Drafting Trusts and Will Trusts

The Finance Act 2006 makes revolutionary changes to the IHT treatment of trusts. Until 2006, the basic principle of tax policy has been that the tax system should not discriminate against trusts:

The government recognises the important role trusts play in society and has said that as far as possible it wants a tax system for trusts that does not provide artificial incentives to set up a trust, but equally avoids artificial obstacles to the use of trusts where their use would bring significant non-tax benefits.^¹

This policy has been completely reversed. The policy now is to impose additional charges on trusts, other than very limited, privileged trusts, with the result that:

(1) In most cases trusts will not be created. In particular a lifetime gift to another individual is a PET: a gift to a trust is generally chargeable.

(2) In most cases, where privileged trusts have been created, they will be wound up as soon as possible:

(a) IPDI trusts will generally be wound up on the death of the life tenant. In particular, a gift to another individual may qualify for the spouse/civil partner exemption: the termination of an IPDI will not usually do so unless the trust then comes to an end.

(b) Bereaved Minors trusts and Age 18-to-25 trusts will be wound up when the beneficiaries reach 18 or 25.

More striking than the revolutionary nature of these changes is the dishonesty used in their presentation. Fundamental misconceptions (a less charitable commentator would say, lies) were propounded by those pushing through the new law:

(1) The changes “aligned” the formerly “privileged” tax treatment of IP and A&M trusts with the “normal” “mainstream” tax regime for discretionary trusts.^² In fact, as any practitioner knew, substantial discretionary trusts, i.e. those paying any substantial IHT, were highly exceptional.^³

(3) Only a very small number of very rich people, quantified as 20,000, would be affected.

(4) Wills made before the introduction of the new law would not need to be rewritten. (This was later made broadly true, by radical amendment of the Finance Bill in Committee; though accompanied by a false claim that those changes were only intended to clarify what the Government had always intended.)

(5) Trusts of life insurance policies made before 2006 were not affected. (This was also later made true by amendments in Committee, accompanied by the false claim that those changes were not in fact necessary.)

(6) That the new rules, requiring (on pain of penal tax charges) property to be distributed to children at the age of 18, had been supported by professional institutions in prior consultation.

To anyone knowledgeable in practice in this area, these statements are absurd and scarcely deserve refutation. But the formal evidence of refutation was in due course assembled, at short notice, and this was done with sufficient success to lead the Select Committee on Treasury to conclude:

With respect to the new rules on the tax treatment of accumulation and maintenance and interest in possession trusts, we are concerned that estimates of the expected numbers of affected trusts vary so widely between Government and practitioners. If the Government’s estimate, that the new rules will affect “only a very small number of very wealthy people” is correct, then the Government needs to provide much more detailed information about its estimates, in order to allay taxpayer and industry concerns. We are concerned that a legitimate measure designed to reduce tax avoidance may penalise trusts established to protect family members and consider that the issue merits further consideration. We recommend that the Government provide detailed information about how it has arrived at its estimate that the new rules on the tax treatment of certain trusts will affect only “a minority of a minority” of 100,000 discretionary trusts. This information should be provided prior to consideration in Committee of the House of Commons of Clause 57 of, and Schedule 20 to, the Finance Bill^⁵.

Trusts offer important protection for beneficiaries as the Courts have often accepted:

Speaking in general terms, it is most important that young children should be reasonably advanced in a career and settled in life before they are in receipt of an income sufficient to make them independent of the need to work.^⁶

Research by the Financial Services Authority shows (if proof was needed) that 18-year-olds are much less financially capable than 25-year-olds.^⁷

People with mania sometimes believe they are rich and go on spending sprees and people with depression commonly spend money in an effort to make themselves feel better. Conversely, people with depressive symptoms may withdraw and ignore official letters, appointments and bills often leading to mounting debt.^⁸

Until now the financial protection which trusts can confer has been available to everyone; it was one of the great benefits of living in a common law jurisdiction. The attack on trusts is a reform which in the long term (if it remains) has profound social implications. But the dishonest manner in which the changes were introduced effectively prevented any serious debate on the policy issues from taking place.

Does it now matter? Readers may think it pointless to cry “foul” in a game which has no referee, and whose result has now been declared. But the story does need to be recorded, for several reasons.

The UK tax system is notorious for its instability^⁹ and tax law which is not founded on proper debate and a modicum of consensus is not likely to prove stable.

