Consultation : Inheritance Tax : Simplifying Charges on Trusts – the next stage Consultation document published by HMRC on 31 May 2013

Consultation : Inheritance Tax : Simplifying Charges on Trusts – the next stage

Inheritance Tax: Simplifying Charges on Trusts – the next stage
Consultation document published by HMRC on 31 May 2013

The Association of Corporate Trustees (TACT) is the membership organisation of the UK corporate trustee sector. Its members include trust companies owned by banks and major financial institutions as well as those set up by firms of accountants, lawyers and pension advisors. Those trust companies are responsible for the management of over £1 trillion worth of assets, including sovereign and other debt of over £900 million and occupational pension funds with in excess of 1.25 million members, representing over 10% of that sector

Members of TACT provide trustee services to a wide private client base, ranging from individuals who wish to ring-fence their modest accumulations of wealth for the benefit of their children (perhaps after a second marriage); to families with substantial wealth who view themselves merely as custodians for future generations; and many in between who might be seeking to protect the family from imprudent relationships and/or extravagant spending

TACT supports the stated aim of HMRC to improve the way in which inheritance tax is to be calculated, whilst being fiscally “neutral”, and in simplifying the way it is returned.
Having considered the proposals, TACT does not consider them to be neutral, nor to deliver fairness in the eventual outcome.
Whilst the adoption of a fixed rate of tax has the look of creating simplicity, it would not appear to be neutral. The rate of 6% represents the maximum rate of tax that could be charged under the present regime and appears to take no note of the potentially significant cost saving to HMRC in the introduction of a simplified arrangement.
TACT welcomes the proposals to remove the need to obtain historic information, that may often not be readily available, and the need to take into account details of non-relevant property when calculating the inheritance tax liability. However, we are concerned that by requiring that any calculation include all trusts created by the settlor and in existence within the 10 years before a periodic charge is due is merely replacing one set of difficulties with another.
Many individuals have settled life policies in trust, mainly due to them being advised that it is better to do so as upon their death the proceeds can be immediately available, say, to meet the living expenses of the family until probate is issued and the estate administered, or to pay inheritance tax due on the grant application without the need to borrow from banks, etc. The understanding that this is a trust situation may often be overlooked. Similarly, settlors may lose sight of pilot trusts created to receive death benefits should the settlor die within a certain period. Even if settlors are aware of these trusts, the trusts will be of a purely nominal value (perhaps £10) until such time as the life policy falls in, or the trustees of the pension scheme decide to exercise their discretion in favour of the pilot trust trustees (if at all). The existence of these small value trusts can result in a trust which would otherwise be well within the nil rate band, and thus not liable to inheritance tax, being brought well within the tax net. Where such changes affect trusts that have existed for some little time, this cannot represent fairness in taxation and may well undermine confidence of the public generally in the way in which their estates may be taxed.
The Government has repeated on a number of occasions that it intends to tax trusts in a way that would result in the revenues from trusts representing the revenues that would have been received had the property remained in the original settlor’s estate. These proposals appear to further undermine that assertion.
The proposals seem to conflict with this stated aim, in that :
• they impose tax on trusts which have not previously been liable to tax (and which the settlors have been encouraged to have reasonable expectations that they will continue to be free of tax whilst they remained within the nil rate band), and
• whilst masquerading as “clarification”, the proposal to deem the accumulation of undistributed income increases the inheritance tax change whilst creating a stranded tax pool, thus preventing beneficiaries from obtaining a refund of tax to which they may otherwise be entitled.

With the second bullet point, as well as giving rise to double taxation, putting tax law and trust law into conflict, and creating new levels of complexity in trust administration, the proposal would also need changes to the income tax provisions. We address this point more fully in answering the specific questions below
We note that various elements of the calculation of inheritance tax under the proposals mirror the provisions of the current regime, without properly considering the impact this has. This is particularly evident in looking at example 7 (page 18)
• under both the current and proposed regimes, where a distribution has been made an exit charge will apply and, when calculating the next periodic charge, the nil rate band will be reduced by the amount of such distribution
• the current regime provides for the reduced NRB to be used to calculate the estate rate – applied to the value remaining in the trust as at the date the periodic charge is due in order to calculate the IHT charge (generally, a relatively small uplift)
• however, under the proposed regime, any reduction in the NRB will feed through directly to the calculation of the IHT liability, so that there will be a 6% tax charge on the amount by which the NRB is reduced
• as a result of this, any capital distribution is subject to tax both at the time of its exit and on the next periodic charge which, surely, cannot be HMRC’s intention, nor represents “fairness” in taxation.

