Every budget has its fair share of nasty surprises and this was no exception. Press release BN 25 had the innocuous sounding title "Aligning The Inheritance Tax Treatment For Trusts". Innocuous it certainly isn't. It announces fundamental changes to the taxation of trusts, which are arguably retrospective, as they will apply to both new and existing settlements. The changes will affect thousands of trusts, whether set up in life or on death under a will, and the extra inheritance tax bill could be very substantial indeed.

Accumulation and Maintenance Trusts

Discretionary trusts have always been heavily taxed, with a 20% entry charge on the value of the trust assets at the outset, a further tax charge every 10 years of up to 6%, and an "exit" charge of up to 6% when trust assets are distributed between 10 year anniversaries. In contrast, accumulation and maintenance (A&M) trusts, traditionally used by parents or grandparents to pass assets down the generations, have always been treated favourably. Now the distinction is to be removed, as most A&M trusts will now be taxed in the same way as discretionary trusts. Existing A&M trusts (including those created under a will) will have to pay the 10 year and exit charges while new post-budget A&M trusts will also have to pay the 20% entry charge. Existing A&M trusts will have two years to change their terms if they want to avoid these charges but that will be at the cost of forcing the children or grandchildren to receive the trust assets

outright at 18 rather than the more usual age of 25 or later. Why the government would want to encourage the transfer of valuable assets to potentially vulnerable young people is puzzling.

Life Interest Trusts

Life interest trusts are also being brought into line with discretionary trusts. This is particularly strange since they are rarely used for tax avoidance purposes. The typical life interest trust gives the life tenant a right to the trust income but ensures that the trust capital will eventually pass to someone else. For Inheritance Tax purposes, the trust assets are still treated as part of the life tenant's taxable estate on his death so the exchequer does not lose out. Now most life interest trusts will also be subject to the 20% entry charge as well as ongoing 10 year and exit charges. This sounds suspiciously like double taxation. Fortunately existing life interest trusts will benefit from some transitional protection.

Comment

The government has not changed the tax rules on normal outright gifts to individuals known as potentially exempt transfers. Why a gift into trust for that same individual should now be penalised is illogical, particularly where there will often be very good non-tax reasons for avoiding an outright gift. Could this be the precursor to an immediate inheritance tax charge on all lifetime gifts?

What should you do?

At this stage, it is impossible to say exactly what changes will be made or whether they will even become law, as there will certainly be intense lobbying against the proposals. However, if the changes are brought in, most existing trusts and wills will need to be reviewed to see if they are still efficient. You should also seek immediate advice if you are about to sign a new trust or will that includes a trust. Over the next few weeks and months we hope to contact all clients who may be affected.

This article is only intended as a general statement and no action should be taken in reliance on it without specific legal advice.