QROPS Advice: PBR - IHT planning with trusts clampdown

As you will be aware, the Chancellor took advantage of the Pre-Budget Report (PBR) to announce changes in legislation aimed at what it described as two artificial IHT mitigation schemes involving trusts, which had come to the attention of the Treasury.

The first scheme took advantage of the loophole caused by poor drafting of one particular part of the legislation introduced on 22nd March 2006. It is this scheme that will be considered here.

Planning with interests in possession
To explain. Before the changes, it was possible to create an interest in possession trust and have the transfer treated as a potentially exempt transfer (PET). The downside of this type of trust was that the full value of the trust fund was treated, for IHT purposes, as being in the estate of the beneficiary entitled to the income. Since IHT is primarily intended to tax assets once a generation, treating the interest in possession in this way ensured that aim.

Example: John created flexible interest in possession trust for the wider benefit of his family (excluding himself) but with his daughter Emily entitled to any income generated by the trust fund.

Under a discretionary trust, however, no beneficiary has a right to income and so IHT is not dependent on the life of a beneficiary. You could consider the discretionary trust as having an artificial life of its own – a transfer in is a chargeable lifetime transfer (CLT) and periodic and exit charges also potentially apply.

Example: John created a discretionary trust for the wider benefit of his family (excluding himself), under which no one individual was entitled to either income or capital.

In order to avoid a potential double charge to IHT under any new interest in possession trust, it was necessary to make a change in the legislation. The legislation introduced in 2006 provided that a new interest in possession created after that date would not form part of the Settlor's estate for IHT purposes.

It is worth repeating that: a new interest in possession created after 22nd March 2006 will not form part of the Settlor’s estate for IHT purposes.

That is the crux of the planning in this scheme.

Planning with reversionary interests
Before 2003, if a Settlor created a discretionary trust for the benefit of his family, it was possible to claim capital gains tax (CGT) holdover relief. The rationale for this being that if IHT was payable when creating the trust, CGT should not be so.

Those seeking to achieve the advantage of CGT holdover relief without actually incurring an IHT liability were advised to create trusts under which they retained a valuable right. This valuable right depressed the value of the transfer for IHT purposes, meaning no IHT was actually payable but secured CGT holdover relief nonetheless.

Example: John created a discretionary trust as before, with shares worth £1m having gains of £300k. The value of the CLT was £9,990k. No IHT is payable. CGT holdover relief was claimed in respect of the £300k gains, no CGT was payable at this time.

Clearly this was unacceptable to the Revenue and, having lost in the test case of Melville, legislation was introduced to combat this perceived abuse. However, it was accepted that the mechanism of depressing the initial value for IHT purposes achieved its aim.

Putting the two together!
Settlors were encouraged to create trusts under which they retained a reversionary interest but that reversionary interest was not in the full trust fund but in an interest in possession in it, i.e. a right to income for a specified period, typically 99 years. The initial transfer into trust, although being a CLT, was depressed by the significant value of the reversionary interest, i.e. it was negligible.

When the reversionary interest fell in and the interest in possession vested, at the end of whatever period the Settlor had determined, the full value of the trust fund fell out of his estate!

If he died, there would be no liability to IHT on the trust fund.

If he gave away his interest in possession, there would be no transfer of value. Further, there would be no value in the estate of the donee who received the interest in possession – and so on and so on, ad infinitum!

The “solution”
Whilst it had been anticipated that the Treasury would take steps to prevent interests in possession being treated in this way, i.e. to address the poor drafting which allowed this planning, as we have seen, the measures introduced have gone far further than this, impacting on the tax treatment of reversionary interests in general.

The impact for those caught
Bearing in mind that the changes introduced in 2006 intended to ensure that transfers into trusts that were within the relevant property regime actually gave rise to an IHT liability when the sums transferred were in excess of the available nil rate band, the “solution” might seem apt.

If a Settlor has created such a trust under which his reversionary interest has not yet fallen in or been given away, he will face a charge to IHT at lifetime rates when one or other of those events occurs.

