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Finance (No. 2) Bill

We are not talking about the bands of inheritance tax—that is not the debate—but about new additional and penal inheritance tax charges that will apply to circumstances that are now altogether free of inheritance tax. On Second Reading, the Paymaster General said that the measures on trust proposed in the Bill were aimed at preventing ““wealthy individuals”” from"““using trusts . . . to shelter their wealth from inheritance tax.””—[Official Report, 24 April 2006; Vol. 445, c. 460.]" However, trusts seldom give rise to any tax advantages whatever; they are generally tax neutral. As the impressive coalition of professionals campaigning against these measures has pointed out, the trusts penalised by the Bill are generally motivated by unobjectionable non-tax objectives: family and social objectives, which will become prohibitively expensive as a result of the proposed measures. Since estate duty was introduced in 1894, trusts have received broadly the same tax treatment as outright gifts. For example, under current rules, a gift on a flexible trust to a spouse, with the remainder going to children at the age of 25, is taxed in the same way as an outright gift of the property to the spouse, which is then passed on to her children on her death. Thus, the tax exemption means that no tax is charged on the first death, but the capital is charged at the full rate when the surviving spouse dies and the property passes to the children. Far from removing some sort of privileged status, as the Paymaster General claimed on Second Reading, the Government are effectively proposing to introduce additional new and penal tax charges on trusts, treating them more harshly than an outright gift. The Chancellor is actually tearing up a 100-year consensus, repeated only recently by the Revenue in its attempt to maintain a tax system for trusts that does not provide artificial incentives to set up a trust, but equally avoids artificial obstacles to using trusts where they would bring significant non-tax benefits. Before Budget day, section 18 of the Inheritance Tax Act 1984 exempted gifts on trusts to spouses in exactly the same way as the system operated for outright gifts and transfers. Unless the Bill is amended, it will become almost impossible to set up a trust for a spouse without losing the exemption, as it will incur an immediate inheritance tax charge on the death of the first spouse. The spousal exemption will survive only in cases falling under the definition of an immediate post-death interest, complying with six very narrow and restrictive conditions set out in the new section 49A of the 1984 Act, as proposed in schedule 20. No one has yet been able to say with certainty how the six opaquely drafted conditions will apply in practice. It seems clear that severe problems will be caused by conditions 1, 3 and 4. Condition 1 states that the gift must take effect by will or intestacy. That means that spouses will no longer be able to set up trusts for one another during their life time without incurring the new charges. A particular concern is that it is not clear that condition 1 will be satisfied where a trust has been established not under a will, but under a pension policy or death in service arrangements, leaving the threat of the new charges applying in those circumstances. Condition 3 requires that the power to terminate the surviving spouse’s life interest is exercised only by the spouse or with the spouse’s permission. That sounds technically innocuous, but the net result is that a significant number of trusts created on divorce would fall outside the provisions of condition 3, with the risk of the new charges applying. Condition 4 provides that the life interest for a surviving spouse will qualify for the exemption only if, following its termination, assets pass absolutely to the beneficiaries. With very limited exceptions, if the property remains in trust after the death of the live tenant, the spouse exemption will not apply. The net effect of those conditions is that, if there is any flexibility in the trust, the spousal exemption is lost and a bereaved spouse or civil partner will face an immediate inheritance tax bill.