may be an immediate charge to IHT on set, up and during the lifetime of the trust.,

The new rules also affect some trusts already in existence. If you have set up any of the following, or you are a beneficiary of any such trust, a review should be carried out:

• Any trust which has had life policies or pension policies assigned to it;
• An Accumulation and Maintenance Trust (often known as a Children’s or Grandchildren’s Settlement);
• A Life Interest Trust (or Interest in Possession Trust);

A Discretionary Trust is not directly affected by the new legislation, but trustees could take the opportunity to review the trust to make sure the assets are still the most suitable for the needs and interests of the beneficiaries. Ideally there should be at least annual reviews of the trust./br>

The Government has provided for a transitional period to 6 April 2008 for any restructuring of trusts. However, particularly in respect of Accumulation and Maintenance trusts, it is extremely important that they are reviewed straightaway and any recommended changes carried out sooner rather than later to achieve the most favourable treatment going forward.

For more information please contact Harvey Barrett, Partner.

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