The relationship between the individual and HMRC has in the past depended mainly on willing compliance. (A system based substantially or entirely on forced compliance could be created, and indeed we are presently moving in that direction, but no-one has ever openly advocated that). HMRC rightly protest when they are cheated:

HM Revenue & Customs expects professionals such as accountants who act on behalf of taxpayers to be entirely professional and honest. [The convicted defendant] has abused the trust of his clients and has failed in his legal and professional responsibilities to HMRC. He has cheated family, his friends, clients and all honest taxpayers.^¹⁰

But honesty is a two-way street. Taxpayers should also expect HMRC to be “entirely professional and honest”. In this matter HMRC have abused the trust of the public (which generally assumed that HMRC press releases are reliable). Settlors and beneficiaries of A&M trusts have been cheated. They have entered into arrangements which have never until now been regarded as tax avoidance and find themselves being penalised for having done so. The rank unfairness of some of the 2006 rules, combined with its dishonest presentation, will corrode the goodwill upon which HMRC has historically relied.

One can only hope that this proves to be a one-off and not a regular feature of future tax reform.

The usual situations in which lifetime trusts will be used by UK domiciliaries under the current law are as follows:

(2) If the trust property qualifies for 100% business or agricultural property relief.

These are of course significant categories. Basic IHT planning now will be for an individual to make a series of nil rate band gifts every 7 years.^¹¹

In all other cases, the 20% IHT charge will rule out lifetime gifts to trusts. An individual who wishes to benefit his family should:

(3) In the case of companies not qualifying for 100% BPR, deferred share arrangements should be considered (this topic is not discussed in this book).

A sensible course is to do nothing for now and wait for the fiscal climate to improve. Experience suggests that the pendulum swings to and fro, just as old Labour’s capital transfer tax only lasted from 1974 to 1986. The present tax regime, founded on misconceptions and lies, is unlikely to last longer. At least the sensible advice for a client not in old age may be to wait and see.^¹⁴

A&M Trusts

(1) To retain the trusts in their present form and pay 10 year and exit charges from 6 April 2008.

(2) (a) To wind up the trusts by 6 April 2008,^¹⁵ transferring property to beneficiaries absolutely or by transfers to bare trusts. If the transfer is to the A&M beneficiaries, this is straightforward. A transfer to other beneficiaries can also in principle^¹⁶ be achieved by giving the A&M beneficiaries a short term interest in possession.

(b) If the A&M beneficiaries are under 18, to exercise the overriding power of appointment so that they will become absolutely entitled at the age of 18.

(2) To appoint a new life interest, before 2008, which will be a “transitional serial interest”. This will constitute a PET by the current life tenant, and the GWR rules will apply so it would normally be necessary to exclude the current life tenant.

Route (1) has the attraction that the spouse/CP exemption will apply more readily on the death of the life tenant.

3 There was a good reason for this. The discretionary trust regime was designed in 1982 to impose on discretionary trusts a burden roughly equal to the burden of capital transfer tax on non-settled property. It achieved that. In 1986, CTT was then replaced by the much lighter IHT regime, under which tax was no longer charged on liftetime gifts. There is no obvious solution as to how to deal with discretionary trusts under an IHT regime. The solution adopted was to retain the old CTT rules, which then imposed a burden on discretionary trusts rather greater than that which applied to non-settled property, but allowing the alternative route of IP trusts (and A&M trusts) which were, broadly, treated in the same way as non-settled property. Thus the charges on discretionary trusts had something of the nature of anti-avoidance provisions. Although the tax charge could be unduly high, that did not matter at all because nobody needed to pay it, and very few actually did.

5 Select Committee on Treasury Fourth Report, para. 109, accessible on www.publications.parliament.uk/pa/cm200506/cmselect/cmtreasy/994/99407.htm#a46.

6 Re Holt [1969] 100 at p.122. Another example: Re Gates [2003] 3 ITELR 113, accessible www.jerseylegalinfo.je, “It is not in our judgment generally in the interests of young persons to come into possession of large sums of money which might discourage them from achieving qualifications and from leading settled and industrious lives to the benefit of themselves and to the community.”

7 The report, “Levels of Financial Capability in the UK” concluded that 18-year-olds have a factor score of just 27 out of 100, while those aged 20 to 29 have a higher factor score of 40. See www.fsa.gov.uk. Dawn Primarolo’s response was “I, for one, have more faith in our young people”. During this soi disant debate, members of the standing committee passed the time reading “Private Eye”: col. 710.

Quote from website of “Rethink” (the Schizophrenia charity) Persons with mania or depression will often not qualify as “disabled persons” in the IHT sense.

11 Spouses and civil partners may each make gifts to the same trust, as that trust will be treated as two separate trusts for IHT purposes: s.44 IHTA 1984.

13 If desired:

The loan (say, to a child) could be repayable only on the death of the borrower.
The individual could give away the benefit of the loan to grandchildren.

16 The position depends on the extent of the trustees’ powers of appointment. In the A&M trusts in earlier editions of this book, the trustees had sufficiently wide powers. Other trusts used were sometimes narrower.