SUMMER BUDGET 2015: INITIAL THOUGHTS PRIVATE CLIENT
TRUSTS & INHERITANCE TAX
Delay for Main Residence Nil Rate Band
The additional inheritance tax nil-rate band for family homes will not be introduced until April 2017.
It will be phased in starting at £100,000 in 2017 to 2018, £125,000 in 2018 to 2019, £150,000 in 2019 to 2020, and £175,000 in 2020 to 2021. The ordinary nil rate band of £325,000 will remain frozen until April 2021. The extra nil rate band will apply only where the main residence, or the proceeds from its disposal, is passed to direct descendants. It is tapered for estates worth over £2 million, which could translate into a marginal inheritance tax rate of 60% on certain estates.
It is not clear from the available information available whether the home must be the subject of a specific gift to direct descendants, or whether the value can be included as part of a residuary gift to them. If a specific gift is required, most people hoping to benefit from the relief will need to draft or re-draft their wills. If, as is more likely, a gift of residue will qualify, the calculation of the nil rate band could be complicated where other beneficiaries, such as an unmarried partner, take a share of the estate. The additional nil rate band will only be available on death. It will not apply to lifetime transfers that become chargeable on death.
By focussing on a particular asset for special relief, parents and grandparents will be encouraged to concentrate as much as they can afford in the value of their home.
Initial legislation will be included in Finance (No 2) Bill 2015, but the adjustments relating to downsizing and possibly other refinements will be deferred until Finance Bill 2016 after consultation.
Changes to the Inheritance Tax Regime for Trusts
The calculation of inheritance tax principal and exit charges will be simplified by removing the requirement to include non-relevant property in the initial value to determine the rate of tax. This is a welcome amendment in light of the difficulty of obtaining historic valuations, say, for instance, in the case of old accumulation and maintenance trusts, where an initial value was not required when the trust was created.
HM Revenue & Customs had been consulting on counteracting the inheritance tax advantages of pilot trusts and this culminated in targeted anti-avoidance being announced in the 2014 Autumn Statement with draft legislation following. It has been confirmed that this legislation will now be included in the second 2015 Finance Bill.
In general terms, ‘same-day additions’ to more than one relevant property trust on or after 10 December 2014 will be aggregated for the purpose of calculating inheritance tax charges. A transitional rule will apply to transfers on death before 6 April 2017 pursuant to Wills executed pre-10 December 2014. Same day additions totalling £5,000 or less will be excluded from the new rule.
Although the same-day additions rule is unwelcome insofar as it counters the use of pilot trusts, confirmation of the changes will allow practitioners to finally be able to advise with certainty on relevant property trusts.
The Frankland Trap
The removal of the Frankland trap is welcome, in particular as appointments to a spouse in the first three months after death will be able to be read back to death to benefit from spousal exemption. The trap meant that certain appointments from a Will trust in the three months after death were not read back to death.
Non-domiciliaries will need to review their tax arrangements over the coming months. Some long term residents may wish to leave the UK before the new rules take effect and advice should be sought in this regard.
Those that remain and those coming to the UK should seek advice as to how the new changes will affect them. There will be no ‘one size only’ answer. Some may wish to wind up existing offshore trusts, others may wish to set up new ones.
Buy to Let Landlords
The private landlord sector has increased significantly over the last ten years or so with many investors looking to supplement their income through property investment. Coupled with the proposed changes to the ‘wear and tear allowance’ and the potential risk of rising interest rates, these restrictions on finance costs are likely to lead to increased rental demands by affected landlords in the medium term. Some landlords may consider selling properties which they judge are uneconomic without full interest relief.
Interestingly, the measures appear to apply to individuals only, not trustees or corporate landlords. The measures do not appear to apply to commercial property and furnished holiday lets. This may suggest the direction future planning may take.
As it appears that this provision is not going to be subject to consultation and will be legislated in Finance (No 2) Bill 2015, there is little opportunity for interested parties to make representations.
Although a technical consultation is to take to place over the summer on the ‘wear and tear’ allowance, it appears that this amounts to a reintroduction of the old non-statutory renewals basis.
Inheritance Tax on Residential Property
The government has been attempting to discourage the holding of UK residential property through offshore corporate structures for some time. The latest rules follow the introduction of the ATED rules in April 2013 and the non-resident capital gains tax charge in April 2015. Like the ATED rules, the intention of these new rules is to encourage the de-enveloping of UK property.
The ATED rules in this respect were largely unsuccessful because many retained corporate holdings of UK property for the inheritance tax benefits and the tax costs associated with de-enveloping. It is intended that the new rules will remove such inheritance tax advantages. As a result it is expected that many corporate structures will de-envelope UK residential property in the coming months subject to costings.
Finally, the restructuring of dividends in relation to trusts is worth mentioning.
There currently appears to be no guidance on how this new system will apply to trustees. The worst case scenario is that a rate of 38.1% will apply to all dividends received by discretionary trusts (following the alignment of the trust rate with the individual additional rate). Presumably, the tax paid, at whatever rate, will go into the tax pool and become potentially repayable, thus changing the issues of a mismatch of tax rates in the tax pool. Further developments are awaited.