Pre-owned assets tax rules relating to intangible property and in particular offshore bonds were introduced to impose an income tax charge where UK resident taxpayers circumvent the gift with reservation of benefit rules for UK IHT.
Pre-Owned Assets Tax (POAT) was introduced by Schedule 15 of the Finance Act 2004 to impose an annual income tax charge from 6 April 2005 in circumstances where UK resident taxpayers have successfully circumvented the inheritance tax (IHT) gifts with reservation of benefit (GWR) rules, yet are still able to benefit from the asset transferred.
For intangibles such as insurance products the charge will apply if:
- the asset is transferred to a settlement created on or after 17 March 1986, and
- that settlement is one under which the settlor would be liable to income tax on any income arising (broadly, a settlor-included trust).
Calculating the taxable benefit
The taxable benefit, deemed to be retained by the settlor, is the value of the asset(s) within the settlement on a prescribed date multiplied by a prescribed rate of interest. However, deemed benefits under the annual limit are not taxed.
The formula is:
Value of the Trust Fund at 6 April x valuation rate = deemed benefit
The valuation date was confirmed as 6 April for 2005 and will also be 6 April for on each subsequent year i.e. 6 April 2006, 6 April 2007 etc. Although the interest rate changed on 1 March 2009, for example, the valuation date will still be 6 April.
The valuation rate was confirmed as the official rate of interest:
Valuation Date Official rate of interest
6 April 2010 4%
6 April 2011 4%
6 April 2012 4%
6 April 2013 4%
6 April 2014 3.25%
6 April 2015 3%
What is the annual limit?
The annual limit was set at £5,000 or less.
The annual limit relates to the value of the deemed benefit for each settlement, not the income tax liability. This should not be confused, however, with an allowance. Should the deemed benefit exceed the annual limit by even a penny, then the entire deemed benefit becomes taxable.
If the Trust Fund is valued at £123,750 on 6 April 2014 then:
£123,750 (value of Trust Fund) x 3.25% valuation rate = £4,022(deemed benefit)
This is within the annual limit, therefore the POAT charge does not apply.
If the Trust Fund is valued at £126,250 on 6 April 2015 then:
£126,250 (value of Trust Fund) x 3% valuation rate = £3,875.50 (deemed benefit).
This is above the annual limit, therefore the POAT charge applies to whole of deemed benefit.
Exemptions from the POAT charge
Double Charging relief
There are separate rules for applying POAT in respect of land, buildings and chattels. Therefore if assets within the settlement are charged to POAT under the land and building rules or the rules for chattels, then this value is excluded when calculating the deemed benefit for intangibles.
Property subject to IHT or where IHT would apply except for IHT legislation providing specific exemption from IH
Assets within the settlement are subject to IHT. This would most commonly be where the trust fund (or part of it) is deemed to be a GWR.
The exemption for assets that would be subject to IHT except for specific legislation exempting them is a more uncertain area.
Until 6 April 2006, revert to settlor trusts were not caught by POAT as the reversion to the settlor is specifically excluded from IHT, however the UK Finance Act 2006 introduced legislation to ensure that the revert to settlor exemption for IHT was not sufficient to protect assets in a settlement being caught by POAT.
However, current IHT legislation does offer exemption to IHT to UK registered pension schemes and Qualifying Non-UK Pension Schemes and these schemes are not caught by POAT even though the benefits are paid to the member.
Election for an asset to be treated as a GWR
It is possible for the settlor to elect that the settlement should be treated as a GWR using HM Revenue and Customs (HMRC) form IHT500.
The election must be made before 31 January in the year following the first year in which you are liable to pay the income tax charge. For example, in order to avoid suffering the POAT charge in respect of tax year 2016/17, the election must be made before 31 January 2018.
Further guidance and a helpline number are available on the HMRC website.
Excluding the settlor from benefit
The POAT charge will cease to apply once the settlor’s right to benefit from the settlement is removed.
Residency of the settlor
The POAT charge is an income tax charge levied on UK resident settlors. If the settlor is not UK resident, they will not be liable to pay the income tax.
Applying the POAT charge
Once the deemed benefit has been calculated and where it is above the annual limit and is not otherwise exempted from the POAT charge, the deemed benefit is added to the settlor’s taxable income, and then multiplied by the individual's marginal income tax rate.
£5,050 (the deemed benefit) is added to the settlor’s taxable income of £12,000 for the 2016/17 tax year. As this is within the basic rate tax bracket, the applicable rate of income tax would be 20%.
Therefore, the POAT charge is £5,050 x 20% = £1,010.
What if the settlor is excluded from benefitting from the settlement within the assessable tax year?
If the settlor does not enjoy a deemed benefit for a complete year from 6 April, then a proportionate POAT charge will apply.
It is then necessary to calculate how many days the POAT charge would apply since 6 April and apply the proportionate formula.
