On 6 June 2014, HMRC published the third Consultation Document in relation to the simplification of trust charges for relevant property trusts – Inheritance Tax: A Fairer Way of Calculating Trust Charges. HMRC had published two earlier Consultation Documents on the same subject. The first Inheritance – Tax: Simplifying Charges on Trusts – published in July 2012 was a very generic document seeking practitioners’ views on trust simplification generally. The second – Inheritance Tax: Simplifying Charges on Trusts – the next stage – published on 31 May 2013 introduced for the first time the idea that an individual’s ‘nil-rate band’ would be split amongst the trusts that he or she had created. In Budget 2014, following much criticism from professionals, the proposed rules for splitting the nil-rate band were deferred and HMRC stated that they would come back with new proposals prior to 2015 when the proposed new rules would come into play. This latest document represents HMRC’s latest (and we believe final) suggestion in this area.
The mischief that these rules are particularly aimed at is the idea of being able to establish a number of trusts, each of which should get the benefit of a full nil-rate band when it came to, for example, calculating a ten-yearly charge. Both planning involving the creation of multiple settlements, and also planning whereby a settlor creates a new settlement every seven years, appear not to be to HMRC’s liking and hence their desire to ensure that each settlor only gets the benefit of one ‘nil-rate band’ to apportion between however many settlements they choose to establish.
Overview of the new rules
The two key proposals in these new rules are:
- that each individual shall be provided with a ‘settlement nil-rate band’ which is entirely separate from his or her own nil-rate band for general inheritance tax purposes; and
- that each settlor should have the ability to decide which trusts should get the benefit of that settlement nil-rate band.
The key point that the nil-rate band applicable to a settlement is now going to be entirely separate to what might be thought of as the transferor’s normal nil-rate band is absolutely central to these new proposals and is key to understanding them. The following example helps to illustrate the point.
If an individual creates a nil-rate band settlement now with cash of say £325,000, the creation of that settlement would not trigger an upfront inheritance tax charge precisely because it would be within the individual’s nil-rate band. In the past, that settlement would then also get the benefit of a nil-rate band. However, going forward, it will be up to the settlor as to whether or not he or she wishes to allocate all or part of their new and separate ‘settlement nil-rate band’ to that new trust. If they do, then when it comes to calculating the ten-yearly charges the trustees will simply take the value of the assets, deduct the settlement nil-rate band and multiply the balance by 6%. On the other hand, the settlor could decide not to allocate any part of the ‘settlement nil-rate band’ (or some percentage of it) to that settlement in which case the calculation will be different.
If we then roll the clock forward seven years and imagine that the settlor’s own inheritance tax nil-rate band has revived, he or she would be able to establish a second trust, again using cash to a value of £325,000. There is nothing in these new proposals which would stop the settlor doing that. The only difference is that the settlor would not then be able to allocate any nil-rate band to that settlement (unless of course their full ‘settlement nil-rate band’ has not been used against the first settlement). So that settlement would simply be taxed at 6% going forward every ten years and without the benefit of any nil-rate band.
The solution being proposed by HMRC deals quite neatly with one of the objections to the original proposals for splitting the nil-rate band, being that it would be very difficult for trustees to know how many other trusts have been established by the same settlor. With this new system, the trustees either will have been given a ‘settlement nil-rate band’ by the settlor, or they won’t and there will be a specific form of election that the settlor will need to execute to advise the trustees of the status. Over-allocation will result in sanctions against the settlor.
Where trustees have not been notified of an allocation to them then they will be required to assume that the settlement has received a nil allocation.
These new rules will take effect from tax year 2015/16; however, because HMRC are concerned that taxpayers will try to take advantage of the previous rules (e.g. to establish a series of settlements) the rules will apply to all settlements established on or after 6 June 2014. They will also apply from this date to additions to existing settlements and changes to existing settlements where property first becomes relevant property. In effect, therefore, these new rules are already in place notwithstanding the fact that the consultation period is ongoing until 29 August 2014.
The following additional points can be noted in relation to the proposed new rules:
- It will be possible for a settlor to amend the allocation of their ‘settlement nil-rate band’ but only as long as it hasn’t already been used in a tax calculation. In the Example given above, therefore, if there are no ‘exits’ from the settlement, the settlor would be able to withdraw the allocation of the nil-rate band up to any point before a ten-yearly charge arose in the first settlement. Thereafter it will be possible to increase an allocation where property is added to the settlement.
- Likewise, on death, if an individual has not created any settlements in his or her lifetime, his or her PRs will be able to elect (within two years of the death) to use the ‘settlement nil-rate band’ in relation to any trust created by the Will. Alternatively, they could allocate any unused part to lifetime trusts which the settlor hadn’t allocated themselves.
- There is an interesting rule in relation to a trust which is wound up. Where a trust ceases to exist, the ‘settlement nil-rate band’, in effect, reverts to the settlor to be, if necessary, allocated elsewhere (unless they have died). Again in relation to the example above, if the first settlement was wound up at, let’s say Year 9, the benefit of the ‘settlement nil-rate band’ could then be used in calculating the exit charge. That having been done and the settlement having been wound up, the ‘settlement nil-rate band’ could then be reallocated to the second settlement.
In relation to settlements in place before 6 June 2014, the old rules will continue to apply to the extent that they determine the amount of nil-rate band applicable to a settlement. In other words, in relation to an existing settlement one will work out the nil-rate band available to the settlement by reference to the settlor’s own nil-rate band less any chargeable transfers they had made in the previous seven years. Beyond this point, however, the same calculation rules will apply so that the trustees will again carry out a simple calculation of deducting that nil-rate band from the overall value of the trust and multiplying it by 6%. In other words, all the complicated aspects of a ten-yearly charge calculation such as the working out the historic value of related settlements etc. will disappear. To this extent, many existing settlements will be better off under these rules.
Clearly, there is some time to go before these rules are finalised as the consultation period doesn’t end until 29 August 2014. Our view, however, is that it is likely that these rules will become law in more or less these terms, to be effective from 6 April 2015; however, the devil will be in the detail.
The more interesting thing which perhaps these changes suggest is a possible change to the general principle that an individual’s normal nil-rate band should revive every seven years. In many jurisdictions, an individual is provided with an inheritance tax exemption which, if used, is then used forever and never revives. In the UK, the fact that a nil-rate band revives every seven years is clearly very useful for settlors who have the means to create a number of settlements over a long period of time. The idea that each settlor should only have one ‘settlement nil-rate band’ to allocate between their trusts could easily be extended in the future to the idea that each settlor should only have one inheritance tax nil-rate band to be used during their lifetime. We will see!