The broader picture

Julie Hutchison takes a look at how the recent Budget has affected estate planning

There are certain perils associated with writing about tax and estate planning just before a general election.  Without the benefit of a crystal ball, however, it is best to remain on the available firm ground. With that in mind, this article will review the landscape for estate planning in light of Budget 2010 and other developments.

The Budget had three main ingredients to it from an estate planning perspective. Firstly, there were measures driven by developments in Europe. Secondly, the inheritance tax (IHT) nil rate band was placed in the deep-freeze until 2014/15 (in theory). Lastly, the threat of a strong dose of bureaucracy was thrown-in as a possible deterrent to IHT planning in the future.

An eye on Europe

Just as agricultural property relief for IHT had to be extended to cover land in the EU in 2009, the Budget’s announcement about charity tax relief falls into a similar category. It had been expected that the UK would change its tax laws at some point to extend the wide variety of tax reliefs available to UK charities to those in Europe. The Budget measures mean that, for example, someone leaving money in their will to a French-based charity can do so with the added benefit that the IHT exemption for gifts to charities could be available.  For advisers with clients who have European connections, this will be welcome news.

The IHT nil rate band

If the IHT nil rate band for 2009/10 was still the same as it had been in 2005/6, it would be £275,000 rather than £325,000. This sort of gap gives a sense of the inflation-related increases which have taken place in recent years, but the 2010 Budget has put a halt to such increases for the foreseeable future. The figure of £325,000 is being fixed as the nil rate band up to tax year 2014/15.

As a pre-election measure, it is perhaps not a surprising one. As any lawyer will tell you, however, a law is only a law until it is changed by a future law. Just as the planned increase to £350,000 (as documented in Finance Act 2007) was reversed for 2010/11, so apparent freezes can be changed by future Budgets and Finance Acts. The IHT measures in the Budget are therefore best interpreted as a ‘message’ rather than a significant tax-raising measure, in the context of the nation’s current finances.

The Disclosure regime and IHT

In Pre-Budget Report 2009, there was a statement that “The Government announces it is also examining wider solutions to the problem of trusts being used to avoid inheritance tax charges.” January’s official consultation meetings had hinted at the possibility that the disclosure regime would be extended to cover IHT, and in the Budget we found the next steps being announced. This seems to amount to further consultation, as the note refers to work being undertaken over the summer of 2010.

The disclosure regime involves two key stages. Firstly, providers of ‘schemes’ have to tell HMRC about the scheme they are marketing, and be given a scheme reference number which users of the scheme are notified of. Secondly, the UK tax payer who uses the scheme then reports they have used it in a special box designed for that purpose in their annual tax return. This whole bureaucratic process alerts HMRC to possible activity which they may wish to investigate, and arms HMRC with information about the types of schemes being marketed, putting them more on the front foot and allowing them to take action to close schemes via future legislation more quickly.

It is not clear that the disclosure regime is well suited to IHT. There is a clear reason for its existing use with, for example, income tax or capital gains tax (CGT) schemes where any loss of tax could be a tangible loss in the current tax year, as relevant for that year’s tax return. IHT is different. Often, gifts are made and it is then a case of ‘wait and see’ if the client survives the seven-year period. There are some examples of where an immediate loss of revenue would bite, e.g. a scheme which purports to create a Potentially Exempt transfer (PET) where arguably there is a CT, avoiding the 20% IHT charge (and such a scheme using reversionary trusts was targeted in the Pre-Budget Report 2009). On a positive note, at least there is a period of consultation ahead where any disproportionate impact can be highlighted. The application of the disclosure rules to discounted gift trusts and loan trusts remains to be seen once any draft rules are published.

Tax agents’ legislation

There is a continuing theme in terms of how the government is seeking to reduce the amount of tax mitigation activity (and I use that term deliberately rather than evasion). If a straight line is drawn from the disclosure legislation above to the new draft legislation aimed at tax agents who advise their clients on how to pay less tax, the new frontier emerges which involves the intermediary rather than the end client. In the case of the disclosure legislation, there are obligations on scheme providers to submit information to HMRC in specified timescales.  With the draft tax agent legislation, matters are rather more serious.

The significant threat posed by this draft legislation is found in the so-called ‘Working with Tax Agents’ paper published in February 2010 which sets out a framework which will allow financial penalties to be imposed on advisers who are guilty of ‘deliberate wrongdoing’.  The published draft may yet go through amendments. The consultation was due to close on 3 March, and was then extended to April due to the outcry at the previous tight deadline.

The issue for financial planners in terms of the scope of the draft legislation is that ‘deliberate wrongdoing’ is almost a strict liability offence. If an adviser gives advice which directly or indirectly leads to a loss of tax, and that was a deliberate piece of advice, then even if a loss of tax does not actually arise, the adviser could be guilty of ‘deliberate wrongdoing’ and subject to the penalty framework in the document. The draft legislation is so simply worded that, for example, does giving advice about investments which are to be held in a trust make the financial adviser guilty of ‘deliberate wrongdoing?’ The recommendation about using a trust would probably have several motivations, including asset protection for the beneficiaries, but it would likely also include an inheritance tax outcome for the donor in terms of reducing the value of their estate which could be subject to IHT. Where is the line to be drawn?

Representations need to be made to illustrate the world of difference between fraud and tax evasion on the one hand, and advising a client on how to make best use of the statutory exemptions and reliefs which exist. The muddying of the waters between tax evasion and tax mitigation is in evidence in this draft legislation, which (if unchanged) would radically alter the environment for those giving investment advice which involves certain taxation outcomes. The draft legislation is quite simply too wide in scope.