HMRC have published further helpful guidance following the radical changes to the inheritance tax treatment of trusts enacted in the Finance Act 2006.
Trustees of accumulation and maintenance (‘A & M’) trusts have been put in a difficult position following the changes. They must consider whether it is in the best interest of the beneficiaries to accept the 6% inheritance tax charging regime from 6 April 2008 or to alter the trust before that date so that these charges are either avoided or mitigated.
It is understandable that trustees are reluctant to take action that means the beneficiaries will become entitled to the capital outright at 18 or 25. In many cases, it will not be possible for the trustees to determine whether this will be for the benefit of a young beneficiary.
Fortunately, HMRC have confirmed that the position is not as inflexible as many advisers had feared. If a trust is altered so that the beneficiaries become entitled to the capital outright on or before the age of 18 or 25, it may still be possible to defer subsequently a beneficiary’s capital entitlement if it is for that beneficiary’s benefit. They have also confirmed that there is more flexibility than previously thought to vary the shares in which the beneficiaries take.
A & M trusts – entitlement on or before age 18
If an A & M trust is altered before 6 April 2008 so that the beneficiaries become entitled to the capital outright on or before age 18 then the trust will never be subject to the 6% inheritance tax charging regime.
This will be the case even if the trust includes a wide power of advancement.
Although in most cases the beneficiaries will become entitled to the capital outright by age 18, the trustees may subsequently decide that it is for the benefit of the beneficiary concerned if they exercise their power of advancement to defer the beneficiary’s capital entitlement to a more appropriate age and potentially indefinitely. HMRC have confirmed that in these circumstances, there will be no charges to inheritance tax when the entitlement is postponed but the 6% inheritance tax charging regime will apply going forward.
It is also clear that whilst the beneficiaries are under the age of 18, the trustees can retain discretion over the payment of income and capital and future born beneficiaries are also capable of benefiting.
A & M trusts – entitlement on or before age 25
If, instead, an A & M trust is altered before 6 April 2008 so that the beneficiaries become entitled to the capital outright on or before age 25, the trust will only be subject to the 6% inheritance tax charging regime if assets remain in trust after a beneficiary has reached the age of 18. The maximum inheritance tax charge that can apply is at a rate of 4.2% if the beneficiary does not become entitled to the assets until age 25.
As with a trust that is altered so that the beneficiaries become entitled to the capital outright on or before age 18, it is possible to include a wide power of advancement for reasons of flexibility. If the trustees decide that it is for the benefit of the beneficiary concerned, they can exercise this power to defer the beneficiary’s capital entitlement. There will still be an inheritance tax charge up to a maximum of 4.2% but HMRC have confirmed that there will be no other charge to inheritance tax. The 6% charging regime will continue to apply going forward.
HMRC have clarified that although the trustees can retain discretion over the payment of income and capital among the class of beneficiaries, it is not possible for future born beneficiaries or beneficiaries who have been wholly excluded on a revocable basis to benefit.
Will trusts for children
The position is similar for trusts set up for children under a Will under which the beneficiaries become entitled to capital outright on or before the age of 18 or 25. The trustees can therefore maintain flexibility to defer capital entitlement in appropriate circumstances and will need to take care if excluding beneficiaries on a revocable basis.
The ability to defer the capital entitlement of a beneficiary in appropriate circumstances beyond age 18 or 25 and the power to vary beneficiaries’ shares will be an important consideration for trustees when deciding before 6 April 2008 what is in the best interest of the beneficiaries. The clarification of this additional flexibility is to be welcomed as it will help the trustees to protect beneficiaries and preserve wealth for future generations.