UK: The Budget - Trusts and Inheritance Tax: Major Changes

Included in the Budget detail yesterday was a major change to the inheritance tax treatment of Trusts. This will apply not only to any new trust created on or after Budget Day but also existing trusts. The detail presently available is limited and we will follow up this Budget Alert once the draft Finance Bill is published.

With effect from yesterday (22^nd March 2006):

• You should not set up a new Accumulation and Maintenance Settlement (A&M) or Interest in Possession Settlement (IIP). A transfer into these types of trust will now potentially trigger an immediate inheritance tax charge. This will be charged at the lifetime rate of 20%.

• You should not add any property to an existing A&M or IIP Settlement. Again most transfers into these trusts will trigger an immediate inheritance tax charge. There are certain exemptions, for example where additions are made out of surplus income, but these need to be checked very carefully.

• You should not make any changes to any existing trust arrangements (including within Discretionary Settlements) until the new provisions have been reviewed in detail.

The new rules apply to all new and existing A&M and IIP Trusts. The only trusts not affected are Discretionary Settlements. In broad summary, going forward all Settlements will now be taxed under the same IHT rules, being those rules that presently apply to Discretionary Settlements.

• Transfers into the Settlement (including when first established) over the ‘nil rate band’ (from 6 April 2006 £285,000) are taxed at 20% as an IHT lifetime charge;

• the Settlement is subject to an IHT charge every ten years - currently at 6% of the value of the Settlement Fund over the ‘nil rate band’; and

• there are ‘exit’ charges when property is paid out of the Settlement - currently at a maximum of 6% .

These rules do not currently apply to A&M or IIP Settlements. Instead a transfer into such trusts is treated as a Potentially Exempt Transfer (consequently with no IHT if the Settlor survives by seven years). The assets in the trust are then treated as those of the Life Tenant for IHT purposes (for A&M Settlements only once the children or grandchildren reach 25). There are therefore no ten year or exit charges.

With the exception of certain trusts created on death and certain lifetime trusts created for disabled beneficiaries it is proposed that the Discretionary Trusts IHT rules will apply to all trusts.

• There will be a period to 6 April 2008 in which changes can be made to existing Settlements.

• Existing A&M Settlements - either these will need to be amended to give the child/grandchild an absolute interest at 18 or from 6 April 2008 they will be treated as Discretionary Settlements for IHT.

• Existing IIP Trusts

• If the Life Tenant dies before 6 April 2008 then the trusts arising following that death will also benefit from the transitional rules (this is not entirely clear but we believe it is implied in the information available).
• There will be no change to the IHT treatment until the end of the present life interest (whether ended during the lifetime of the Life Tenant or on death).
• At the end of the life interest if this is on death it will trigger an IHT charge (the same as at present).
• If the life interest ends during the individual's lifetime and the trusts continue at the end of that interest then this will be treated as a lifetime chargeable transfer by the Life Tenant (i.e. on present rates a 20% tax charge if over the nil rate band).
• If the trusts continue following the death of the Life Tenant then from that date the Discretionary Trust rules will apply going forward.

• The above provisions will apply equally to trusts created during lifetime and those created on death.

• All existing A&M and IIP Trusts will need to be reviewed to determine what, if any, steps should be taken going forward.

• It is likely that many Wills will need to be reviewed to determine what the impact will be on any trusts set out in the Wills.

• In the case of Discretionary Settlements care will need to be taken when considering any restructuring of these and therefore the new rules will be of some relevance also to existing Discretionary Trusts.

• One point that is not clear at present is how the new rules will relate to the existing spouse exemptions whereby there are no charges to inheritance tax when property passes from a Life Tenant to their spouse on death - we will need to see the detail to determine whether this will remain the case.