Brown backs down (a bit) on trusts

Trust me, you might not have to rewrite your will after all. Chancellor Gordon Brown, he who has made an art form out of the BSA (Budgetary Stealth Announcement), has apparently climbed down on his trust-busting tax proposals announced in March.

This softening of the flinty Scottish heart came to light earlier this month when there was a tabling of a series of amendments to the Finance Bill, then in its committee stage in the House of Commons. Strangely, there was no accompanying announcement from the Treasury or HM Revenue & Customs, so it might be best to wait until the Finance Bill gets Royal Assent and becomes law (within the month), before deciding whether your will does need a revamp. Amendments, after all, can be amended.

It was estimated that up to one million people could be forced to redraft their wills, at a cost of some £250 million, when the changes to the taxation of trusts were sneaked out in the Budgets small print.

In essence, these would have forced parents to let children inherit assets on their 18th birthday or face a punitive tax, and would have made it prohibitively expensive to set up trusts in wills to protect spouses. The Treasury argued that the changes would only affect a relatively small minority of wealthy families and would help tighten the rules against tax avoidance.

Gordon Brown's claim that only 20,000 trusts would be affected was met with 'gobsmacked' incredulity and hotly disputed by lawyers, accountants and financial experts. It's probably safe to say that his about-turn has been prompted by concern over the future voting habits of Middle Britain rather than any environmental considerations stemming from wasted will-writing ink and parchment.

Trusts are commonly recommended for families of modest means, because, despite what the Treasury may argue, such everyday citizens are increasingly becoming liable for inheritance tax (IHT). Property prices alone have seen to that and they are likely to continue outpacing increases in the IHT threshold. This threshold is currently £285,000 and is scheduled to rise to £325,000 by the 2009/10 tax year.

Trusts provide a vehicle for protecting wealth and estates from the voracious appetite of IHT (not everyone can benefit from royal provenance as a boost for an IHT fund-raising auction!).

Not quite back to square one, but almost

These latest amendments to the Finance Bill return the tax treatment of trusts for children and spouses almost to the situation that prevailed before the Budget, although not exactly.

So what's the situation now? With regard to 'accumulation and maintenance' trusts (commonly used to prevent children from squandering their bequests at age 18 rather than the more sensible age of 25) the proposal had been for a continuing tax charge of 6% over 10 years, in addition to inheritance tax, if inheritance was deferred beyond 18.

This situation has now been amended so that tax is only applicable for those years when the beneficiary is over 18, rather than from birth. The result is that, for those wills restricting payment until age 25, a tax charge of 4.2% will be faced, rather than a maximum 15% as previously planned.

Restrictions were also proposed for 'interest in possession' trusts, frequently used in second marriages to bequeath an income to a surviving spouse for life; on their death the remaining wealth would go to children from the first marriage. One of the most serious implications in the proposed legislation was the resultant limited availability of the spouse exemption where assets are left to the surviving spouse.

Certain conditions, for the most part not found in existing wills, would have to be met to allow spouse exemption. Unless the will is rewritten, or possibly the trust terms amended, an unexpected IHT charge could arise on the first death. These conditions have been withdrawn and trusts set up in wills to protect spouses have been spared new tax charges. Spouse exemption has been restored in such circumstances.

The Law Society's tax law committee spokesperson viewed the Chancellor's climb-down as a "limited reprieve", noting that parents would still be penalised for prudence (who is so obviouly no longer Gordon's girlfriend!). They will have to evaluate whether it is worth taking a 4.2% tax charge on the estate in exchange for their children receiving payments at 25 instead of 18.

15 June 2006 © Moneyextra.com

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