Important Inheritance Tax Changes for Trusts

Summary

As is well known, non-UK property which is settled onto a trust by a settlor who is not domiciled in the UK, is excluded property for Inheritance Tax (IHT) purposes [1]. Trusts benefitting from this status are usually referred to as 'excluded property trusts'.

What is the position where property is added to an excluded property trust after the settlor has become domiciled?

HMRC’s position has long been that such additions cannot piggy-back on the trust’s excluded property status. However, HMRC’s interpretation was challenged in the 2017 case of Barclays Wealth Trustees (Jersey) v HMRC.

Having lost the case, HMRC naturally decided to move the goal-posts and the Finance Bill 2020 ('the Finance Bill') puts their original interpretation onto a statutory footing.

However, in addition to this the Finance Bill also changes how historic trust to trust transfers will be taxed going forwards. Until now, transfers of property from an excluded property trust to another excluded property trust would not impact the excluded property status of the transferred property (even if the settlor was domiciled or deemed domiciled at the time of the transfer). 

The Finance Bill changes preserve the historic position for relevant property purposes in the trust, but importantly they do not for gift with reservation of benefit ('GROB') purposes. As a result, if the settlor reserves an interest in the transferee trust then the transferred property may now become taxable in the settlor’s estate once the Finance Bill is granted Royal Assent. 

As the Finance Bill is currently working its way through the House of Lords, Royal Assent is expected to happen imminently. This means that trustees and settlors do not have much time at all to review and (if necessary) restructure the position to prevent the settlor from having the transferred assets become taxable assets in their estate for inheritance tax purposes.

For shorthand, in this briefing:

• 'excluded property trust' is used to mean a trust settled by a non-domiciled settlor; and
• 'relevant property trust' is used to mean a trust settled by a UK domiciled or deemed domiciled settlor.

Additions to Trusts – the old position

Section 48(3) Inheritance Tax Act 1984 ('IHTA') as it applies before the 2020 changes states that where property comprised in a settlement is situated outside of the UK, the property is excluded property unless the settlor was domiciled in the United Kingdom at the time the settlement was made.

HMRC’s view on this has always been that for any particular item of property held in a settlement, the settlement was made in relation to that property when the property was put in the settlement [2]. This interpretation has always been slightly dubious. As a matter of trust law a settlement is made when it is funded and new additions to the same settlement do not make a new settlement as a matter of trust law. However, HMRC’s view has been well known and documented so few clients will have been advised to ignore it. The consequence of this is that HMRC have never accepted that a deemed domiciled individual could settle further excluded property on an excluded property trust (i.e. a trust they originally settled when they were non-domiciled).

Even if a taxpayer decided to proceed with an interpretation of s.48(3) that went against HMRC’s analysis [3], the transfer of the assets to the trust would still incur an IHT entry charge (as the transferor would have been UK domiciled so not entitled to excluded property status for assets held personally). As a result, this would rarely happen in practice unless, perhaps, the assets transferred in to the trust qualified for a relief like business property relief.

Transfers between Trusts – the old position

For transfers made between trusts (and it is important to note that this can be wider than a trust to trust transfer and can also include appointing assets onto new trusts, appointments and restatements etc.) there are two additional sections of the IHTA which are in play.

Section 81 IHTA provides that '[w]here property which ceases to be comprised in one settlement becomes comprised in another then, unless in the meantime any person becomes beneficially entitled to the property (and not merely to an interest in possession in the property), it shall for the purposes of this Chapter be treated as remaining comprised in the first settlement.' As a result, there is a tax fiction for relevant property purposes that the transferred property continues to remain in the transferor trust.

Section 82 IHTA provides that property covered by s.81 IHTA (i.e. property that has been transferred between trusts) will only continue to be excluded property if two tests are met:

(a) the person who is the settlor in relation to the transferee settlement was not domiciled in the United Kingdom when that settlement was made; and

(b) that the person who is the settlor in relation to the transferor or transferee settlement was not a formerly domiciled resident for the tax year in which the relevant time falls.

It is a pre-requisite under s.48 IHTA that the settlor of the transferor trust was non-domiciled when that settlement was made.

As a result, the domicile position of the settlors of the trusts at the time of any trust to trust transfer was not relevant (save for if they were a formerly domiciled resident).

HMRC’s interpretation under the old law can broadly be summarised as follows:

The Barclays Wealth Case [4]

Lots has already been written about the Barclays Wealth Case and it is the Court of Appeal decision in this case which resulted in the government bringing forward these changes. 

Broadly the relevant facts of the case were:

• Trust A was settled by an individual while he was non-domiciled
• Trust B was settled by the same individual after he became UK deemed domiciled
• Assets were transferred from Trust A (an excluded property trust) to Trust B (a relevant property trust) so they became relevant property in Trust B (as the settlor of Trust B (the transferee trust) was domiciled when that settlement was made)
• Just before the ten year anniversary of Trust B the assets that were transferred from Trust A to Trust B were transferred back to Trust A.

The question was whether the assets which were now back in Trust A could benefit from excluded property status.

