Before the axe falls
A warning of the changes affecting inheritance tax on tusts, and capital gains tax, as from 6 April, which may be avoidable if action is taken before then
The seasonal nature of tax has changed somewhat in recent years, particularly with the growing importance of the Pre-Budget Report. But some things remain fixed in stone. One of those is 5-6 April, that cusp of the personal tax year, unique in its timing to the United Kingdom and some of those countries influenced by it. What has changed markedly, however, is a willingness of the government to give advance notice of major tax changes.
This is often accompanied by what appears to be rather rushed draft legislation, some of which can be improved by the time of enactment or its coming into force. It is even sometimes influenced by the results of consultation. But still the changes come, and the purpose of this brief note is to give a final warning of two of particular relevance to solicitors that will come into effect on 6 April 2008. If you have torn open the plastic cover of this March Journal with your usual boundless enthusiasm, there may still be time to do something about them.
Inheritance tax on trusts
This is not a reference to the extremely welcome change allowing (effectively) the transfer of nil rate bands between spouses or civil partners announced in the October 2007 Pre-Budget Report. Although not yet law, this is in practice effective now, and a note will follow in a later issue on some of the issues arising from it.
The changes to mention here are those made to the inheritance tax rules on trusts in the last “revolution in estate planning”, that which led to the changes in Finance Act 2006, sched 20. Extensive amendments were made to the trust regime for inheritance tax and while some were effective immediately, others only come into final play on 6 April 2008.
Accumulation and maintenance trusts
Perhaps the most important change to mention is that in relation to accumulation and maintenance trusts. The old regime for such trusts, which was extremely privileged compared to that for full discretionary trusts, has its death throes on 5 April. From that date, such trusts will move automatically into what is termed the “relevant property regime”.
In most cases, this will not be disastrous. If the current trust property is within the current IHT nil rate band and the trust was set up by a truster who had a nil or low cumulative total at the time of the trust’s inception (and there are no “related trusts”), then any IHT charges in the near future are likely to be non-existent. Even if they do exist, they will certainly fall below 6%, in most cases considerably below. But (as the preceding sentence amply demonstrates) there are likely to be increased administrative complications; and reporting requirements may be a significant burden.
It may thus be decided to do something about existing accumulation and maintenance trusts – if this can be done. There are a number of possible alternatives, but much will depend on what the actual trust deed allows.
The first possibility is simply to bring the trust to an end, paying out all of the trust assets. This may well be acceptable if all possible beneficiaries are of sufficient maturity to receive the trust property.
A second possibility may be to convert the trust, so that all property must emerge outright as each beneficiary attains the age of 18.
A third possibility is to convert the trust so that it becomes an “age 18 to 25 trust”. In such a trust, the property must emerge outright by the time each beneficiary attains the age of 25. In addition, the trust property must be “channelled”, so that at any given time the share of the total trust fund destined for a particular beneficiary must be clearly calculable. This thus removes one of the elements of discretion available in a traditional accumulation and maintenance trust. (The need for such channelling is an important factor to bear in mind when drafting to create an age 18 to 25 trust at any stage, whether as a result of the transitional rules, in a will or in a deed of variation.)
In any case where one of these possibilities is desirable, it will need to be done before 6 April – and as noted, that will now depend on what is available within the trust deed. It is perhaps extremely fortunate that in relation to a very large number of accumulation and maintenance trusts, “do nothing” is a perfectly valid option. For those where it is not, the time available to do something is disappearing fast.
The same deadline applies to the rather more limited options that may be available in relation to some liferent trusts (which may themselves have emerged out of accumulation and maintenance trusts).
Liferents in existence before 22 March 2006 continue to receive the inheritance tax treatment which applied before that date. Essentially, the property subject to the liferent is aggregated with that of the liferenter, and an actual or deemed termination of the liferent will be treated as a potentially exempt transfer (if it occurs during the liferenter’s lifetime) or a chargeable transfer (if it occurs on his or her death). This treatment continues to apply for new liferents which are created by will, which liferents are inelegantly termed in the new regime “immediate post-death interests”.
There is another breed of liferent which will continue to attract the same treatment. These are termed “transitional serial interests” and come in several species, details of which are now found in Inheritance Tax Act 1984, ss 49B-49E. The one which may require action is found in s 49C.
For this section to apply, a liferent must have been in existence before 22 March 2006. That must come to an end before 6 April 2008, at which point a new liferent must commence. If that occurs, the new liferent will continue to receive the old treatment and the liferented property will continue to be aggregated with that actually owned by the liferenter.
Some trust deeds may allow liferents to be passed on in this way. It may be considered desirable to have such treatment for a new liferent, which would otherwise suffer not only an inheritance tax charge on its creation (as an immediately chargeable transfer, subject to the nil rate band available), but also ongoing 10-year charges and charges on exit from the trust, under the relevant property regime.
There is one important unresolved point, which is whether the “new” liferent created before 6 April 2008 can be for the same person as held the old one. Originally, it was thought that this could be done without a charge arising on the creation of the new liferent. The current HMRC view is that this is not the case and that this type of transitional serial interest will attract an entry charge. But it may be possible and desirable to create a new liferent for a genuine third party.
Capital gains tax
The evolving changes to capital gains tax, this time announced in the Pre-Budget Report 2007, have been extensively covered in both the specialist and the general press. This is a major simplification, with the abolition of taper relief and indexation relief, accompanied by a single rate of capital gains tax of 18%. The new rules, including the recent confirmation of an introduction of “entrepreneurs’ relief”, will be covered elsewhere.
But for many taxpayers, there will be increased capital gains tax to pay on disposals after 5 April 2008. From that date both taper relief and indexation relief are abolished. It is however possible to take action in some cases before 6 April to maximise available reliefs.
Particularly for assets owned for a long time and for which there were significant acquisition costs, it may be possible to “bank” indexation relief, by a transfer between spouses or civil partners or by utilising hold-over relief on a gift.
It is much less easy to bank taper relief without a third party sale, although there are possibilities by transfers into and out of trust.
In general, for taxpayers contemplating sales at some time around the 5-6 April cusp, there is no real alternative to carrying out the appropriate calculations under both the old and the new rules, and then deciding whether to make the disposal before or after the magic date. Two important reminders – a disposal immediately before 6 April will bring about the need to pay any tax due on 31 January 2009, whereas one immediately afterwards will only require payment by 31 January 2010. And for most capital gains tax purposes, it is the date of contract which determines the date of disposal.
By the time this note appears, the 2008 Budget may well have brought further changes. Time will run out to react to those also – but the turn of the tax year is likely to remain a crucial deadline for many years to come.
Alan R Barr, Brodies LLP/The University of Edinburgh