Inheritance tax: simplifying charges on trusts

Changes announced in the draft Finance Bill clauses published on 10 December 2013 go some way to achieving the simplification of trust IHT charges but there are more changes to follow.

Effective for trust chargeable occasions on or after 6 April 2014

New rules will be introduced in relation to:

  • apportionment of nil-rate bands among trusts with a common settlor; and
  • whether a flat 6% rate is to be used as the basis of charges on trusts, rather than a rate based on the effective rate charged on settlement or on the preceding principal (ten-year) charge.

Single accounts filing and IHT payment date for trusts

Trustees will have to file IHT accounts and pay the tax due no later than six months after the end of the month in which the chargeable event occurs, including:

  • appointments out of the trust;
  • principal (ten year) charges on trust property;
  • transfers of property into the trust where the trustees have agreed to bear the IHT;
  • the death of a life tenant; and
  • failure of the conditional exemption for heritage etc. property.

Penalties apply for late filing and interest runs immediately from the date when the tax becomes payable.

This change does not affect the payment date when additional IHT liability arises because a settlor dies within seven years of making a potentially exempt transfer.

Automatic accumulation for the ten-year charge

The ten-year anniversary charge rules will be amended to clarify when trustees must treat undistributed income as having been accumulated to capital.

The old rules

The capital of a trust on which IHT is charged at each ten-yearly anniversary of the date of original settlement includes income

  • that the trust deed requires to be accumulated to capital; and
  • that the trustees have exercised their discretion to accumulate.

It cannot include income that automatically becomes income of a life interest in possession beneficiary or income that is not allocated to any beneficiary in particular but which the trustees are bound to distribute. HMRC also hold that where the trustees have a power to accumulate and do not formally exercise that power but effectively treat undistributed income in the same way as capital, that income should also be treated as being accumulated to capital. Under the current rules accumulated income is charged as from the date when it was accumulated by reference to the time for which it has been ‘relevant property’. This can entail complex computations to determine the IHT chargeable.

The new rule

The new rule removes the need to do any apportionment.  It does not alter the fact that income that would have been treated as accumulated anyway will still be subject to charge but it takes any remaining unaccumulated income and applies a relatively straightforward test.

Income is treated as accumulated to capital if it:

  • is still held by the trust on the ten-year anniversary;
  • was received in the trust more than five years before the ten-year anniversary; and
  • was received from relevant property in which there was no interest in possession at the time when it arose.

Non-relevant property

Certain income is not to be included in relevant property for the purpose of the ten-year charge, i.e.:

  • income arising on property settled by a person who was non-UK-domiciled when the property was settled, but only if it is not situated in the UK or
  • represented by a holding in an authorised unit trust or an open-ended investment company (OEIC); or
  • is represented by free of tax to residents abroad (FOTRA) gilts and certain conditions are satisfied by all actual or actual or potential beneficiaries of an interest in possession in those securities – ie they would be excluded property.

Rate of tax on income deemed to be accumulated

Income deemed to be accumulated by the new rule is treated as if it had been relevant property throughout the ten years prior to the current ten-year charge. This removes the need to calculate an apportionment of the effective rate for this income. The requirement to apportion the effective rate remains for income that was actually accumulated before the ten year charge date.

Measures deferred for consultation

Pilot trusts and simplified rates

In the Autumn Statement the Chancellor announced that there would be further consultation on:

  • splitting the nil-rate band (NRB) among trusts created by the same settlor; and
  • replacing the present system of making ten-year charges at an “effective rate” based on the amount of tax actually charged on the last ten-year charge, taking into account the trust’s NRB.

These matters will be subject to further consultation with a view to including changes in Finance Bill 2015. It seems likely, however, that changes will be made which will remove or reduce the benefit of pilot trusts by requiring some degree of splitting of the NRB among all the trusts that each settler creates.

IHT online has also been deferred, at least until 6 April 2015.