Deemed benefit x number of days held since 6 April/365
So, using the example from earlier in the article, the taxable deemed benefit is £5,050 calculated on 6 April 2015. We will assume the POAT charge applies until 6 July 2015, so for 92 days.
The proportionate charge is therefore:
£5,050.00 x 92/365 = £1,272.88.
This proportionate deemed benefit is under the annual limit of £5,000, so no POAT charge would be due in this example.
Which Old Mutual Wealth trusts were caught by POAT?
No Old Mutual International Ireland trusts are caught by POAT.
Where your client has either:
- an Old Mutual International Lifetime Trust, or a
- Old Mutual International Trust Company Power of Appointment Trust including Settlor; or a
- Old Mutual Wealth Settlor Beneficiary Trust
created before 6 April 2005 where the initial named beneficiary was the settlor’s spouse, your client may be caught by POAT.
Before 20 June 2003, the above trusts could be set up to allow the settlor to benefit from the trust without being included within the GWR rules using the following steps.
Where the settlor’s spouse was the initial appointed beneficiary for these trusts, the transfer into the trust was not deemed to be a GWR due to the inter-spousal transfer exemption and the gift to the spouse is also exempt from IHT due to the inter-spousal transfer exemption
Therefore, it was possible to set up these trusts to allow the settlor to benefit as a possible beneficiary as well as the spouse as appointed beneficiary, but not be subject to IHT.
The trustees would appoint the trust fund away from the spouse to their children as the appointed beneficiaries but exclude the settlor’s spouse. This would have been a potentially exempt transfer from the spouse. This would still allow access to the trust for the settlor (but not the settlor’s spouse at this stage).
From 20 June 2003, the government enacted new legislation relating to the GWRs from new settlements. Although the initial creation of the trust for the spouse was still not a GWR, due to the inter-spousal transfer exemption, the further appointment to the children would be deemed a GWR.
POAT and Trusts created before 20 June 2003
Step one or steps one and two completed at 6 April 2005
While the trust remained in force, from 6 April 2005 it became liable to the new POAT charge. This is because the settlor is able to benefit from the trust fund but the scheme would not be caught by the GWR provisions.
POAT and Trusts created on or after 20 June 2003
Step one completed at 6 April 2005
While the trust remained in force, from 6 April 2005 it became liable to the new POAT charge. This is because the settlor is able to benefit from the trust fund but the scheme would not be caught by the GWR provisions (due to the inter-spousal transfer exemption).
Step two completed at 6 April 2005
While the trust remains in force and is at step two, it is within the GWR rules. The POAT charge will therefore not apply.
Options available to stop the POAT charge before 6 April 2005
Elect for the trust to be treated as a GWR
By electing that the trust fund be treated as a GWR before 31 January 2007, it was possible for the settlor to avoid being liable for the POAT charge (a charge to income tax) for the previous tax year.
Electing the Trust to be treated as a GWR means the entire value of the Trust Fund falls into the settlor’s estate for IHT on their death.
Exclude the settlor from benefit
Where Old Mutual International Trust Company is the trustee, the settlor confirmed in writing to the trustee stating that the settlor wished to be permanently excluded from being a beneficiary of the Trust. Old Mutual International Trust Company then completed an instrument in writing to record this.
For Old Mutual International Lifetime Trusts and Old Mutual Wealth Settlor beneficiary Trusts, the trustees complete a ‘Deed of Exclusion’.
Terminate the trust
The trustees completed a Deed of Appointment and Assignment of the trust fund in favour of the settlor, which reverts the legal and beneficial ownership of the contract to the settlor outside of the trust. As there is no trust property any longer, the trust was automatically terminated.
The transfer of value created by appointment of the trust fund from the beneficiary to the settlor would normally qualify for exemption under Section 54 of the Inheritance Tax Act 1984, more commonly known as the ‘revert to settlor’ exemption. Therefore, no immediate or potential liability to IHT would arise. The trustees vesting the legal and beneficial ownership in the settlor as beneficiary will terminate the trust. This means the value of the trust fund will form part of the settlor’s estate for IHT purposes, but the transaction has no other income tax or IHT implications.
Options available to stop the POAT charge now
For clients who still hold Old Mutual International Lifetime trusts or Old Mutual International Trust Company Power of Appointment Trusts including the Settlor, or Old Mutual Wealth Settlor Beneficiary Trusts and none of the above options were selected, they will have been paying the POAT charge each tax year unless they are otherwise exempted. Should these clients now want to stop the POAT charge for future tax years (for example, maybe the settlor was not UK resident, therefore the POAT charge was not payable, but they are now looking to become UK resident and want to consider their options) the following options are available:
Excluding the settlor from benefit
See above for further details.
Terminating the trust
See above for further details.
If your clients are UK resident before they exercise one of these options, a proportionate charge will apply from the last 6 April to the date the option is exercised, and then no further POAT charge will apply for future tax years.