Bill on wills

The government has relented on draconian proposals for will trusts concerning the spouse exemption. The pre-Budget position has largely been restored.

Restrictive provisions for minors have been slightly relaxed: where the will trust provides that a child must receive capital no later than 25, the trust remains free of extra IHT charges (until the child is 18). There are further transitional rules for existing accumulation and maintenance trusts where children take capital by 25.

Life interests

Amendments to the Finance Bill passed on 15 June dispensed with restrictive conditions for putting a life interest outside the discretionary trust regime. As under the old rules, a life interest under a will or intestacy commencing immediately on death will result in the life tenant being treated as the owner of the underlying capital. The spouse exemption will apply and in any other case (while there will be charge to tax on the death which generates the life interest) trust assets will not be discretionary trust property.

If a life interest is surrendered during the life tenant's lifetime in favour of a beneficiary who becomes entitled outright, this will be a potentially exempt transfer (PET) free of IHT, should the surviving spouse live for another seven years.

If the life interest is surrendered in favour of another trust interest (other than a trust for the children of the deceased who become entitled no later than 18, which will be a PET) there will be liability to IHT at the normal rate of 20 per cent above the nil rate band of £285,000.

If property remains subject to the life interest until the survivor's death, capital will be treated as part of the survivor's estate for IHT purposes.

Leaving assets to children

For children, in place of the accumulation and maintenance trust regime, the Finance Bill provided for a 'trust for bereaved minors'. There were wide representations that 18 (an age on which the government was not prepared to budge) was too young for children to receive the capital in every case. As a partial relaxation of this rule, a trust will have a limited exemption from IHT discretionary trust rules if the capital must vest no later than 25. The trust would remain free of IHT until the child's 18th birthday. If the capital remains in trust after that, there will be a liability to IHT on the capital distributed or on ten-year anniversary charges. The maximum tax will be 4.2 per cent on current rates, applying 0.6 per cent for every year (up to seven) that the trust continues after the child reaches 18.

There are many ways in which assets may be left to children under wills. Assets can be left on trust for children who take outright at 18. Capital can be left in trust for children up to 25, outside the scope of the discretionary trust rules until the child is 18. Rather more attractively, under an immediate post-death interest, the child would receive a life interest immediately, but with no automatic access to capital at any particular time. The trust would be free of IHT and ten-year anniversary and exit charges, although the assets would be taxed as part of the child's assets should the child die. The risk of a tax charge may not be much greater than in the case of a trust where the child gets the capital at 18, as from that age the child would have received the capital, which would be taxed as part of the child's estate on his or her death. The risk of the child dying under 18 may not be felt to be of great concern. Insurance is available in most cases.

Other changes

Budget proposals whereby gifts into trust made during lifetime would be immediately chargeable transfers on a value in excess of the nil rate band have not been altered.

The limited exemption for gifts in favour of disabled people remains.

There has been limited relaxation of charges that would be applied on accumulation and maintenance trusts from 2008 unless the terms are varied by then so that capital passes to the child not later than 18. There will be no charge to tax before the child is 18, as long as the capital must vest no later than 25. Between 18 and 25, the trust will be treated as a discretionary trust potentially liable to tax on ten-year anniversaries and where the capital vests or is paid to the child.

Under a welcome amendment, a discretionary trust set up under a will is treated as free-standing and does not have aggregated with it (for calculating tax charges) assets where the spouse is given a life interest. A further amendment means that, as before the Budget, residue trusts for the spouse are not aggregated.

Unfortunately, the Budget brings excluded property trusts made by non-domiciled settlors within the scope of IHT where the settlor or spouse retains an initial life interest and has become domiciled or deemed domiciled in the UK by the time their interest comes to an end.

The government passed amendments designed to take life insurance policies written in trust before 22 March 2006 out of the new regime. This is achieved to some extent.

A climb-down?

To call these amendments a climb-down is an overstatement: rules charging tax on the creation of new lifetime trusts remain unaltered, although the position on will trusts has been vastly improved. In most cases, there should be no need for an urgent review of wills drafted before the Budget which relied on the spouse exemption. Wills still need to be reviewed however in the light of the provision made for children. Further amendments may be tabled at the Report Stage.

Owen Clutton is a partner at City law firm Macfarlanes