Other aspects that we consider should be included as a part of any simplification exercise are :
• removal of what is often described as the “Frankland Trap”. The “trap” operates in a number of ways :
(i) it denies the ability for capital gains to be held over on assets leaving a trust within 3 months after the due date of a periodic charge. Since March 2006 a life interest trust may be a relevant property trust and, statistically, 1 in 40 life interest trusts will cease on the death of the life tenant within 3 months after the due date of the periodic charge. What logical basis is there for denying the benefit of hold-over relief in such cases?;
(ii) to enable flexibility to take account of the family circumstances applying following their death, many testators direct that their estates be held on short term discretionary trusts. However, as a result of the “trap” if any payment is made to their surviving spouse or civil partner within the 3 months after death, relief under s.18 IHTA will be denied to that payment. It is understood that the “trap” was originally introduced to prevent abuse of the CGT hold over by the manipulation of assets gifted into lifetime trusts, and that the effect on estates following the death of an individual may be an unexpected consequence
• there is an increasing use of trusts by individuals who have received substantial funds for personal injuries suffered, or are potentially vulnerable and wish to set their assets up in a trust structure to protect their wealth from various eventualities. Following the changes in 2006, the range of options is significantly limited and creating a Disabled Persons Interest is not always appropriate. Any other such trust created by an individual will be both a relevant property trust and subject to the gift with reservation rules. TACT believes it would be appropriate for those trusts subject to the gifts with reservation rules not to be treated as relevant property trusts. By applying only the gift with reservation rules, the trust will be taxable as though it remains a part of the settlor’s estate, which reflects the stated aim of Government.
TACT asks that these issues also be addressed as a part of the proposed simplification

We now address the specific questions raised in the Consultation Paper
Questions on the simplification of IHT trust charges
1: Do these proposals meet the objective of reducing complexity and administrative burdens and in what way(s)?
1.1 the proposals go some way to meeting the stated objectives. However, the provisions relating to the sharing of the nil rate band and the deemed accumulation of income will add new layers of complexity and, so far as the latter is concerned, give rise to conflict between tax law and trust law

2: Does a single rate of 6% present any difficulties, particularly for smaller trusts?
2.1 the principle of a single rate of tax is generally seen as providing benefits, so long as the structure for calculating the liability also makes sense.
2.2 the suggested rate of 6% looks rather high, mindful that it replicates the existing rate (30% of the lifetime rate) and makes no allowance for the significant cost saving which will accrue to HMRC as a result of the simplification
2.3 it is not clear if HMRC has merely adopted the maximum rate chargeable under the current regime, or has undertaken any modelling to arrive at the 6% figure. Mindful that the current proposal will effectively remove the nil rate band currently available to many relevant property trusts, to take into account the potential increase in receipts, and the reduction in HMRC’s own administration costs, we would suggest a single rate of 4% might be more appropriate. If the proposed structure of the new regime is altered, as suggested above, the potential tax flow will need to be remodelled

3: How much time would the simplified method save trustees and practitioners, on average per trust?
3.1 it is difficult to provide a simple answer to this question. Whilst under both the current and the proposed regimes, some trusts will clearly fall outside of the charge, the changes are likely to result in many trusts which would have been subject to charge at the nil rate becoming liable to actually pay tax. This will inevitably increase the work, rather than reduce it.
3.2 2 simple examples to highlight the point at 3.1 are :
a) settlor 1 – in 2005, creates a discretionary trust (DT) with £150,000; in 2009, creates a pilot trust (PT) with £10 to receive death benefits from pension fund; in 2015 PT still £10 & DT valued @ £287,500 – under current regime IHT periodic charge is nil, but nil rate band sharing results in DT being charged to IHT on £125,000 (£7,500)
b) settlor 2 – in 1998, creates discretionary trust (DT) with £100,000; 2011 creates relevant property trust (RPT) with £250,000; in 2018, DT valued @ £312,500 – whilst again, under current regime IHT periodic charge is nil, under the new proposals the nil rate band sharing results in DT being charged to IHT on £150,000 (£9,000)
3.3 the time spent by practitioners and trustees in completing the return could be significantly reduced if the return form IHT100 were to be redesigned. At present it is a multi-purpose document and is not fit for purpose. TACT understands that HMRC has indicated it may consider revising the IHT100 and urges it to do so as an element of the simplification procedure

