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Matthew Hutton MA, CTA (fellow), AIIT, TEP highlights further practical points on the inheritance tax changes to trusts following Finance Act 2006.

Context

More interesting points arose in the second LexisNexis Conference on the Taxation of Trusts on 5 October 2006.

Business property relief: future planning

BPR can be exploited by a passive portfolio of AIM trading companies.  Some commentators are suggesting that once the two-year minimum holding period has expired the shares can be given to a trust free of IHT.  However, the retention rules in s 113A would have to be considered.  Care will be needed if relievable property has been given to an interest in possession trust: an outright appointment will result in a change of IHT ‘ownership’ if the original gift was made into trust on or after 22 March 2006.

Consider investing £1 million on the AIM, holding for two years and then giving the shares into trust.  The trustees could then sell and buy investment property, insuring against application of the retention rules.  One would have to ensure that the AIM shares were not quoted on a recognised foreign exchange: if so there is no BPR (as pointed out in a recent Investors Chronicle article).  

(Lecture by Terry Jordan of BKL Tax)

Sales at an undervalue for an IOU

A sale at an undervalue to a trust is a useful method of keeping the transfer of value for IHT purposes within the nil-rate band.  Hold-over under s 260 is available on the undervalue element provided that the consideration does not exceed the unindexed base cost.  The trustees can borrow to fund the purchase [which will attract SDLT], but alternatively could give an IOU to the settlor.  One problem here is the potential income tax charge for the settlor on repayment of the IOU if from a discretionary trust (ITTOIA 2005, s 633, formerly TA 1988, s 677).  So the problem can be avoided by selling instead to an IIP trust, in which case s 633 is not applicable but hold-over under s 260 is available.

Deeds of variation

Where property is settled following a deed of variation:

• the deceased is the settlor if the property would otherwise have been settled notwithstanding the variation.  For example, an income beneficiary varies his interest into a discretionary trust.    
  
• Otherwise the person giving up his entitlement is the settlor.

(Lecture by Ian Maston of Chiltern plc)

Comment

The above constitutes an interesting miscellany of practical suggestions in the context of the Sch 20 regime.  I note a few further specific points below which have emerged in the course of lecturing.

Business property relief:  future planning

In terms of the risk of quotation on a recognised foreign exchange, was the point not so much that it was the AIM shares themselves but that any securities in the company were not so quoted, e.g. loan notes quoted on the Luxemburg stock exchange even if the shares owned were not themselves  quoted on any exchange?  This does not seem to be the case, given IHTA 1984, s 105(1)(bb).

Deeds of variation

The new statutory rule for income tax and CGT purposes is in one particular case an improvement on the old rule.  This is the case where for example the beneficiary of an interest in possession settlement made by Will varies his entitlement into a discretionary trust under which he or his spouse can benefit.  Under the old rule this would surely have been settlor-interested for income tax (though not for CGT) purposes, whereas under the new rule the deceased is the settlor.

IHT and discretionary trusts:  basis of ten yearly charge

A further possible reform of the IHT regime for trusts could be to change the current lifetime rates used in calculating the ten yearly charge to the death rates, as consistent with the philosophy announced in 1975 to tax the capital in a trust as if it had been subject to the charges to tax applicable on passing down the generations (taken as 33? years each).  Surely, however, it was suggested, this would disregard the immediate ‘hit’ at up to 20% on capital entering the discretionary trust in the first place?  Possibly the response to this is that in very few cases does 20% actually get paid in so far as settlors of lifetime discretionary trusts ensure that the value is within the nil-rate band or, if over that, it is protected by agricultural or business property relief.  The same point is of course not necessarily true with discretionary trusts created on death, however.

Discretionary trust points

Lifetime gifts of agricultural or business property:  the clawback

There is a distinct advantage in having the initial transfer made as a chargeable transfer as against a PET.  Under the latter if the donor or donee dies within 7 years and the clawback test under IHT 1984, ss 113A or 124A is applied and failed (e.g. because the donee had since sold the original property and not replaced it with qualifying business or agricultural property), the effect is to reinstate a chargeable transfer of the gross amount, i.e. with a loss of the BPR or APR.  However, where the gift had been made to a discretionary trust as a chargeable transfer, no additional tax is payable on death: see IHTA 1984, ss 113A(2) and 124A(2) confirming the assumption that in calculating the additional tax BPR or APR had been given.  This seems to be an anomaly, albeit one accepted by HMRC in the Manual.

More Information

The above article has been taken from Matthew Hutton’s Capital Tax Review, a quarterly update for professional advisers of private clients. For more information, click here.