ABI RESPONSE TO HMRC CONSULTATION ON INHERITANCE TAX: SIMPLIFYING CHARGES ON TRUSTS THE NEXT STAGE. The UK Insurance Industry The UK insurance industry is the third largest in the world and the largest in Europe. It is a vital part of the UK economy, managing investments amounting to 26% of the UK s total net worth and contributing 10.4 billion in taxes to the Government. Employing over 290,000 people in the UK alone, the insurance industry is also one of this country s major exporters, with 28% of its net premium income coming from overseas business. Insurance helps individuals and businesses protect themselves against the everyday risks they face, enabling people to own homes, travel overseas, provide for a financially secure future and run businesses. Insurance underpins a healthy and prosperous society, enabling businesses and individuals to thrive, safe in the knowledge that problems can be handled and risks carefully managed. Every day, our members pay out 147 million in benefits to pensioners and long-term savers as well as 60 million in general insurance claims. The ABI The Association of British Insurers (ABI) is the voice of insurance, representing the general insurance, protection, investment and long-term savings industry. It was formed in 1985 to represent the whole of the industry and today has over 300 members, accounting for some 90% of premiums in the UK. The ABI s role is to: Be the voice of the UK insurance industry, leading debate and speaking up for insurers. Represent the UK insurance industry to government, regulators and policy makers in the UK, EU and internationally, driving effective public policy and regulation. Advocate high standards of customer service within the industry and provide useful information to the public about insurance. Promote the benefits of insurance to the government, regulators, policy makers and the public. Page 1
INTRODUCTION The ABI welcomes the opportunity to comment on this consultation. We also very much welcome HMRC s proactive approach in arranging face to face meetings with stakeholders. For our part, we found the recent meeting with HMRC open and constructive and believe that this sort of approach is key to improving the quality and clarity of tax legislation. But we are concerned that the proposals in their current form have a disproportionate and detrimental effect on trusts created for family protection and look forward to working with you to finding a fairer solution for these taxpayers. GENERAL COMMENTS We accept that the proposed changes, with the intention of simplifying the inheritance tax (IHT) charges on relevant property trusts, are targeted primarily at trustees who have the obligation to report chargeable events and pay any tax due. Also, it is trustees who will have to pay any fees for advice relating to those obligations. However, although insurers generally have no practical involvement in that, many will produce guidance for trustees who use their specimen trust documentation. However, the latest consultation document introduces proposals that would have a detrimental impact on life policy trusts and some pension death benefit trusts, and indeed we believe could be disproportionately detrimental to these. The suggestions are included in the section Simplifying the calculation of IHT trust charges including the consideration of charges on certain death in service pension schemes. We have no comment to make regarding the other two sections in the consultation. RESPONSES TO QUESTIONS Question 1: Do these proposals meet the objective of reducing complexity and administrative burdens and in what way(s)? Response: Ignoring previous lifetime transfers and non-relevant property would be a welcome simplification. It would save a great deal of time and effort trying to establish facts from the 7 year period before a trust was created. Similarly using a universal 6% tax rate would undoubtedly reduce the complexity in calculating the tax due as the current regime requires a number of involved calculations to be performed to determine the rate of tax. However there is a risk that splitting the NRB between a number of trusts could increase complexity and whatever methodology is used it Page 2
is likely to raise a number of issues of detail (see below). We would be particularly concerned if the proposals were to go forward on the basis suggested as we believe this would produce an unfair outcome. Question 2: Does a single rate of 6% present any difficulties, particularly for smaller trusts? Response: Although not directly our concern (see general comments above), and we make no comment on the rate itself, it would seem likely that it will save trustees professional fees. However, although the examples used in the consultation document suggest that this might result in lower tax bills, this will not always be the case and we are not sure where the balance will lie in practice. In practice many smaller trusts may not engage a professional adviser to file their tax return and a HMRC calculator would particularly help them. Question 3: How much time would the simplified method save trustees and practitioners, on average per trust? Not in a position to comment. Question 4: Will there be significant costs to trustees and practitioners familiarising themselves with the new system and if so can you quantify these? We are not really in a position to comment but as a general point would suggest any proposal which involves apportioning the NRB runs the risk of increasing complexity rather than achieving simplicity. Under current rules, many small trusts will not be filing IHT returns so their costs will increase if they have to engage professional advisers to file their returns. Question 5: Do HMRC s proposals in paragraphs 54-58 on the way in which the nil-rate band should be split for ten year and exit charges provide the right balance between fairness and the risk of manipulation? The consultation document states that Splitting the nil-rate band is integral to the proposals to simplify the calculations and will allow other simplification measures such as ignoring the settlor s previous lifetime transfers and any non-relevant property within the trust assets. The split would be amongst all the relevant property trusts the settlor had made. Two methods of splitting the NRB are mentioned i.e. equally amongst the trusts or by apportioning it between the number of trusts in existence. The examples within the consultation document all use the equal split method, and it is unclear on what basis an apportionment might be made or how it might operate in practice. Also, the examples suggest that any advantage or disadvantage to either HMRC or the taxpayer would be relatively small. Page 3