HMRC argued that the transfer of the assets back to Trust A was a new settlement made at a time when the settlor was deemed domiciled so the assets in Trust A were no longer excluded property. However, the Court of Appeal found that the assets were always deemed to be in Trust A for relevant property purposes (under s.81 IHTA) so the transfer back from Trust B was not a disposition resulting in a settlement as the assets were already in that settlement. 

Henderson LJ giving the leading judgment did not go as far as finding against HMRC’s interpretation of s.48(3) IHTA (that each time property is added to a settlement a 'settlement is made' meaning you need to review the settlor’s domicile position at that time to determine excluded property status) as this was not an issue that needed to be decided in the case. However, a logical extension of his reasoning suggests that he would not have agreed with the analysis that a new settlement is made each time assets are added to a settlement.

HMRC was somewhat alarmed by the judgment and the government quickly announced that they were to enact legislation in light of the decision. The result is the Finance Bill changes which are about to become law.

Additions to Trusts, 2020 Changes:

As set out above, the current wording in s.48(3) IHTA states that where property comprised in a settlement is situated outside of the UK, the property is excluded property unless the settlor was domiciled in the United Kingdom at the time the settlement was made.

Under the Finance Bill changes, the references in s.48 to 'the time the settlement was made' have been replaced with 'the time the property became comprised in the settlement'. As a result, it is now clear that it is the domicile position of the settlor at the time of the addition that is relevant for determining excluded property status and not the time the settlement was made (which logically would be when it was first settled).

In addition, wording has been added to prevent accumulations of income after the settlor becomes UK domiciled or deemed domiciled from automatically becoming relevant property.

These changes to s.48(3) effectively put HMRC’s old interpretation of additions to excluded property trusts on a statutory footing. While some taxpayers may have gone against HMRC’s interpretation, their view has been known for some time. As a result, while taxpayers may feel like this is a case of HMRC moving the goal-posts (after the Court of Appeal effectively found against HMRC’s interpretation) the risk of HMRC challenge even before these changes must have been known.

Transfers between Trusts, 2020 Changes:

The legislation in s.81 IHTA has also been changed so that on any transfers of property between settlements it is now necessary to also look at the domicile position of the settlor of the transferor trust (or the settlor of the property moving from the first trust) at the time the property is transferred. If they are domiciled or deemed domiciled at the time of the transfer then excluded property status does not apply.

This is a fundamental change in HMRC’s practice and changes the outcome in scenario three above.

Under the legislation, going forwards property transferred between excluded property trusts (after the Finance Act receives Royal Assent) after the settlor of the transferor has become UK domiciled or deemed domiciled will become relevant property for both the relevant property regime and the GROB regime. 

For transfers which were made before the Finance Bill receives Royal Assent, the transferred property will not become relevant property in the transferee trust (as the new rules do not catch trust transfers under the relevant property regime which were made prior to the commencement of the Finance Act). However, this property will now cease to be excluded property for the GROB rules as it is no longer protected by s.48(3) IHTA since it is property which became comprised in the settlement at a time when the settlor was domiciled/deemed domiciled. 

What to do now?

As a result of these changes, a key planning point for affected trustees will be to do the following (if they haven’t already):

• Review their trusts and find any cases where there have been trust to trust transfers which took place when the settlor was UK domiciled or deemed domiciled for IHT purposes
• Check whether the settlor retains a benefit for IHT purposes so the GROB rules are in scope
• If appropriate, consider excluding the settlor for IHT purposes.

If the exclusion of the settlor happens before the Finance Bill receives Royal Assent then the exclusion should not trigger any IHT charges[5]. If the exclusion happens after Royal Assent then this will be a deemed PET by the settlor and he/she will need to survive seven years to avoid an inheritance tax charge. However, depending on the settlor’s age and health, it may be possible to take out life insurance to fund the inheritance tax charge.

The Finance Bill changes are also wide ranging in terms of their impact for other additions made to excluded property trusts since a settlor has become UK domiciled or deemed domiciled (including lending from third parties).

Given the breadth of the changes, it would appear sensible for trustees to also consider reviewing all excluded property trusts where the settlor has become UK domiciled or deemed domiciled in order to confirm the impact of the changes for the settlor and the trust going forwards. This is even more important given the new extended 12 year time limits which can now apply for offshore tax assessments.

How can Burges Salmon help?

We have extensive experience of assisting overseas trustees and individuals with their inheritance tax reporting and planning using overseas trusts.

If you or your client would like further guidance on the impact of these new changes then please contact John Barnett or your usual contact in our private client team.

[1] Section 48(3) Inheritance Tax Act 1984

[2] IHTM27220 - https://www.gov.uk/hmrc-internal-manuals/inheritance-tax-manual/ihtm27220

[3] i.e. they proceeded on the basis that their additions to an excluded property trust after they were deemed domiciled still became excluded property for the relevant property regime & GROB rules (as they were non-domiciled when the settlement was made (originally funded)).

[4] Barclays Wealth Trustees (Jersey) Ltd and another v HMRC [2017] EWCA Civ 1512

[5] so long as the trust fund is comprised of excluded property only under the current rules (i.e. no UK situs assets are held at trust level and no relevant loans or UK residential property interests are held anywhere in the trust structure).