The now infamous changes to the inheritance tax treatment of trusts, introduced in the 2006 Budget, ...
The now infamous changes to the inheritance tax treatment of trusts, introduced in the 2006 Budget, took most, if not all, practitioners by surprise. These changes extended the 'relevant property regime' (basically the discretionary trust regime) to most trusts.
The inheritance tax consequences of membership of the relevant property regime include potential charges on establishment, 10-yearly anniversaries and transfers of capital to beneficiaries.
The harshness of the new regime was somewhat lessened by providing a 'period of grace' during which affected trusts could be restructured.
Trustees of accumulation & maintenance settlements (A&M) and interest in possession trusts (IIP) that were already in existence on Budget Day 2006, have until 5 April 2008 to reorganise the trusts while retaining the benefit of the benevolent pre-22 March 2006 IHT rules.
Accumulation & Maintenance (A&M) Settlements
A&M trusts in existence on Budget Day 2006 will fall into the relevant property regime on 6 April 2008 unless the trust is restructured so that beneficiaries are absolutely entitled to capital on attaining age 18.
One possibility may be to change the trust provisions so that the beneficiaries become absolutely entitled to capital after attaining age 18, but before attaining age 25. Such trusts are known as young person's trusts (YPTs). YPTs will suffer an IHT charge on a beneficiary becoming absolutely entitled to capital. As the maximum life of a YPT is seven years, the maximum IHT charge will be (7/10) x 6% = 4.2%. The charge will be proportionately reduced should a beneficiary become absolutely entitled before reaching age 25.
Interest in Possession (IIP) Trusts
IIP trusts in existence on Budget Day 2006 will generally continue to enjoy the tax treatment offered by the old regime so long as the interest in possession beneficiary(ies) remain unchanged. The trust fund will be in the inheritance tax estate of the interest in possession beneficiary(ies). If, however, the interests are varied, then the trust will fall within the relevant property regime.
Where interests in possession are varied before 6 April 2008, the 'old treatment' will continue to apply. The 'disappointed' beneficiary must be excluded from all benefit under the trust (otherwise that beneficiary will be treated as having made a 'gift with reservation').
For both trust types, where the value of trust fund is expected to remain within the nil-rate band, the relevant property regime could be 'accepted' without an actual tax charge.
Additionally, trustees might consider a future tax charge an acceptable price to pay for the benefit of keeping assets within a flexible trust structure and out of the hands of financially immature beneficiaries.
Professional advice is essential - as is prompt action.
- Gerry Brown, Tax and Trusts Manager, Prudential International.
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