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Matthew Hutton MA, CTA (fellow), AIIT, TEP, Editor of Monthly Tax Review, highlights some topical inheritance tax issues affecting trusts.

Matthew Hutton

Context

The following were among some interesting points made at the 7th Annual LexisNexis Tolley Tax Planning with Trusts Conference 2007 in London on 16 May 2007.

Termination of interest in possession and reservation of benefit

The introduction by FA 2006 of section 102ZA into FA 1986 was intended to prevent (especially, but not only, in a Will trust) the termination of an interest in possession in property which the beneficiary continued to occupy or enjoy.  However, note that new s 102ZA applies to create a disposal by way of gift only ‘for the purposes of section 102 and Sch 20 FA 1986’.  No mention is made of ss 102A to 102C which are the post-Ingram sections directed by FA 1999 at gifts of land.  It may therefore be possible to achieve effective carve-outs by terminating an interest in possession without giving rise to a reservation of benefit.

Charge on creation of Transitional Serial Interest (TSI)?

Section 53(2A) provides that:

‘(2A) Where -

(a) a person becomes beneficially entitled on or after 22nd March 2006 to an interest in possession in settled property, and
(b) the interest is not a disabled person’s interest,

subsection (2) above applies in relation to the coming to an end of the interest with the omission of the words “or to another interest in possession in the property”.’

Emma Chamberlain and Chris Whitehouse in the January Tax Advisor suggest that the word ‘interest’ in all three occasions is referring to the original interest. For this reason they suggest that if a pre-22 March 2006 interest is terminated after 6 April 2008 in favour of interest in possession trusts for the same beneficiary, s 53(2A) will prevent a charge even though the property is no longer subject to the interest in possession regime.  However, the first two references to ‘interest’ could be to the new interest. The exception for disabled trusts possibly makes better sense on this basis (as why should it matter whether the former trusts were disabled?).

The problem with this construction is that s 53(2A) does not prevent an immediate charge when a beneficiary obtains a new s 49C TSI in place of an existing interest. HMRC have not published a view on this issue. However, HMRC’s answers to questions 6-7 of the questions put by STEP and ClOT about Schedule 20 of FA 2006 highlight the fact that there may be circumstances where a beneficiary’s existing interest in possession may be replaced by a new interest. It will generally be desirable to take care to ensure that powers are not exercised in this manner. For example, if a power of appointment can just be exercised in respect of part of a fund it should be exercised on that basis rather than appointing new trusts of the whole fund.

The worry therefore is that there may be an IHT charge when a Budget Day 2006 interest in possession is replaced by an s 49C TSI which is not a disabled person’s interest.  The problem is identifying what is an interest in possession.  There is ambiguity here which HMRC need to resolve.

S71A and s71D trusts and the use of an extended s 32 power

The Courts have recognised that it can be for the benefit of a beneficiary to settle property on their behalf even though others may be incidentally benefited: IRC v Pilkington [1964] AC 612. In Re Clore’s ST [1966] 1 WLR 955 Pennycuick J considered that the power could be used to pay funds to charity on behalf of a wealthy beneficiary who was under a moral obligation to make charitable gifts. Similarly in Re Hampden’s ST [2001] WTLR 195 an advance onto accumulation and maintenance trusts for a wealthy beneficiary’s children was considered to be for his benefit. The position might have been different had he not been well provided for. The new trusts must vest within the perpetuity period of the original trusts: Pilkington v IRC 40 TC 416 at p 442 per Viscount Radcliffe.
                           
In X v A [2005] EWHC 2706 Hart J considered that a revocation and appointment which sought to redirect property to charities and to non-beneficiaries could not be regarded as being for the benefit of the wife of the settlor, who had a life interest in the trust. Hart J at para 38 accepted that the power was very wide and extended to any advance that ‘…,viewed objectively, can fairly be regarded as being for the benefit of the object of the power, and subjectively they believe to be so’. The financial resources of the beneficiary will frequently be important and Hart J at para 42 considered that it must in some sense improve the material situation of the beneficiary. He noted that in Re Clore’s ST the beneficiary would have otherwise funded the payments from other sources. Hart J considered the advance could not be justified on this basis because its size exceeded her resources nor did she have any moral obligation to make such a payment.

