In announcing an alignment of the tax treatment of Accumulation and Maintenance (A & M) and Interest In Possession (IIP) trusts with discretionary trusts, the Chancellor, in the Budget in March 2006, has given the trust world its biggest shake-up for years.
Trusts are used to protect and pass on family wealth in a controlled and tax-efficient manner. The latest proposals remove tax advantages which have existed for many years and will restrict the scope for the use of trusts in future.
A & M trusts have been particularly popular with parents and grandparents wanting to give or bequeath assets free of tax whilst preventing them from being squandered. Such a lifetime gift, until now, has been a Potentially Exempt Transfer for inheritance tax, which meant that as long as the donor survived seven years it fell outside their estate for inheritance tax purposes. Also, there should have been no inheritance tax liability when the fund passed to the beneficiary. However, under the new tax regime, gifts into A & M trusts will attract an immediate inheritance tax charge. They will also be subject to 10-yearly and exit charges that apply to discretionary trusts.
It was thought that this new regime would also apply to wills but an exception has been made for an A & M trust set up by a parent in their will for a minor child as long as they become absolutely entitled at the age of 18. If a parent wants to leave a gift to their child in their will with a condition that they don’t become entitled until 21 or 25, then there will now be an inheritance charge, although it will not exceed 4.2%. It is difficult to see why the Chancellor should impose this penalty when many feel that 18 may be far too young to receive an inheritance.
Interest in Possession (IIP) trusts are often used to protect family wealth or individual family members. A beneficiary’s entitlement is usually restricted to income only but the capital remains in the control of the trustees. As with A & M trusts, a lifetime gift into an IIP trust was a Potentially Exempt Transfer, so there was no inheritance tax to pay on survival by seven years. The trust was then included in the estate of the beneficiary for inheritance tax purposes. Now, lifetime IIP trusts will be subject to the same entry, 10-yearly and exit charges as described above. However, an IIP in a will is still going to be treated under the old rules!
The changes are complicated and we suggest you review your wills and any trusts you have as soon as possible. It is perhaps a case of misalignment rather than alignment!
Aug 2006
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