4: Will there be significant costs to trustees and practitioners familiarising themselves with the new system and if so can you quantify these?
4.1 as with any change in procedure, there will need to be a period of re-training and familiarisation. The costs of this will inevitably be passed on to the “consumer”, in this instance the various trust beneficiaries
4.2 the level of costs incurred will depend greatly upon the final structure and processes which are put in place
4.3 if the final process is a significantly simplified version of the current regime, and the format of the return is changed so that it is easier (and more intuitive) to complete than the IHT100 (which we understand is accepted as not being “fit for purpose”), this will help offset the costs incurred in re-training, etc. and, therefore, the cost impact on the “consumer”

5: Do HMRC’s proposals in paragraphs 54 – 58 on the way in which the nil-rate band should be split for ten year and exit charges provide the right balance between fairness and the risk of manipulation?
5.1 No
5.2 whilst the sharing of the nil rate band could reduce the risk of manipulation, the application to all relevant property trusts in existence, whenever created causes significant unfairness. Taxpayers will have organised their affairs in reliance upon the tax code that existed at the time such arrangements were put in place. What is proposed is not an adjustment to that code but a radical overhaul. Whilst it might be categorised as “retro-active”, the effect is to charge to IHT arrangements set up many years ago for non-tax purposes and which continue to fulfil such purposes
5.3 if any variant of the proposals were to be adopted, the way in which the nil rate band is shared for the first periodic charge will need to be reviewed. Para 55 identifies that “under a more simplified regime” “all relevant property trusts made by the settlor and in existence at any time between the date the trust concerned was set up and the time of the charge”. Whilst this might not been seen to pose an issue where the trust concerned has at all times been a relevant property trust, significant issues arise where, say the trust was created some 30 or 40 years ago as an interest in possession trust and, following the death of the life tenant (or person entitled to a transitional serial interest – TSI), has only recently fallen into the relevant property regime. In such cases, we suggest the sharing of the nil rate band should be limited by reference only to the period during which it has been a relevant property trust

6: Are there any other ways that the nil-rate band could be split that would not risk a loss to the Exchequer?
6.1 in considering this question, it seems to us that the way in which the nil rate band proposals will operate is likely to bring a windfall to the Exchequer, so that in looking at ways in which the proposals might be restructured, any comparison should be with the current position, rather than measured against the proposals
6.2 we note HMRC has provided no impact assessment in relation to the overall tax receipts under the current regime and under the proposed regime. The provisions of such a comparison would assist respondents in providing a considered response to this question
6.3 the present proposals take no account of the length of time that a trust has existed, nor the value within any such trust, so that the NRB will be shared between 2 trusts created 20 years apart (even though they would each have their own separate full NRB under the present regime), or if a trust of the full NRB is created and there already exists a £10 death benefit pilot trust created by the same settlor (however long ago). In the later instance, the pilot trust will only ever be of value if the settlor dies and the trustees of his pension scheme exercise their discretion in favour of the trustees
6.4 whilst TACT is supportive of some proposals for sharing the NRB, it considers that there should be both a de minimis limit for trusts being within the sharing mechanism, and that trusts created within a defined window only should be aggregated
6.5 there are many life policy trusts and pilot trusts in place, the existence of which will not have been disclosed to HMRC and some may not have been recorded by the settlor. Many years ago, HMRC Trusts decided that a 41G would not be required for life policy trusts until the life policy paid out, and then only if the trust was not fully distributed within 6 months. A similar situation was agreed for pilot trusts. This practice is reflected in TSEM1405. Without a suitable de minimis limit, HMRC will need to consider how it might obtain details of all such trusts in existence, and the level of resource that it will need to employ to obtain and maintain such information. Whilst trustees may ask living settlors for information, where settlors are without capacity, or have died, the ability to obtain details of any other trusts may not exist. Even where settlors are administratively efficient, and have maintained records of such arrangements (which can be multiple), that the trustees may well be different in each case will make the position more complex.
6.6 TACT recommends that the nil rate band sharing should apply only to those trusts created after a certain date, and that all trusts below a de minimis limit should be excluded. For trusts created before that date, the trusts might have the full nil rate band, reduced by the value of any chargeable gift(s) made by the settlor within the 7 years before the date of the gift into trust
6.7 where trusts have already been subject to the periodic charge, the trustee should have information on the settlor’s cumulation as at the date of the settlement. For settlements which have not yet been subject to the first periodic charge, in the light of the 2006 Finance Act trustees of these are likely already to have obtained details of any cumulations in the knowledge that these would be required (or have satisfied themselves that the extent of any cumulative gifts was such that the trust would not become subject to the periodic charge other than at the nil rate)
6.8 if it is proposed to introduce nil rate band sharing in any event, there should be a limitation of the fractions into which it may be divided. For CGT purposes, this is set a one-fifth of the annual CGT allowance available to trustees and a similar floor level might be applied for IHT. However, this should be applied only to trusts created on or after the date upon which the provisions come into force
6.9 if the nil rate band is to be shared amongst trusts created before the date upon which the provisions come into force, the floor limit should be no less than a half share of the nil rate bad per trust