Further comment

The important limitation on the Pilkington principle constituted by the 2005 decision in X v A should be noted.  The wife’s motivation was simply that she thought that the existing beneficiaries were too well-off: hence the desire to redirect property to charities and to non-beneficiaries.  The problem here was that the funds in question went way beyond what the beneficiary owned in her own right.  Further, as against the situation in Clore, there was no moral obligation on the wife to make gifts to those charities or non-beneficiaries.

David Ewart QC noted a Chancery school of thought that it is quite difficult to take away something from a beneficiary without giving him something for which he can call.  Therefore there could be difficulties with the s 32 power except in specific cases (drug dependency etc).  There is a significant trust law issue here.

(Jeremy Woolf of Pump Court Tax Chambers)

The impact of FA 2006 on the creation of new settlements

First one must ascertain if there is a trust at all for IHT purposes.  What about an absolute right subject to a power of appointment?  HMRC have not pronounced on this structure.  Could it be a useful type of arrangement?

There are a number of ways in which settlements might be created post FA 2006. 

(i) Settlements can be created by Will. There will be a chargeable transfer at this time in any event (subject to the spouse exemption).

(ii) A settlement can be created with a modest amount of cash and subsequently financed by way of loan. The loans can be repaid in time and the growth in value of the assets will remain within the settlement. [This could be a way to invest in a particular company which does not attract BPR, but keeping within the nil-rate band.]

(iii) Assets which currently have a modest value or which have potential for growth can be settled. Such an asset could be deliberately manufactured, eg ‘freezer shares’.  If steps are taken to reduce the value of an asset before it is settled (eg by the granting of options), it will be necessary to consider IHTA 1984, s 163 (restriction on freedom to dispose). This provides:

(1) Where, by a contract made at any time, the  right to dispose of any property has been excluded or restricted, then, in determining the value of the property for the purposes of the first relevant event happening after that time:

(a) the exclusion or restriction shall be taken into account only to the extent (if any) that consideration in money or money’s worth was given for it, but

(b) if the contract was a chargeable transfer or was part of associated operations which together were a chargeable transfer, an allowance shall be made for the value transferred thereby (calculated as no tax had been chargeable on it) or for so much of the value transferred as attributable to the exclusion or restriction.

However, it is not clear that s 163 does apply to options.

One must also consider the possible application of TCGA 1992, s 18(7) under which an option exercisable by a connected person can be ignored in valuing the asset for CGT purposes. Consider also HMRC’s 1991 statement about the application of IHTA 1984, s 98 to deferred shares?

(iv) The property can be settled on a trust under which the settlor has a very valuable absolute reversionary interest after, say, 100 days. The settlor can assign that interest to another individual by way of a PET. Thereafter the trustees would have power to extend the trust period to 80 years. The result is an ordinary 80 year settlement created by way of a PET. [This is an old Melville-type arrangement.  A bit more detail is involved.  While one needs to watch associated operations, none of the anti-avoidance provisions apply.  Hold-over relief would not be available for CGT purposes, as the trust is settlor-interested.]

Identification of an interest in possession

HMRC’s answer to Question 6 of the 43 Questions put by STEP/CIOT considered that a beneficiary’s original interest in possession which he had at Budget Day 2006 under Trustee Act 1925 s 31, to be enlarged to an absolute interest at age 30, will have ‘come to an end’ when the trustees exercise their power of advancement to extend this to a new interest in possession until age 45. This therefore, if done before 6 April 2008, will qualify as a TSI.  HMRC’s reasoning is that the interest is expressed as an entitlement to capital contingent on his attaining age 30: it seems reasonable to regard the exercise of the s 32 Trustee Act power as immediately bringing this interest to an end and replacing it with a new one.  Is this so, wondered David Ewart?  There is a strong argument that it is the same interest because the original interest in possession was always subject to the power of advancement/appointment. 

(David Ewart QC of Pump Court Tax Chambers)

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