About-turn to restore pre-Budget position welcomed
The Chancellor has decided against potentially forcing millions of families to rewrite their Wills and sounded the retreat from the most controversial of his Budget 2006 measures unveiled in March.

The Treasury has, in effect, abandoned plans to force parents to leave assets for their children to inherit on their 18th birthday or face a punitive new tax rate.

Another move, which would have made it prohibitively expensive for husbands to leave their assets to their spouses in a trust rather than outright, has also been dropped.

This announcement effectively returns the tax treatment of trusts for children or spouses to a position similar to that before the Budget.

Many parents planning to leave assets in a trust for their children prefer them to inherit at 25, rather than 18, which was previously allowed in trust law without incurring tax. Parents will now be able to defer their children’s inheritance to the age of 25 and be liable to a lesser charge of 4.2 per cent. Previously they could have faced a continuing tax charge of 6 per cent over ten years, in addition to inheritance tax, on such trusts for every year after the parents’ death if inheritance was deferred beyond 18.

Trusts set up for spouses are commonly used in second marriages to bequeath an income to a surviving spouse for life but, on their death, leave the remaining wealth to children from a first marriage. A spouse exemption in such circumstances has now been restored.

This is also used by Muslim families because they comply as Islamic Wills by avoiding interest charges, which are prohibited under Sharia law.

The new regime creates a series of different choices for families that may make their existing Wills unsuitable. Many families could still be put to the inconvenience of having to review their Wills, especially if they have set up trusts for children.

The about-turn goes some way towards allaying fears that irresponsibility would be encouraged by forcing family trusts to choose between losing tax advantages or letting children receive capital from the trust at age 18.

As a result, families seeking to use trusts to diminish or avoid IHT liabilities will now have three broad choices. They are:

Give children capital outright when they turn 18 years of age with no liability to pay tax at 6 per cent as originally proposed in the Budget

Leave children capital in fully flexible trusts with no certainty as to when they will receive their share. In this case, the trust will enter the 6 per cent tax regime on the death of the parent and remain subject to that regime until capital is paid to the child outright

Leave children the capital in trusts broadly similar to pre-Budget accumulation and maintenance trusts where they must receive their capital by age 25. In this case, the trusts would not become subject to the 6 per cent regime until the child turns 18.

The premium for deferring capital entitlement to age 25, using favoured accumulation and maintenance trusts, is now only payable after 18 and families will be able to choose by age 18 whether to pay the additional tax to secure flexibility or hand the capital over.

In many cases, it will still be necessary for individuals who have established trusts under their Wills to review their estate planning arrangements, so that they can consider whether, under the post-Budget Day rules, they wish to establish continuing trusts after the life interest in favour of a surviving spouse or partner comes to an end.

Under the modified proposals, it will now be possible for families to create trusts in favour of children that extend beyond the age of 18 and up to the age of 25, but only at a price.

Qualifying trusts set up under Wills that meet the criteria will enter the discretionary trust regime at age 18 without an initial 20 per cent tax charge, as originally proposed in the Budget.

The maximum rate of tax which families will have to pay if capital passes to children outright at 25 is 4.2 per cent.
The about-turn could also be beneficial for existing accumulation and maintenance trusts established before Budget Day.

In other words, where beneficiaries are under the age of 18 at the end of the transitional period on 6 April 2008, the 6 per cent regime will not apply until beneficiaries reach 18, provided the trusts are modified before 6 April 2008.

This, in part, reverses the impact on existing trusts but still starts from the premise that leaving assets in trust for children after 18 is a ‘privilege’ for which a premium in tax should be paid.

If you require any further information, please email or contact us.