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Establishing multiple trusts can be a useful IHT mitigation technique, but wealthy individuals need to be aware of important changes to tax on trusts.
The government announced in the Autumn Statement that, following three rounds of lengthy consultations, it had abandoned earlier proposals to split the nil rate band among multiple trusts established on different days by the same settlor. This is a very welcome development and, indeed, represents a remarkable turnaround in attitude. HMRC’s original consultation papers and proposal made it clear that, in their view, the approach of splitting the nil rate band was very much non-negotiable, stating that: “without this provision, the scope for any changes to simplify the calculations would be limited due to the risk that it would lead to greater avoidance and the adverse impact to the Exchequer”.
Had the proposals been made effective as suggested, they would have brought to an end any advantage for individuals in having multiple trusts. For a great number of individuals, multiple trusts are commonplace and are created for legitimate asset protection, wealth planning or administrative reasons. The proposed changes were also set to have a retrospective effect impacting on trusts established before the change in law where assets were added afterwards.
One practice HMRC were seeking to remove would typically see HNW clients creating a number of trusts over a period of time. The legal principle being that these multiple settlements, when created on different days, would each have their own inheritance tax nil rate band to offset against any inheritance tax charges. Wills were then typically drafted to divide the testator’s estate on death into those separate settlements giving an overall IHT saving. The regime for the taxation of trusts such as these provided that each settlement with its own nil rate band would be taxed at an effective rate of no more than 6% every ten years on the funds in each settlement in excess of the nil rate band. The nil rate band is currently £325,000. It was therefore possible to create a number of settlements so that when an estate was divided, it fell neatly into a number of settlements, each containing assets on or below the nil rate band. In any event, the overall saving was beneficial as against one large settlement holding a person’s entire estate. The proposed change would have resulted in an increased tax revenue for HMRC from those with multiple settlements.
Simplifying the system
The government will now look to introduce legislation in the Finance Bill 2015 to provide new rules on the IHT treatment of additions into multiple trusts on the same day. The original proposed changes as to how discretionary trusts would be considered for IHT tax purposes were justified by HMRC as steps to simplify calculations as opposed to anti-avoidance. The proposed legislation also retains the introduction of a common filing and payment date to ease the administrative burden on trustees and their advisers.
In principle, legitimate changes to the current complicated regime for trust calculations that genuinely simply the system would be welcomed by clients and advisers alike. However, the philosophy underlying what was originally proposed in a single settlement nil rate band seemed to be that all trusts are used for aggressive tax planning and tax avoidance, which was in practice simply not the case. For a number of clients, trusts are created over many years and for many different purposes and not as part of the tax planning structure above. A number of professional bodies and practices made representations to HMRC during the consultation period. It was suggested that it would be preferable for changes in the law relating to multiple trusts to focus on targeted anti-avoidance provisions rather than a wholesale revision of the existing system.
The arguments made appear to have been taken on board and the new proposals still contain changes intended to simplify the rules, such as removing the requirement to include the value of certain assets when calculating property trust charges.
Important rule changes
The changes that come into effect as of 6 April 2015 mean that additions made to multiple trusts on same day are to be aggregated for the purpose of determining the IHT charged on future transfers by the trustees, or on the 10-year anniversary charge. In effect, one nil rate band will be shared between them. However, other trusts will retain their own nil rate band to offset against any 10-year and exit charges.
The new rules will apply to tax charges arising on or after 6 April 2015 for relevant trusts created after 10 December 2014. There are also rules to catch certain additions made to multiple trusts on the same date where they were created before 10 December 2014.
The good news is that the new rules also include provision for “protected settlements”. These are defined as settlements established before 10 December 2014 where the addition into that trust was a transfer of value made in the settlor’s will following death which occurred before 6 April 2016.
This will protect the position where a testator has made a will in the style set out above. The addition on their death would be to multiple trusts and so would, on the face of it, be caught by the new rules so this exception is a welcome one.
Individuals with these sorts of Will arrangements ought to leave them in place until after 6 April 2016 but take advice on more suitable and tax efficient structures after this date.
The new rules should at least provide a greater degree of certainty about the treatment of relevant property trusts in future. The abandonment of the nil rate band splitting proposal is very good news and preserves the legitimacy and effectiveness of using several trusts (each with their own nil rate band) as a well-established and entirely ethical tax planning strategy.
It also means that the use of trusts to protect assets for future generations can continue to be an important element in protecting the interests of children or individuals who cannot manage sums of money themselves.
The use of multiple trusts is one of a number of strategies available to reduce your estate for IHT purposes. Individuals are still well advised to consider the strategy of making regular gifts during their lifetime as an easy way to reduce the value of their estate for IHT purposes. Making use of the allowances available to you on an annual basis is great advice, for example the “small gifts allowance” of £250 which can be paid to as many people as you like without triggering an IHT charge. A larger annual gift allowance of £3,000 is also available and you can make one-off tax-free wedding gifts of £5,000 to your children (£2,500 to grandchildren).
The key is to get professional advice tailored to your own specific circumstances and to ensure that your existing arrangements are reviewed on a regular basis. Your personal circumstances may change as well as HMRC legislation and practice.