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Capital Tax Review by Matthew Hutton MA, CTA (fellow), AIIT, TEP

Matthew Hutton MA, CTA (fellow), AIIT, TEP highlights a potential misconception regarding the effect of the FA 2006 rules on trusts and divorce arrangements.

Context

There have been rumours in both the professional and national press that the Finance Act 2006 provisions relating to trusts will adversely effect property placed in trust for one of the parties to a marriage under the terms of a consent order between a husband and wife on a divorce. For example, if a husband is to transfer an investment portfolio worth £1 million to his wife, he may prefer it to be placed in trust for his wife for life, and thereafter for the children of the marriage. This would safeguard the fund in the event that the wife were to remarry and seek to divert the assets to her new family. Alternatively, a property may be held under a Mesher order, by which one party has the use and enjoyment of it until a future date when it is to be sold and the proceeds divided between them; this is treated as a settlement of the asset for tax purposes.

The problem is that under FA 2006 many lifetime settlements incur an Inheritance Tax (IHT) charge when funds are settled. In the case of the £1 million investment portfolio, after deduction of the IHT nil-rate band, tax at 20 % would amount to £143,000. It is being said that this will impact on divorce arrangements.

Why should the s 10 and s 11 exemptions not be applicable?

The contributor finds all these comments rather puzzling. The IHT legislation contains two exemptions from charge which have historically always been considered to be applicable in divorce situations. These are at IHTA 1984, ss 10 and 11: section 10 relating to dispositions not intended to confer gratuitous benefit and s 11 relating to dispositions for maintenance of the family. Neither of these exemptions has been affected by anything in FA 2006 and they still apply to financial provision on divorce. So in the majority of cases, where there is no gratuitous intent between the parties, there cannot be any IHT charge where the consent order provides for one of the parties to place assets in trust for the other.

Accordingly, far from a trust being unsuitable for the financial arrangements between the parties, it may in fact be quite tax-efficient. Without the entry charge, the trust will only give rise to IHT ten-yearly charges and it is not difficult for these to be reduced or eliminated. Without the trust, 40 per cent IHT liability might well be payable on the death of the transferee.

Application

All this goes to prove that rumours of the death of trusts in the UK are premature. There are a number of other situations in which exemptions apply so that there will be no IHT entry charge if funds are made the subject of a gift into trust, rather than an outright gift; common obvious examples would be regular gifts out of income, and for non-domiciliaries, gifts of excluded property. Once the IHT entry charge is avoided, the ten-yearly charges might well be much the better option when compared with the 40 per cent charge otherwise payable on death.

(TAXline September 2006 Issue 9 p8 contribution by Malcolm Gunn of Squire, Sanders & Dempsey)

Matthew Hutton MA, CTA (fellow), AIIT, TEP
October 2006

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, visit http://www.taxationweb.co.uk/books/capital_tax_review.php.

About the Author

Matthew Hutton is a non-practising solicitor (admitted 1979), who has specialised in tax for over 25 years. Having run his own consultancy (latterly through Matthew Hutton Ltd) until 30th September 2000, he now devotes his professional time to writing and lecturing.