Finance Bill 2006 - Trusts,Wills and Inheritance Tax

The Finance Act was given Royal Assent on 19 July 2006. A number of amendments have been made to the proposed new rules as the Bill has gone through Parliament. The principal changes are:-

• Relaxation on the requirements for a qualifying surviving spouse/civil partner life interest under a Will Trust.

• Special rules for children's trusts under a Will which benefit children at 25 instead of at 18 (known as ‘18-25’ Trusts).

• Extension of children's trusts provisions to those created in Wills of individuals with ‘parental responsibility’ (extended from parents and step-parents).

• Spouse exemption for IHT now available where Life Tenant dies and surviving spouse/civil partner obtains an interest on their death under an existing Settlement.

• There are also various specific changes for Disabled Trusts particularly those created by an individual for themself - these are not covered further in this note.

These changes should be considered in the context of all the Finance Act changes which we have set out in our previous updates. The following therefore repeats the key issues but adding in the new changes.

• Existing A&M trusts will continue with the existing IHT treatment until 5 April 2008.

• An existing A&M trust can be amended before 5 April 2008 so that the beneficiaries become absolutely entitled at 18. If this is done then the existing IHT treatment will continue until the beneficiaries are 18.

• If no change is made and the trust is worded so that the beneficiaries become absolutely entitled at an age more than 18 then from 6 April 2008 the A&M trust will be taxed as a discretionary settlement.

• The existing tax treatment remains during the existing life tenant's life.

• If an existing life tenant dies, or otherwise ends his interest, in favour of another life tenant before 6 April 2008 then the existing tax treatment will continue during the life of the successor life tenant.

• If a surviving spouse takes an interest on the life tenant's death then the spouse exemption will apply and the existing tax treatment will continue during the surviving spouse's life.

• At the end of the present life interest there will be an IHT charge - unless there is a successor interest for their spouse (the same as at present).

• At the end of the existing (or successor) life interest if the trust continues it will be taxed as a discretionary settlement.

• If a nil rate band trust is contained in your Will then the changes will not affect that trust.

• Outright payments to your spouse on your death continue to benefit from the spouse exemption and are not subject to IHT on the first death.

• If you create a life interest trust for your spouse - then the existing spouse exemption is available.

• If you create a trust for your children in your Will then beneficial tax treatment is available if the trusts provide that they will become absolutely entitled at an age no more than 18. As under the present rules there is a charge on your death but no charge on the death of a child under 18 or when the child becomes absolutely entitled. Until the child reaches 18, all of the income of that child's share must either be applied for their benefit or accumulated. On reaching 18, the child must become absolutely entitled to any accumulated income. Special rules apply if the beneficiary can benefit only once 25, (provided that they then become absolutely entitled), which are similar to the discretionary trust regime but with some variations. Again, no extra tax will be due on your death. Similar provisions to those described above apply to income arising before the child becomes absolutely entitled.

If you specify an age later than 25 then again no extra tax will be due on your death but the trust will be taxed as a discretionary trust from the date of your death.

• Any grandchildren's trust (whatever age your grandchildren may be and even if they benefit at 18) will not give rise to extra tax on your death but will be taxed from your death as a discretionary trust.

• It is still possible to leave the residue of your estate into a special two year discretionary trust set out in your will. The trustees can then make appointments during those two years to seek to achieve the most tax efficient way of realising your wishes. The IHT rules then tax your estate as if you had yourself set out those appointments in your Will.