May 2006

2006 Budget Closes Trust Fund Loophole

The 2006 Budget has closed a loophole in inheritance tax law that has been exploited by the tax profession for many years. Inheritance Tax will now apply to Accumulation and Maintenance (A&M) trusts and trusts with an interest in possession (IIP).

Accountants claim that the new rules will affect at least one hundred thousand families, those with estates valued at £500,000 may have to pay up to an extra £20,000.

Those most likely to be affected by this change are those who have set up or have an interest in A&M and IIP trusts, the circumstances of which do not meet the new Inheritance Tax rules.

The changes will mean that A&M and IIP trusts created after the 22 March 2006 will face:

• An immediate 'entry' tax charge of 20% on lifetime transfers that exceed the Inheritance Tax Threshold, which is currently £285,000

• A 'periodic' tax charge of 6% on the value of trust assets over the Inheritance Tax Threshold to be taken every 10 years

• An 'exit' charge when capital is taken out of a trust fund, between the ten year anniversaries, of up to 6%

Exemptions

There will be only three exemptions from these new rules:

• Trusts that are created on the death of a parent for a minor child who will be fully entitled to the assets of the trust on reaching the age of eighteen

• Trusts that are created on death for the benefit of one life tenant in order of time whose interests cannot be replaced

• Trusts that are created either in the lifetime or on death of the settlor for a disabled person

Existing Trusts

A&M
Those existing trusts also face periodic and exit charges from 6 April 2008, but this can be avoided by ensuring that assets vest absolutely at the age of eighteen. Existing trusts will also be exempt from the 'relevant property' charges if they satisfy conditions for ongoing protection. However, the new rules will apply to the addition of new assets to existing trusts.

IIP
The current rules for existing IIP trusts will continue until the interest in the trust property at 22 March 2006 comes to an end. If a person then takes absolute ownership, the transfer will be viewed as a transfer by the person with an interest in the property and hence will receive the same Inheritance Tax Threshold treatment as now. If, however, the interest ends and the property remains on trust, this will be treated as the creation of a new settlement of property and will avoid these new rules.

If you should require any more information please do not hesitate to contact Johanna Knott at our Beaconsfield office.