This article aims to explain the inheritance tax reporting requirements that are now in place and what this means for Old Mutual International’s trusts.
Following the changes to inheritance tax (IHT) on 22 March 2006, HM Revenue & Customs (HMRC) stated that new reporting thresholds would be introduced. The regulations on ‘Inheritance Tax (Delivery of Accounts) (Excepted Transfers and Excepted Terminations)’ came into force on 6 April 2008 and apply for the 2007/08 tax year onwards. These describe the circumstances in which a settlor making a chargeable lifetime transfer (CLT) to a trust needs to report it. Additional regulations were laid out at the same time, describing the circumstances in which trustees suffering 10-yearly periodic and exit tax charges also need to make reports.
Where an individual makes a CLT, the regulations introduce two new tests to determine when a report at the time the CLT is made to HMRC is NOT required and these can be summarised as follows:
Excepted transfers (Test 1)
a. The asset transferred is cash or quoted shares or securities, AND
b. The value transferred by the chargeable transfer, together with the values transferred by any previous chargeable transfers made by the transferor during the seven years preceding the transfer, does not exceed the IHT threshold*.
This means that CLTs of cash, quoted shares or securities will not be required to be reported where all CLTs made by the client in the previous seven years (including the CLT now being made) do not exceed the value of the individual’s available nil-rate band (NRB). In principle this means that reports in these circumstances will only be required where IHT is due.
* IHT threshold means the available NRB taking into account previous transfers.
Excepted transfers (Test 2)
a. The value transferred by the chargeable transfer, together with the values transferred by any previous chargeable transfers made by the transferor during the seven years preceding the transfer, does not exceed 80% of the IHT threshold, AND
b. The value transferred by the transfer of value giving rise to the chargeable transfer does not exceed the net IHT threshold.
The net IHT threshold means the IHT threshold (currently £325,000 for 2016/17) less the summed values of all previous chargeable transfers made during the seven years preceding the current chargeable transfer (not including the CLT now being made).
For the purposes of Test 2b above, business property relief and agricultural property relief will not apply in determining the value of the chargeable transfer. The 80% limit in Test 2a means the reporting level in 2016/17 is £260,000.
For example for a CLT not to be reportable it must pass two tests; firstly that the cumulative total (current CLT £100,000 plus previous CLTs £125,000 = £225,000) does not exceed 80% of the current NRB (£260,000), and secondly that the current CLT (say £100,000) does not exceed the net IHT threshold (NRB £325,000 less previous CLTs £125,000 = £200,000).
So in this case, both tests have been met so reporting is not required.
HMRC has provided guidance on what would or would not be acceptable from a reporting perspective in relation to a trust and whether it was established under Test 1 or Test 2.
Our view is that Test 2 applies to the following Old Mutual International Trusts:
Discretionary Trust (Settlor included and excluded) and
Discounted Gift Trust (Discretionary version).
Test 2 applies as these are created using a life assurance or redemption contract. See example below.
The reporting requirements have no impact and therefore no initial reporting is required for:
Discounted Gift Trust (Bare version) (DGT) and
Loan Trust (Discretionary and Bare versions).
This is due to the first two trusts being set up with potentially exempt transfers (to the extent that the transfers are not exempt) and the Loan Trust not having a chargeable lifetime transfer when it is set up.
What does this mean for DGTs?
For a discretionary DGT there is still only a requirement to report the discounted value of the gift and not the whole investment.
Mr Jones, aged 65, invests £400,000:
Interest retained £190,000
Discounted value of gift £210,000 (CLT), assuming no exemptions available
Depending on the nature of the scheme and previous gift history, but assuming no previous gifts, this would not be reportable, as the CLT is within the limits in Test 2.
The regulations do not change the period in which a report should be submitted, or when tax should be paid if due. Where tax is due this is required to be paid within six months of the end of the month in which the transfer is made. Whether tax is due or not, where the new limits are exceeded the report will be required within 12 months following the end of the month in which the CLT was made.
These significant increases in the reporting thresholds should mean the majority of clients will not have to report their gifts and this should lessen the administration burden of all involved.