Pre-owned assets charges still a threat to investors

The Inland Revenue have confirmed to representatives of the UK insurance industry that the proposed income tax charge on gifted pre-owned assets will not apply to insurance-based schemes such as discounted gift trusts.

The new proposals are contained in Schedule 15 to Finance Act 2004, and contain new charging rules in relation to land, tangible assets (chattels), and intangible assets. When the proposals were first announced, it was thought they were to be narrowly targeted at schemes that allowed individuals to enjoy the use of private property while removing the value from their taxable estate without breaching the gift with reservation rules.

One such scheme was an arrangement where the individual would sell his property to a trust, of which he was a beneficiary, but leave the purchase price outstanding as a debt against the trust. He would then create another trust, from which he could not benefit, and transfer the debt to that trust. The effect on death, therefore, was that the value of the debt owed by the first trust to the second was deducted from the value of the settlor's estate. There were other arrangements that were targeted, such as those where the settlor would gift works of art, but retain enjoyment of them.

However, the new charge now attempts to have a very wide application, catching any arrangements that meet the tests, regardless of the type of asset involved. The new regime will introduce an annual income tax charge on the individual if he continues to derive benefit from property previously owned by him that has been disposed of.

The new proposals have created outrage among legal and tax planning professionals in the UK, and there has been much comment on them, much of it highlighting entirely innocent transactions that could be caught by this. It will be interesting to see whether this will be given ample time for debate in the Finance Committee sessions.

In relation to land, the new charge is pegged to the annual market rent that would have been payable had the land been let to the chargeable person. The formula for the new charge is: R x DV/V, where R is the rental value, DV is the disposal value, and V is the value at the 'valuation date'. The valuation date can be prescribed in further regulations, and the current value and rental value can be determined by valuations from earlier years (presumably so that taxpayers do not have to acquire annual valuations). The Government intends to consult further on the operation of this part, and in relation to the valuation of benefits derived from chattels and intangible assets.

The section on intangible assets states that where the settlor is a beneficiary of a settlement which holds intangible assets transferred by him, he will be subject to an annual income tax charge. The formula for working out the chargeable amount is N - T where N is the amount of "interest that would be payable for the taxable period if interest were payable at the prescribed rate on an amount equal to the value of the relevant property at the valuation date" - in other words, the Revenue will deem an annual income, regardless of actual income. Further regulations will be made to prescribe the rate, and this can vary between different types of property.

T is any tax that may have been payable under normal rules on the property during the year of assessment.

It is this section that caused most worry to those using life assurance-based schemes for IHT planning. Such schemes are a transfer into trust of one sort or other, and all rely on certain benefits being retained by the settlor. However, in a recent meeting between the Revenue and representatives of the UK insurance industry, the Revenue confirmed that discounted gift and other schemes were not the target, no matter how they are engineered. This is certainly good news for the industry, clients and their advisers. At the time of writing, further detail on this is expected.

Important Note: The above is based on our understanding of Schedule 15 of UK Finance Bill 2004, which is not guaranteed to become law. No responsibility can be accepted for any interpretation to the contrary.

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