HMRC inheritance tax plans will disproportionately affect those with only moderate wealth, says expert

HM Revenue and Customs (HMRC) is consulting on changes to the way in which inheritance tax trust charges are calculated which it says will "ensure fairness in the system". The consultation, which closes on 29 August, proposes that those that divide their property into multiple trusts would only be allowed to take advantage of the exemption from inheritance tax for the first £325,000 of property once where that property is divided across multiple trusts.

However tax expert Janet Hoskin of Pinsent Masons, the law firm behind Out-Law.com, said that the changes would create complications for those with life insurance policies, which are often structured into trusts to speed up payments on the death of the policyholder.

"Once again those with only moderate wealth will be caught by changes aimed at the very wealthy," she said.

"Our main concern is the impact of the proposed changes on trusts used with life insurance policies, including death in service and pension death payments. In these cases, trusts are mainly used to speed up payments out on death to support the family but the tax changes will make the position far more complicated," she said.

Inheritance tax is charged at 40% on the value of a deceased person's estate over a 'nil-rate band threshold', which is currently £325,000. However, if an individual transfers assets into a trust before death then those assets no longer form part of their estate so would not be subject to an inheritance tax charge on death.

"The government wants to ensure that there is consistency of treatment between those individuals who transfer their assets on death and those individuals who make lifetime transfers through the use of trusts," HMRC said in its consultation. "In the circumstances we believe that it is right that there should be one nil-rate band available for those individuals settling property into trust just as there is only one nil-rate band available to an individual transferring assets on death."

Under the current rules, where assets worth more than the nil-rate threshold are transferred into a trust the excess is subject to a 20% 'entry charge'. A 'periodic charge' is due on every ten-year anniversary of the assets being put into the trust, and an 'exit charge' is payable when assets are taken out of the trust. The effect of these rules is roughly equivalent to imposing a 40% charge on assets above the nil rate threshold held in the trust once a generation. Anti-fragmentation rules exist to reduce the scope for individuals to artificially reduce their tax liability, however the HMRC consultation said that these could be easily "side-stepped".

HMRC has already revised its proposals following an earlier consultation, and now intends to introduce a statutory requirement for individuals with multiple trusts to elect how their nil-rate band would be split across these trusts. Responsibility for doing so would rest entirely with the individual, backed with sanctions against the individual for over-allocation and the recovery of any tax underpaid. Trustees would also be subject to sanctions if any error was made as a result of their "careless or deliberate actions".

If adopted in their current form, "anti-forestalling" rules would apply so that any settlements made on or before the date of the consultation, 6 June 2014, would be caught by the new rules. Inheritance tax liability would be calculated as of 6 April 2015.