7: Would applying the new rules from a set date cause trustees and practitioners any difficulties?
7.1 As identified above, any new rules introduced should apply to trusts created on or after a certain future date
7.2 whilst the proposals were published on 31 May 2013, it would not be appropriate, or fair on taxpayers generally, to apply new rules for trusts created on or after that date without regard to the time it would take practitioners and intending settlors to understand the impact of any new rules which are to be implemented. Currently, many advisers are not aware of the current proposals and therefore persons creating settlements will not be doing so with knowledge of the current proposals
7.3 once HMRC has published definitive proposals, practitioners should have a reasonable time to become familiar with the new rules and apprise settlors, and intending settlors, of them. It is most unlikely that there will be any significant increase in new trusts as a result of taxpayers “rushing” to avoid being caught by the new rules

8: In what other way could the new rules be implemented?
8.1 trustees could have the right to elect into a flat rate inheritance tax regime with a lower rate of tax which could generate a greater level of take up

Questions on income that may be accumulated
9: Are there any issues with using this method as a practical way of dealing with accumulations?
9.1 Yes, whilst it is asserted in the Consultation Paper that there is a need to “clarify” the rules on accumulation, the creation of a deeming provision for the purposes of inheritance tax creates another layer of confusion rather than providing clarity
9.2 the use of deeming provisions adds another area of conflict between trust law and tax law – the position on the accumulation of income is clear in the light of the judgment in Pierce v. Wood (2010) and IHTM 42224
9.3 any “clarification” would apply only for IHT purposes and would not prevent trustees potentially acting in breach of trust (and could actively encourage this)
9.4 income received in a discretionary trust is subject to the Rate Applicable to Trustees. If income is deemed to be capitalised, then the income will become divorced from the tax pool. Accordingly, whilst currently a distribution of “retained” income may result in the recipient being entitled to a tax refund of up to 45% (i.e. 82% of the distribution made to them), if deemed capital, the trustee will be liable to pay an exit charge, of up to 6% of the amount distributed. This does not look like fair taxation
9.5 HMRC asserts that the last point above would be avoided by the trustee making regular income distributions. However, that may completely undermine the purpose of the trust, which may be to fund grandchildren’s education (how does it stack up against the Children’s Trust Funds that Government was promoting not that long ago). HMRC is effectively advocating the transfer of potentially significant amounts of income (relative to what the recipient might be used to handling) into the hands of minors/vulnerable people. This will distort behaviours, which the tax code should not do
9.6 if there is the automatic deeming of income to be accumulated, the consultation will need to be broadened to include considerations of the income tax considerations, as well, none of which are addressed in the Paper. If the deeming changes the nature of the income in a trustee’s hands, so that it is to be treated as though it were capital, an undesirable effect will be the denial of tax refunds to beneficiaries who are basic, or lower, rate taxpayers
9.7 where income is deemed to be accumulated, rules will need to be introduced to identify the order in which it is deemed to be applied. For example, if a trust receives £100 a year income after RAT and a distribution of £300 is made in year 5, legislation will be needed to identify for tax purposes when the income is deemed to have been received and, based upon that, whether it is wholly an income distribution or partly a capital distribution (attracting an exit charge). Under trust law, it will all be income – it will only be the deemed accumulation for inheritance tax purposes that will cause part to be treated as capital if the trustees have not actively exercised their power to accumulate (assuming of course that they have such a power) This complicates matters further and gives rise to additional administrative burdens, including the need to separately identify, and keep records of, the residual (i.e. undistributed) income arising each year. Will trust accounts be sufficient to identify the separate years’ accumulations?
9.8 it would seem that HMRC is acting in a way contrary to the assertion that it does not give legal advice to taxpayers, by attempting to use tax law to circumscribe the powers given to trustees under trust law (and as validly set out in the trust instrument)

