UK: Budget Briefing

Originally published March 2004 Budgets aren’t what they used to be: we now have pre-budget reports, draft legislation released in advance of the Budget, consultation processes and instant access via the internet to press releases as soon as the Chancellor sits down. It means that there are fewer surprises than there used to be and instead more detail about proposed changes. In this briefing, we look at some of the detail behind some key issues in this year’s Budget, one promoted by Gordon Brown as "prudence for a purpose": we have selected these on the basis that they are directly relevant to the private client.

Our tax tables set out the finer detail. The most significant of the changes are:

• the increase in the inheritance tax threshold -the nil rate band -from £255,000 to £263,000;
• the increase in the rate of tax applicable to trusts from 34%to 40%with effect from 6 April 2004 (see below).

The pre-2004 Budget report announced the introduction of an income tax charge on pre- owned assets to take effect from 6 April 2005 (a grace year is being given to allow structures to be unscrambled before the tax bites).The tax will impose an income tax charge on benefits enjoyed from assets once owned by the individual enjoying the benefit -rather like the benefit in kind charge on employees.

Commentary has been hostile to the proposal to tax these benefits: the new tax has been called, amongst other things, a ‘mongrel ’tax and a ‘wealth tax in disguise ’.The tax has been introduced as a direct result of widely- marketed inheritance tax mitigation arrangements – the so--called ‘double trust ’ schemes -which operate to allow individuals to live in what is effectively their principal residence, the capital value of which is removed from their estates.

The new tax will apply to all assets, both tangible and intangible, and will apply to the world-wide assets of UK domiciled and resident individuals. It will apply only to the UK assets of those UK residents who are not domiciled in the UK.

The Budget confirms that the charge will not apply to:-

• property which ceased to be owned before 18 March 1986;
• property formerly owned by a tax payer, now owned by his or her spouse;
• property which still forms part of the tax payer ’s estate for inheritance tax purposes because it constitutes a gift with reservation;
• property sold at an arm ’s length price, whether or not to a connected party;
• former owners who retain an interest which is consistent with their ongoing enjoyment of the property. The press release gives the example of an elderly parent formerly owning the whole of his or her home who passes a 50%interest to a child who lives with the parent:in this case, the tax would not be charged.

An election for transitional relief can be made. This will enable individuals involved in existing schemes, provided they make the election by 31 January 2007,to avoid the income tax charge in relation to property covered by the election. The election is to have the property in question treated as part of their taxable estate for inheritance tax purposes whilst they continue to enjoy it.

If there is not sufficient liquidity within an inheritance tax mitigation structure to service the new income tax liability, the election is a route that individuals might opt for if they choose not to, or can not, unscramble their scheme before 6 April 2005.

The Government is to force those who devise and market certain avoidance schemes to register details of those schemes with the Inland Revenue.This is apparently to counter large- scale avoidance of direct taxes and will enable the Revenue to pre-empt what the Budget describes as ‘deliberate abuses of the tax system ’. Full details of disclosure requirements are to be published in the Finance Bill later this year.We await these with interest.

Draft legislation published in the Pre-2004 Budget report removes eligibility for holdover relief from 10 December 2003 for gifts to trusts where the settlor, or his or her spouse, can benefit from the settlement in any way at the date of the gift or at any time before the sixth anniversary of the start of the tax year following the one in which the disposal was made. These changes will affect some inheritance tax planning schemes and tax planning involving the transfer of assets which do not attract full CGT business asset taper relief into trust to restart the taper clock and eliminate the non-qualifying period of ownership.

The draft legislation is to be included in the 2004 Finance Bill: no changes to the draft legislation were announced in the Budget.

Draft legislation published in the Pre-2004 Budget report proposes that, when a property is transferred after 9 December 2003,either the transferor can benefit from holdover relief on the disposal or the recipient can benefit from principal private residence relief on a subsequent sale of the property: it will no longer be possible to claim both reliefs.

The proposed changes will mean that a disposal of a principal private residence made after 9 December 2003 by an individual or trustees of a settlement will have to take account of any holdover relief granted on an earlier disposal. This is subject to transitional provisions which restrict the amount of principal private residence relief available on the disposal if made before 10 December 2003.

The draft legislation is to be included in the 2004 Finance Bill: no changes to the draft legislation were announced in the Budget.

From 6 April 2004,married couples will be taxed on dividends from jointly owned shares in close companies according to their specific ownership of the shares.

As part of the implementation of recommendations made in the O ’Donnell review, the Inland Revenue and HM Customs &Excise are to merge. This merger will see Britain part company with Israel and Malawi, which will remain the only jurisdictions with separate taxing bodies.

It is of note that the background paper ‘Reviewing the residence and domicile rules as they affect the taxation of individuals’, published in April 2003,was not referred to in this year ’s Budget. In that paper, the Government said that it was looking to identify those with a long term connection to the UK to ensure they contribute appropriately to the UK Exchequer from their world-wide income and to establish an appropriate divide between long-term and temporary connections to the UK. Once again, a Budget has gone by without attempting to tinker with the legislation which allows non-UK domiciled individuals to structure their affairs to minimise legitimately their UK tax exposure whilst resident here.

The increase in the rate of tax applicable to trusts from 34%to 40%with effect from 6 April 2004 was mentioned above. This increase affects discretionary and accumulation and maintenance trusts: the tax treatment of interest in possession trusts is unchanged. If trustees are considering a sale of trust assets this calendar year, the gain should be realised prior to 6 April 2004.

The Revenue has recently issued discussion papers under the heading ‘Modernising the tax system for Trusts ’inviting comment on modernising the current regime. The Budget confirms that draft legislation will be published later this year, at the time of the Pre-2005 Budget report, with final legislation being put in place by the 2005 Finance Act. The proposals are to:-

• introduce a basic rate band for all trusts of £500:a third of trusts currently liable would not then need to make an annual self- assessment return;
• reduce the number of definitions of "settlements" and "settlor-interested" trusts;
• offer improved guidance to trustees as to what constitutes a trustees ’management expense and the extent to which these expenses are allowable for tax purposes; and
• stream income and gains so that, where funds pass quickly to beneficiaries, the trustees can be exempted from the rate applicable to trusts and instead be taxed at the basic rate. Further consultation will take place before a decision to proceed is taken.