Does ‘simplification’ really mean trusts pay more tax?

Fri 07 Mar 2014

The first phase of the changes aimed to simplify the way in which inheritance tax (‘IHT’) is charged on trusts will be introduced from April.  Their stated intention is to be tax neutral but they look likely to increase trusts’ tax burdens.

The HMRC consultation process has so far demonstrated that the position will be far from simple – with changes to sharing the nil rate band between trusts set up by the same settlor and the introduction of IHT ‘Self Assessment’ being deferred until next year to allow for further consultation.

What we know is that the filing and payment due dates will now always be six months following the end of the month in which a chargeable event takes place.  Slightly simpler than the old rules but barely worth talking about.

The other change to the treatment of accumulated income may be welcome in some cases, not least because this has been a grey area for such a long time.  Given the complex interaction between trust law and tax law the new rule only applies when calculating the trust’s ten-year charge.  For this purpose only, undistributed accumulated will remain as income except where it has remained undistributed for five years or more.  If it is later distributed then it can still be treated as income in the hands of the beneficiary, importantly with a 45% tax credit which is often repayable in whole or in part to the beneficiary.

On balance, this is also a little simpler and, in most cases, should not impact the overall tax cost of holding assets on trust.

What has not been clarified is whether simplification will be used as a way of stopping well established tax planning techniques of using multiple trusts to protect family wealth from a full IHT charge of 6% every ten years.  Further consultation is expected on this but the present proposals are likely to increase the number of trusts paying IHT at ten-yearly intervals and so increase the tax take. 

It is also unclear whether any new rules will apply to existing trusts and no thought appears to have been given to trusts used for innocent purposes such as  structuring life insurance policies that taxpayers may not have at the forefront of their minds?

The findings from the previous consultation show that there is no easy way to simplify the current IHT regime without at least a significant proportion of existing trusts becoming potentially liable to more tax.

The use of trusts can still play an important part in the protection of family wealth and will be key in many plans to pass that wealth from one generation to the next. Remember too that trusts are not only tax-saving vehicles; they can be useful in protecting family wealth against external predators and misguided or spendthrift beneficiaries.

However simple the method of calculation may become, the IHT charge should broadly represent the same duty that would be paid on death once every lifetime.  By charging a top rate of 6% of the value of the trust’s assets every ten years it could take 70 years before a trust pays more IHT than would be payable if family wealth stayed in the hands of an individual (assuming the 20% entry charge is managed).  On this basis it seems clear that there would still be tax savings to be had for many.  For example, grandparents may not trust their minor grandchildren to take care of the family silver at a young age to save the 40% IHT that will otherwise become due on their death.  An outright gift might be out of the question but protecting the wealth and accepting an IHT charge of say 12 or 18% will be seen by many as a ‘win-win’.  Using a trust is likely to still achieve just that.

One thing is abundantly clear; simpler doesn’t necessarily mean fairer.  We’ll have to wait and see how great the cost will be.

The Private Client team at Mazars are happy to talk through how these new rules may affect your existing succession plans.  They can also help you make a plan to pass on family wealth if you have not yet thought about it.  Do you really want to leave 40% of your wealth (usually already taxed once as income or gains if it is savings) to the tax man?