HMRC proposes major reform to tax on trusts HM Revenue & Customs has proposed limiting the amount that individuals can transfer tax-free into trusts in an attempt to clamp down on the use of multiple trusts to avoid inheritance tax. The tax authority has proposed a separate allowance, termed a “settlement nil-rate band” and equivalent to the nil-rate inheritance tax band, that each settlor could allocate to trusts over their lifetime.
Carolyn Steppler, private client tax partner at EY, said the changes would “result in considerably more new trusts falling into the inheritance tax net, increasing the total inheritance tax payable by trustees.” Inheritance tax can currently be minimised by using multiple trusts, so long as the assets in each do not exceed £325,000. There is no limit on the number of trusts that anyone can set up. Under the proposed new rules, a couple would only be able to set aside £650,000 tax-free through the use of trusts. “This doesn’t mean that trusts will no longer be an attractive way to pass on family wealth, but [these changes] will affect those who use multiple trusts to minimise tax,” said Tina Riches, national tax partner at Smith & Williamson. Assets transferred into trusts are removed from an individual’s estate, and so are ineligible for IHT, which is charged at a marginal rate of 40 per cent above the nil-rate threshold. Tax calculator Taxation is never that exciting, but you might be surprised to see where all this tax waste comes from, and how easy it can be to remedy Any amounts above this threshold that are put into trusts are subject to an “entry charge” at a rate of 20 per cent. A further “periodic charge” of 6 per cent is levied on each 10-yearly anniversary of the assets entry into the trust, and an “exit charge” is payable when assets are removed. Combined, these charges are intended to levy equivalent levels of taxation over a generation as a one-off inheritance tax payment upon transfer of assets. In reality, however, the very wealthy may end up paying much less tax by setting up any number of trusts, each with a value lower than the nil-rate band. Should HMRC’s proposals come into force, Ms Riches said there would be likely to be an increase in use of gifts to pass down family wealth. Gifts are exempt from IHT provided the benefactor lives for at least seven years after the gift is made. If he or she should die within this time, IHT is payable on a sliding scale. HMRC’s proposed reforms are open for consultation until August 29.