10: Do you anticipate any additional administrative burden resulting from the proposed changes to the calculation of IHT on accumulated income? If so, what would you estimate to be the average cost per trust?
10.1 Yes, under the present proposal, trustees will need to maintain detailed records to identify if and when any income might be deemed to be capitalised for IHT purposes, and to identify how the rules impact upon any income distributions; any non-professional trustee will find these new proposals difficult to administer
10.2 the proposal will add yet another layer of complication to the administration of a trust – the administrative burden resulting from the proposed changes would be relieved by the proposed deeming of income to be accumulated being withdrawn

Questions on aligning filing and payment dates
11: Are there any issues with bringing IHT within the concept of Self-Assessment?
11.1 TACT welcomes the proposal to bring IHT within the scope of the Self-Assessment regime
11.2 TACT considers it would be beneficial for a similar regime to apply as for individual taxpayers, in that if returns are submitted by 31 October, HMRC will calculate the tax charge, with the tax being due on 31 January following
11.3 whilst there may seem to be benefit in the use of a single return form, perhaps with additional pages being available to disclose the details for the IHT to be assessed, in much the same way as for an individual to disclose income from a trust, the bringing together of all aspects of the taxation of trusts into a single return may well result in an increasingly cumbersome form, and increased workload at a time when many tax teams supporting trustee are already heavily employed

12: How much time will trustees and practitioners save as a result of the payment and filing dates being aligned with the SA framework?
12.1 this would normally be expected to save time, as it may be necessary only to collate the financial information for the trust once – to enable the composite return to be completed
12.2 it is difficult to identify the time savings that might be achieved, as this will be dependent upon the level of information required. If the alternative proposal we have put forward, above, were to be adopted, greater time will be saved

13: What would the impact be on trustees and practitioners’ clients?
13.1 if the time to prepare returns is reduced, this should reflect in the costs to the underlying client trust
13.2 there will be a need for all to become aware of the new rules, whatever shape they take, and for practitioners to be able explain the benefits of any new arrangement
13.3 whilst the bringing of the IHT returns within Self-Assessment might be seen in a positive light, if it coincides with the imposition of potentially significant charges upon trusts that have previously benefitted from a full nil rate band, it is anticipated that this will have a negative impact upon the “clients”
13.4 under the new proposals, there is a significant compliance risk for trustees and those advising them, in identifying the trusts that exist, or have existed, at any time within the 10 years prior to a periodic charge. The aligned filing deadlines could also reduce the amount of time trustees have to collate information, putting additional pressure on both the trustees and settlors (to whom the trustees will need to turn for obtain information to complete the returns). The trustees may not be aware of other trusts created by the same settlor (and the settlor themselves might have forgotten some of the trusts that exist). HMRC may be aware of some trusts of which the trustee has no knowledge, or neither trustee nor, as a result of TSEM1405, HMRC may be aware of other trusts which exist. How will trustees be protected from the risk of innocent non-disclosure which might not become apparent before they have perhaps distributed the trust fund

14: Will alignment bring benefits to customers in terms of reduced fees?
14.1 alignment can, potentially reduce costs, provided that it is appropriately thought through with the information requirements and form to be completed actually being simplified
14.2 if HMRC is looking to benefit “customers” by creating a regime to reduce fees charged for dealing with IHT matters, a first step would be to revise form IHT100, separating out the various functions that this form is supposed to support, and thus making it easier to complete. In its current format, it can be daunting even for experienced practitioners to complete

Response from The Association of Corporate Trustees (TACT)
August 2013