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Matthew Hutton MA, CTA (fellow), AIIT, TEP, presenter of Monthly Tax Review, reports conflicting views on an effect of the Finance Act 2006 inheritance tax changes affecting interests in possession.   

Context

The Transitional Serial Interest (TSI) Regime under IHTA 1984, ss 49C to 49E allows only ‘one bite of the cherry’.  The raising of an apparently straightforward situation on the Trust Discussion Forum has, alas, produced conflicting views from two well respected commentators.

The question

We have a number of cases where a beneficiary of an A & M settlement, who is entitled under the terms of the trust deed to a life interest at (say) 25, actually became entitled to an interest in possession before 22 March 2006 at (say) 18 under Trustee Act 1925, s 31 because the trustees no longer had power to accumulate.  The beneficiary clearly has a pre-Budget Day IIP and it might be thought that his Fund would remain subject to the old regime throughout his lifetime and that if his spouse took a successive life interest on his death the spouse exemption would apply.  But it has been suggested that, when he becomes entitled to a life interest at 25, the original IIP will come to an end and be replaced by a new IIP which is not a pre-Budget Day IIP. On that basis the beneficiary will have a TSI if he attains 25 before 5 April 2008, but if he does so after that date the Fund will become relevant property at that point. There will be no charge to IHT in either case by virtue of IHTA 1984, s 53(2) but there must be many cases like this and, if this analysis is right, there is a trap for the unwary. 

It is not clear what the authority is for the suggestion that the beneficiary becomes entitled to a new IIP at age 25 in this example (although it is arguably consistent with HMRC's view that that a new IIP will be created if trustees defer the age at which capital vests in exercise of a power of advancement (response to STEP/CIOT question 6)). Do members of the Forum think the suggested analysis is right?

Or can it be argued that the original pre-Budget Day IIP simply continues when the beneficiary gets to 25? Unlike the exercise of a power of advancement or appointment, the coming into effect of the life interest trusts at 25 requires no step to be taken by the trustees or indeed the beneficiary.

(Posting by Peter Bostock of Currey & Co on 7.3.07)

Reply no 1: a different interest

I find it hard to see that the new, full life interest at 25 is the same interest as the income entitlement that arises at age 18 under TA 1925, s 31.  It may have the same day to day practical consequences, but it is not the same interest.  (In a typical flexible A&M settlement the two provisions are likely to be set out in different clauses, apart from anything, though that obviously does not determine the question on its own.)

The problem is curable, after a fashion, by ensuring that the full life interest is accelerated to take effect before 6 April 2008; but the consequences are significant in that it will not then be possible for the beneficiary's spouse to take a TSI on the death of the current beneficiary under s 49D, as such a TSI can only follow a Pre-Budget Interest, not another TSI.

(Posting by Chris Jarman of Thirteen Old Square on 13.3.07)

Reply no 2: the same interest

In the original example of a life interest contingent on attaining 25, there is as a matter of property law only one interest conferred on the beneficiary.  Section 31 directs that intermediate income is to be paid to the contingent beneficiary after the age of majority.  This is merely a statutory incident of the life interest at age 25.  For IHT purposes, the effect is to give a right to present enjoyment, ie to bring the interest into possession, at that age.  But there is still only one interest and it seems to me to be strained in the extreme to say that a new and separate interest in possession arises at age 25.

The position is not, perhaps, quite so clear-cut where there are separate clauses dealing expressly with (a) income between 18 and 25 and (b) income from 25 onwards.

But surely the answer is that there is throughout an ‘interest in possession’, that is an interest which enables the beneficiary to claim immediately whatever may be the subject of the interest.  It is unnecessary to break the expression down into its composite parts, and in the now not-so-new era of purposive construction of tax legislation logic, fairness and the absence of a policy reason for doing so seem to me to point firmly to the conclusion that that is the correct construction.

If that is right, then there is no problem however the trusts were drafted.

(Posting by Robert Ham QC Wilberforce Chambers on 13.3.07)

A further analysis

IHTA 1984, s 53(2) expressly recognises, and has always recognised, that one interest in possession can replace another for the same beneficiary. It is only since FA 2006, of course, that the issue as to when this might happen within the same settlement has become material.

The typical A&M trust which vests an interest in possession at age 25 will more commonly be in the second form mentioned by Robert Ham than the first - namely, with income prior to age 25 being dealt with by a different clause from the one that provides for the life interest from age 25.  But even in Robert's first case, of a simple life interest contingent on attaining 25, with respect the s31 provision dealing with intermediate income is simply that - a statutory right (in possession) to the income which arises prior to the vesting (in possession), at age 25, of the interest conferred by the trust deed itself.  The statutory right ends (as there is no more intermediate income for it to apply to) when the express interest vests.

HMRC have already made clear in their responses to the STEP/CIOT questionnaire (Question 4) that they take the view that, if the trustees exercise a power of advancement (or, one assumes, appointment) to defer the vesting of capital from age 30 to age 45, the s31 IIP attached to the interest in capital contingent at age 30 is not the same interest as the s31 IIP attached to the interest in capital contingent at age 45. I do not believe this is necessarily right - it is tantamount to saying that there is a different statutory right to income pending the vesting date (albeit under the same section) just because the interest to which that right attaches, and so the vesting date itself, has changed. However, that approach goes a step further, in my view, than my analysis above: so it can be anticipated that HMRC are likely to treat the s 31 interest as a different interest from the full life interest that eventually vests.  That being so, those not disposed to buy into an argument which could end in litigation will doubtless find attraction in accelerating the eventual life interest to ensure that it vests during the transitional period, even if that does mean that a later IIP (even to the beneficiary's spouse) will be a non-estate IIP.

In the main, it will be 25th birthdays on or after 6 April 2008 which pose the problem most acutely, so those affected have time to await official guidance or concession - or even, dare one hope, amending legislation that corrects this anomaly (and others).

(Posting by Chris Jarman of Thirteen Old Square on 18.3.07)

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