Inheritance loophole closes

Currently 95% of all estates escape inheritance tax and recent years have witnessed a rise in the use of trust arrangements that allow people to transfer assets to their children to avoid paying inheritance tax.

In December’s pre-budget report, the chancellor announced he would make it more difficult for people to set up ‘complex tax avoidance scams’, catching out those who’ve given away assets while continuing to enjoy the benefits associated with ownership. While the concept was not deemed contentious, analysts predicted that homeowners who had legally placed their properties in trust to pass their estate intact to their family would be hit.

Looking at December’s proposals, so-called double trusts, set up to avoid paying inheritance tax will cease to be effective. Under the new scheme, any homeowner who had put the property in a trust but carried on living in it will be liable to pay income tax based on the ‘fair market rent of the property’. The change is to be implemented in April 2005 but the legislation – and this is a case for concern – will apply to all existing schemes.

Yesterday’s budget revealed that the Chancellor had softened his stance. Transfers of property between spouses will be exempt from the new charge, as will gifts where a donor is the beneficiary by a change in circumstances – meaning where a parent had set their child on the property ladder and had later, as a result of ill health, to move in with the child. The new tax remains, however, retrospective although a date has been set which means transactions made now or at any time back to March 1986 are liable.

Robert Ham, a member of the Technical Committee of the Society of Trust and Estate Practitioners says: ‘Thousands of homeowners who have legally placed their properties in trusts to pass their estate intact to their family will be hit. [The cut off date] is going to catch all sorts of arrangements that have been held to work since 1986.’

He added: ‘It is unprecedented for the Revenue to bring in rules that, in effect, apply retrospectively and change the tax treatment of existing transactions.’

Concerns were raised with the Government in respect of taxpayers who may not be able to dismantle schemes they have previously entered into, but the Inland Revenue has offered people who have transferred assets to avoid tax to be spared the new tax if they agree before January 2007 to treat the assets as if they were still in their estate. This means that the trustholders can treat the trust as though it had never been set up, allowing the house to be placed back in the owner’s estate. Easy in principle, however, it will be harder in practice as thousands of people will have to find paperwork from nearly 20 years ago to sort out their affairs if they want to avoid paying the tax.

While most analysts are arguing that many areas of the tax charge require further clarification, the climb down from the proposals set out before Christmas has been welcomed. While the ramifications of the tax will take longer to absorb it is impossible to ignore the fact that a precedent has now been set by the Government, angering many.

‘The idea of imposing an income tax charge where there is no source of income flies in the face of one of the most fundamental principles of income tax legislation,’ said Clive Mackintosh a partner at PricewaterhouseCoopers.