TAXATION OF TRUSTS PROPOSED BY HMRC

HM Revenue & Customs suggested setting a limit to the amount which individuals may transfer tax-free into trusts so as to avoid the use of multiple trusts as a means of bypassing inheritance tax.

The tax authority proposed an alternative allowance called “settlement nil-rate band”, equivalent to the nil-rate inheritance tax band, which each settlor could allocate to trusts.

Currently, inheritance tax may be reduced via the use of multiple trusts, as long as the assets in each trust do not exceed £325,000. There is no limit to the number of trusts a settlor may set up.

Following the proposed new rules, only a few would be able to set aside £650,000 tax-free via the use of trusts.

These changes will have an effect on those who currently use multiple trusts to minimise their tax obligations.

Assets which are transferred into trusts are eliminated from an individual’s estate, meaning they are ineligible for inheritance tax charged at a marginal rate of 40% above the nil-rate threshold.

Any amounts above this threshold that are invested into trusts are subject to an “entry charge” at a rate of 20%. A further “periodic charge” of 6% is levied on each 10-year anniversary of the assets entry into the trust, and an “exit charge” payable when the assets are removed.

These charges combined, aim to levy equivalent levels of taxation over a generation as a one-off inheritance tax payment upon transfer of assets. In reality, however, the high net worth individuals may end up paying much less tax by setting up any number of trusts, each with a value lower than the nil-rate band.

HMRC’s proposed reforms are still under discussion until August 29th.