In the PBR it was announced that “The Government announces it is also examining wider solutions to the problem of trusts being used to avoid inheritance tax charges.” It is understood that what is meant by this statement is that the Government will review the legislation introduced in 2006 to ensure, as far as possible, no other unintended “loopholes” exist. Clearly, we will have to keep an eye on developments!
By Deborah Moon - technical manager for Royal London 360° 16/12/2009

Solution
PRIVATE INTEREST FOUNDATIONS
Private foundations are legal entities set up by an individual, a family or a group of individuals, for a purpose of providing for the needs and objectives of the individual, family or group.
Foundations are more versatile and can accomplish more than Trusts, Companies, Wills and provide strict rules of confidentiality
No one owns a Private Interest Foundation, so you are not the owner of the Foundation, no one is according to the statutory laws of the jurisdiction in which it is held.
A Foundation is a tried and tested way to protect and shelter your assets including real estate, bank accounts, financial instruments, securities, art, family heirlooms, corporations, cars, planes, boats, etc., from existing or potential financial enemies. There is no limit to what a Foundation can own, and the business affairs of the Foundations are anonymous.
The Foundation’s assets are ring-fenced and are totally separate from the assets and liabilities of the party/ies who establish the foundation.

BENEFITS
A foundation can be used in a manner similar to a trust to pass on assets bypassing estate taxes at the time of death.
A Foundation can hold a corporation and a bank account which makes it the cornerstone of some of the best asset protection structures in the world today.
A Foundation cannot engage in business activities in its own right, like marketing and selling a product. A foundation can, however, own an offshore/onshore company and banking accounts. The offshore/onshore company can then engage in business activities.
Foundations do not pay tax on foreign sourced funds. This makes a foundation a great part of any tax planning strategy
A Foundation is an essential tool for asset protection particularly for those engaged in business and HNWIs

FOUNDATION V's TRUST
Operation of Private Foundation Very Similar to a Trust
Foundation Provides More Protections For Founders
Private Foundation is Multi-Generational, No Limit on Duration
Private Foundation is More Flexible
Founder Retains Full Control
Founder May Add, Remove Assets and Beneficiaries At Any Time
No Taxes within a Private Foundations
It is common for an onshore trust to be broken for any number of different reasons. If you want your wishes followed to the "letter" then a Foundation is your best option.
In the case of a Trust the Settlor has to contend with anit-trust legislation, non-recognition of trusts, sham trusts, defective trusts, thus giving away wealth and losing control. Alternatively, a Settlor or the beneficiaries may wish to change the jurisdiction or the trustees which, in most instances would not be welcomed or be resisted by those effected.
The Foundation, however, provides complete control at all times.
Trust Law a constantly being reviewed, for example in the UK trusts can no longer use trustees based in overseas jurisdictions (which enjoy a low or nil rate of local tax and double taxation treaties with the UK to mitigate capital gains tax)
A Foundation would be immune from such disadvantages.

WHAT CAN A PRIVATE FOUNDATION DO?
Ensure Founder’s Confidentiality
Minimize Taxes on Assets and Investments
Protect Assets and Investments From Creditors
Manage Assets and Investments
Defer Income
Preserve Family Assets Over Multiple Generations
Make Distributions to Beneficiaries Like a Trust
Orderly and Quick Distribution of Assets to Beneficiaries Upon Founder’s Passi

TAX BENEFITS OF A FOUNDATION
No Inventory Tax
No tax reporting requirements
No Income Tax
No Capital Gains Tax
No Interest Income Tax
No Sales Tax
No tax on issuance of corporate shares
No tax on shareholders
No property tax
No estate tax
No stamp duty
No gift tax
No succession tax

FLEXIBILTY
What Kinds of Assets Can Private Foundation Hold?
No Limit
Cash in Foreign or Local Bank Accounts
Certificates of Deposit
Interest-Bearing Claims of Any Denomination
Real Property
Intangible Property
Shares (Tradable and Private)
Beneficiary Interests Example: Right to Receive Dividends
Art and collectibles
Corporations
Boats, planes & cars
Ownership of an existing Offshore Company Can Be Transferred to Private Foundation, No Need to Change Offshore Companies’ Structure, Simply Make Foundation the Owner

WHO WOULD BENEFIT FROM USING A FOUNDATION?
Persons Seeking to Manage Taxes
Persons Wanting to Consolidate Holdings Under
Single, Flexible Umbrella
Persons Wanting to Ensure Confidentiality
Persons Who Want a Discreet, Reliable Way to Provide For Loved Ones
Persons Seeking a Vehicle For Retirement
Persons Seeking a Vehicle For Estate Planning

Call 01664 444625 and ask about Foundations