Simplification of IHT charges on trusts

Mon 31 Mar 2014

Individuals who have established trusts need to be aware of forthcoming changes to their tax treatment, due in April 2015. Those looking to use trusts as part of a wealth management/succession plan will need to consider whether the use of a trust is still worthwhile.

The first phase of the changes aimed at simplifying the way in which inheritance tax (‘IHT’) is charged on trusts will be introduced from 6 April 2014. Their stated intention is to be tax neutral but they look likely to increase trusts’ tax burdens. Future changes, expected to take effect from 6 April 2015, will restrict the nil-rate band available to trusts set up by a single settlor and are likely to remove the effectiveness of ‘Pilot trusts’, multiple trusts set up initially with a small capital settlement which under present rules each enjoys a full nil-rate band (NRB) on occasions of charge including ten-year anniversaries.

Changes effective from 6 April 2014

The first, small simplification is that filing and payment due dates will now be six months following the end of the month in which a chargeable event takes place.  Offices need to ensure this deadline is monitored.

The 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 income 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.

Future changes, due 6 April 2015: the end of the Pilot 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 shortly but the present proposals are likely to increase the number of trusts paying IHT at ten-yearly intervals and so increase the tax take. 

The change the Government has in mind is to allow only one ‘trust NRB’ per settlor, to be shared among all the trusts that a person may create in their lifetime. At its most extreme this would even prevent a settlor creating one new trust every seven years as is currently accepted as non-aggressive planning within the letter and spirit of the present law.

The consultation process should make it clear whether new rules will apply to existing trusts.  No thought appears to have been given to trusts used for innocent purposes such as structuring life insurance policies.

Those at risk from this change include all settlors of family trusts and many who have existing trusts for innocent purposes including home ownership and as beneficiaries of life assurance or pension death benefits.