As well as freezing the inheritance tax (IHT) nil-rate band at £325,000 for 2010/11, Alastair Darling also announced draft legislation to prevent certain aggressive IHT avoidance schemes. You can download the press release and draft legislation.
The changes are designed to restrict schemes that escape the twenty percent IHT charge that is applied to the excess over the nil rate band (£325,000) on transfers into trust. For example a transfer of £1 million would incur a tax charge of £135,000. From 2006 this twenty percent charge applied to virtually all transfers into trust and there was obviously considerable appetite amongst the wealthy to continue to make large transfers into trust whilst avoiding any initial tax charge.
The changes specifically target schemes:
- Where an interest in a trust is purchased
- Where an individual retains a certain type of reversionary interest in a trust
The Financial Times erroneously reported that Flexible Reversionary Trusts (FRTs) were caught by the draft legislation. This is clearly not the case when you consider the type of planning targeted and consult the draft legislation.
The reversionary interest trusts that are being targeted are reversionary interests that create an interest in possession in the trust property after an initial period. Under a FRT an individual retains a reversionary interest which provides an absolute interest. The creation of a reversionary interest which provides an interest in possession had considerable advantages after the 2006 changes in trust taxation; paradoxically it was this new legislation that was intended to prevent large transfers into trusts which created the efficacy of the current reversionary interest schemes.
It was widely anticipated in tax planning circles that this sort of aggressive planning would be targeted by HMRC after they became aware of it – considering the sizeable sums involved. Unlike other tax planning schemes, IHT planning schemes do not have to be disclosed to HMRC under the Disclosure of Tax Avoidance Schemes (DOTAS) rules. However, where planning has already been disclosed to HMRC to gain an understanding of whether it is acceptable then this provides considerable reassurance to those contemplating the planning. This is why structures such as Discounted Gift Trusts and Flexible Reversionary Trusts remain popular as there has been considerable positive dialogue with HMRC over the years.
In contrast, those contemplating aggressive planning always enter into it with the spectre of retrospective legislation creating more problems than existed prior to implementing the planning. In this case it seems that there will not be any retrospective element but we will need to await the Finance Bill for confirmation.
You can read more about Flexible Reversioanry Trusts in one of my previous posts Using a Flexible Reversionary Trust to reduce inheritance tax whilst retaining access to capital.
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