Pothecary Witham Weld Solicitors

Finance Act 2006 – 5th April 2008 is last chance to change Trusts and avoid new Inheritance Tax liabilities.

Trusts have traditionally been taxed for Inheritance Tax (“IHT”) purposes depending on the terms of the trust. Historically trusts have been divided in this regard into three classifications: Interest in Possession Trusts, Discretionary Trusts, and Accumulation and Maintenance Trusts.

Now the IHT position for these trusts has been radically altered by the Finance Act 2006, with the provisions having immediate effect on their being announced on 22nd March 2006. There is, however, a transition period, ending on 5th April 2008, during which changes to some trusts can be made for those trusts to avoid the changes.

The Types of Trust and their IHT Treatment

Interest in Possession Trusts (“IIP”)

If a trust is an IIP then this essentially means that a beneficiary is entitled to the present income or enjoyment of the trust fund. This is often referred to as a ‘life interest trust’. A common example is when a deceased wife owned a property, and by her will allowed the surviving husband (possibly of a second marriage) to use the property for his life before the property passes to her children (possibly from her first marriage) on his death. The deceased wife can therefore make sure that the husband does not sell the house and spend the capital to the detriment of her children.

For IHT purposes, for IIP trusts created pre-22nd March 2006, the value of the property would be included in the estate of the (husband) life tenant on his death and taxed accordingly. The life tenant is considered to have ‘owned’ that property for IHT purposes as he has enjoyed it during his life, even if it ultimately passes to the wife’s children on his death. IHT up to a maximum of 40% can be charged on assets in the death estate of an individual.

Discretionary Trusts

Discretionary Trusts give discretion to the trustees as to which beneficiaries are to benefit from the trust funds. As far as IHT is concerned, as no beneficiary has a ‘right’ to receive or enjoy the trust income or capital (as the trustees may decide that another beneficiary is to benefit) then no beneficiary is deemed to ‘own’ any of the trust fund.

On a beneficiary’s death no trust property is therefore included in their estate for IHT purposes. The Revenue taxes property held in a Discretionary Trust for IHT periodically on the trustees, as otherwise the trust funds could escape IHT indefinitely. A system of periodic charges to IHT every ten years, and associated charges to IHT for when property exits the trust fund, was introduced to try and replace the IHT charges that could potentially be avoided. IHT is charged on Discretionary Trusts up to a maximum of 6% on the value of the trust fund every 10 years.

Accumulation and Maintenance (“A&M”) Trusts

A&M trusts were a ‘hybrid’ form of trust for which special tax treatment was introduced in the 1970’s. The trust had to comply with strict requirements set down by statute to be an A&M trust. In essence they had features similar to a Discretionary Trust, but which was treated as an IIP for IHT purposes.

A&M trusts therefore had elements of the flexibility of a Discretionary Trust, e.g. the trustees could decide which beneficiaries to appoint funds to, but the trust was not subject to the restrictive IHT regime of periodic and exit charges of a Discretionary Trust. These trusts were often used by grandparents to pass assets in a tax efficient manner to their grandchildren.

Finance Act 2006

The impact of the Finance Act 2006 was to bring almost all new IIP trusts and existing A&M trusts under the Discretionary Trust taxing regime. Those trusts will therefore become subject to periodic charges of IHT every 10 years and exit charges of IHT where appropriate.

Interim provisions - deadline of 5th April 2008

There are, however, important provisions which allow changes to be made to all existing A&M trusts and existing IIP trusts before the deadline of 5th April 2008. This will allow these trusts to be properly reviewed to assess the possible impact of the Finance Act 2006 and make any changes that are considered necessary to avoid the Discretionary Trust IHT charges. Those trusts that are not amended will be taxed as Discretionary Trusts from 6th April 2008.

Any existing A&M trusts and IIP trusts must therefore be reviewed well in advance of the 5th April deadline to make sure that they take advantage of this opportunity. Any beneficiary or trustee of such a trust should therefore contact us without delay to review the position.