However, the suggestion of splitting the NRB between all of a settlor s relevant property trusts could greatly dilute the available NRB and thus increase the amount that would suffer tax at the 6% rate. Life Cover Policies Many trusts are set up for life cover policies, written on the settlor s life, and wouldn t typically hold assets with a tangible value. There would only be any real value in the trust following the settlor s death. However, those who hold such policies in a trust could be materially disadvantaged by this proposal. These policies are designed to provide financial security for family members in the event of the death of a wage earner. The proceeds from such a policy replace the income lost on the death or disability of the wage earner, and can help the remaining family members to go on without having to rely on state benefits. It would be irrational for Government to arrange the tax rules so as to penalise those seeking to protect their families in that way. It is not uncommon for wage earners to have more than one such policy, since the need for protection will grow over time with the increase in earnings, and indeed with the increase in the number of children. However, if the NRB is split equally these trusts will take up a significant proportion of the NRB. Example Mr A has four relevant property trusts. Three contain protection life insurance policies taken out over the last 5 years and these have no current market value, although the total sum insured is 500,000. He inherits some money from his father s estate and decides to set up a trust with 100,000 to help pay for his three children s future university education. At the 10 year anniversary there will be no tax to pay on the life policy trusts as they have no value. However, his educational trust, which in the meantime has increased in value to 150,000, would no longer have a full NRB (which would have meant no tax to pay). Instead it would have a NRB of 81,250 (assuming no increase in the NRB) with a resulting tax charge of 4,125 ( 68,750@6%). Mr A could of course have chosen not to write his life policies under trust, thus leaving the full NRB for the educational trust. However, if he were to die the 500,000 sums insured would form part of his estate and be subject to IHT. In the absence of any available exemption, at least part of the money designed to give his children financial security could then be taken in tax. Page 4
Pension spousal bypass trusts will also be affected by the proposed changes. But the context is quite different to aggressive tax planning arrangements using pilot trusts. A major motive is the ability to control who receives the death benefits rather than IHT or tax planning. The issues are complex and need to be considered together with the pensions legislation. Therefore, we have decided not to include a more detailed explanation and examples at this stage and would welcome the opportunity to discuss this further with HMRC to find a solution which gives a fair result for these taxpayers. Question 6: Are there any other ways that the nil-rate band could be split that would not risk a loss to the Exchequer? Response: For the reasons above, we believe that pure protection policy trusts should be excluded from the proposed regime. Perhaps this could be achieved by excluding policies which cannot acquire a surrender or maturity value? A relevant property trust containing only a pure protection life policy would not be counted when splitting the NRB, so would not impact on the tax position of a trust containing valuable assets. However, that would presumably also mean that a protection life policy trust would not benefit from any NRB at a 10 year anniversary. The only time that that would cause an issue would be where the life insured died (or perhaps became terminally ill) shortly before the 10 year anniversary, such that the trustees were unable to distribute the cash before the anniversary. A possible solution would be to extend the 2 year tax exemption that currently applies to registered pension scheme trusts following the death of the member to pure protection life policy trusts. Thus, regardless of when death occurred the trustees would have two years in which to distribute the monies without incurring an inheritance tax charge. Question 7: Would applying the new rules from a set date cause trustees and practitioners any difficulties? Response: It would make little difference to us when any changes were made. However, we should be grateful for sufficient time to update the content of any relevant literature. Question 8: In what other way could the new rules be implemented? Response: Amending the rules around related transactions We believe there is scope to improve the operation of the legislation by amending the rules around related transactions. Currently, settlements are related if they are created by the same settlor on the same day (s62 IHTA 1984). At the 10 year anniversary, the historic value Page 5
of any related settlement is brought into charge. However, if the settlements are not related, because for example they are created on different days, each may benefit from its own, separate NRB. The proposal to split the NRB amongst trusts would effectively put an end to this. One possibility might be to keep this facility for non-related settlements, but increase the timescale from those created on the same day to settlements created within X years. HMRC s has informally suggested a value for X of seven years. However, we believe that that is too long. Many people will take out additional life insurance when a baby is born, and the time between babies is typically much less than seven years indeed the UK average is around 3 years 1. We therefore suggest that two to three years would be more appropriate while still providing ample protection for HMRC. Disallowing NRB at 10 year anniversary Another idea suggested by HMRC was to disallow any NRB at the 10 year anniversary, but then reduce the tax rate. (We assume the rate chosen would be such as to produce a tax neutral result.) However, whilst that, together with the disregarding of historic values, would simplify the process, it would also mean that all trusts that held a value would incur a tax charge, and hence have to file a return. Therefore some sort of de minimis rule would be required - e.g. no tax to pay if the charge calculated is less than X. And this would then take us back to the question of fragmentation. HMRC calculate the tax charge Regardless of any other changes made, it was suggested that HMRC might offer to calculate the tax charge for trustees if they supplied all of the relevant information. This would be akin to the facility that exists with self assessment. Clearly trustees could still take their own professional advice if they wished, but we believe this could be a beneficial option to nonprofessional trustees who might otherwise incur fees that are in excess of the tax due. Other comments Issues with splitting NRB irrespective of methodology adopted As noted in our response to question 1, whatever approach is adopted to splitting the NRB, there are issues of detail which will have to be addressed. For instance: How would the NRB fragmentation work if the settlor had died? How would trustees know how many trusts a settlor had created (and does this bring with it potential data protection issues?) 1 'Characteristics of the Mother 2, England and Wales, 2011' by the ONS. Page 6
Questions 9-14 As noted above we have no responses to the second and third sections of the consultation paper. Page 7