Turbulent Times for Pilot Trusts
Changes to Inheritance Tax (IHT) have reduced the effectiveness of pilot trusts in IHT planning. Taxpayers who have created such trusts will need to carefully examine their existing IHT arrangements to determine what changes may be needed.
Pilot trusts were a popular form of IHT planning that sought to obtain a tax advantage by creating multiple “pilot trusts” during a settlor’s lifetime with only nominal capital (e.g. £10) and then, at a later date adding substantial assets, with the additions to the various pilot trusts all taking place on the same day (for example on death).
Pilot trusts are sometimes referred to as Rysaffe trusts in reference to the case of CIR v Rysaffe where HMRC unsuccessfully sought to overturn the tax advantages of pilot trusts.
The tax advantages of pilot trusts arose because of the way in which the nil rate band is calculated for the purpose of ongoing IHT charges for trusts. i.e. On each 10 year anniversary (“Principal Charge”) or on the distribution of capital to beneficiaries (“Exit Charge”).
Amongst other things, the calculation of the nil rate band available to each trust took into account the value of related settlements (i.e. trusts created on the same day) and certain additions to trusts created by the same settlor, but crucially not additions made to different trusts on the same day.
This meant that each pilot trust was able to benefit from its own nil rate band reducing the IHT payable on the Exit and Principal Charges for the trusts.
After a lengthy consultation period on reforming this peculiarity, the Finance (No. 2) Act 2015 brought in specific provisions to prevent this type of tax planning.
The new provisions mean that same day additions are included in the calculation of IHT, thereby removing the incentive to create small pilot trusts.
The new rules apply to Principal and Exit Charges from 18 November 2015 (the date of Royal Assent for the F(No.2)A 2015) for trusts created on or after 10 December 2014 and for trusts settled before 10 December 2014 if additions are made on or after that date.
Exclusions from the new rules apply to:
- charitable trusts,
- additions from regular life insurance premiums,
- lifetime transfers below £5,000, and
- existing trusts for those dying before 6 April 2017 where:
- the will is executed before 10 December 2014, or
- such terms are carried forward to a later will.
The exclusions for those dying before 6 April 2017 are designed give taxpayers sufficient time to change their wills (see below).
The Future for Pilot Trusts
The changes have not prevented the creation of pilot trusts. Taxpayers are still free to settle multiple pilot trusts during their lifetime however the tax advantages are now limited.
For settlors dying before 6 April 2017 with wills executed before 10 December 2014, pilot trusts can continue to benefit from the previous rules provided the abovementioned criteria and the will concerned is a “protected testamentary disposition”; i.e. the disposition to the pilot trusts under the will must be, in substance, as they would have been immediately before 10 December 2014 when the changes were announced.
Therefore taxpayers with existing pilot trusts should take care not to make changes to their wills until after 6 April 2017.
HMRC have accepted that certain changes to wills on or after 10 December 2014 will not result in the will failing to be protected if the changes do not affect dispositions from the estate. However, as this has yet to be fully clarified, settlors may prefer use instruments of variation after their death.
For settlors surviving to/from the 6 April 2017, wills executed before 10 December 2014 will no longer be protected and trusts subject to disposition will be taxed under the new rules. Settlors in this situation will need to review their tax planning arrangements to ensure their trusts do not face substantial tax burdens due to outdated wills.
If you have any queries with regards to Inheritance Tax, please contact Vikki Elliott at firstname.lastname@example.org