Next month marks the first anniversary of the changes to the way trusts are taxed following the March 2006 Budget. Hands-up all those who have got to grips with the impact of the changes…

One common theme we are regularly asked questions on is the effect of changing a beneficiary under an interest in possession (IIP) trust in the transition period from 22 March 2006 to 5 April 2008.

As we now know, existing interest in possession trusts will be unaffected by the new rules provided the person with the current interest in possession is unchanged. The trustees are also able to remove the person who has the pre 22 March 2006 IIP and appoint a different person. In this situation, the old regime will still apply provided the new person takes the succeeding interest in possession no later than 5 April 2008. This has been given the term Transitional Serial Interest (TSI).

As the person who had the interest in possession must have had it before the 22 March 2006 for this to work, it follows that once the trustees appoint the interest in possession to a new person in the period up to 5 April 2008, they cannot do it again. If the trustees do make a subsequent appointment, the trust may fall into the new relevant property regime and could trigger a chargeable lifetime transfer. For example:

1. On 31 January 2005 Jerry makes a gift of £200,000 to a Standard Life Flexible Gift Plan. The trustees buy an Investment Bond with the gift. The trust lists Tom as the main beneficiary.
2. On 1 September 2006, the trustees decide to remove Tom as the main beneficiary and appoint Dick in his place. The trust remains subject to the old regime because Tom had an interest in possession pre-dating the 22 March 2006 changes and therefore TSI applies.
3. On 31 March 2008 the trustees decide to remove Dick as the main beneficiary and appoint….. (you guessed it) Harry as the new main beneficiary. Now the situation changes; Dick did not have an interest in possession pre-dating the 22 March 2006 changes, so the trust now falls into the new relevant property rules and is a chargeable lifetime transfer (CLT). The first Periodic Charge will occur on the 10th anniversary of the creation of the trust (31 January 2015), although the charge will be proportionately reduced for the period 31 January 2005 to 31 March 2008 to reflect the fact the trust was not subject to the relevant property rules during this time.

Now, let’s look at the above example again and change the scenarios slightly. When we do, we’ll see how the outcome changes;

• In step 3, if the trustees decide to appoint the trust benefits to Harry absolutely, this will not be a CLT. The trust is effectively now an absolute trust and will be taxed accordingly. As Harry is over 18 years old he could ask the trustees to transfer the trust property to him. Any tax due on bond gains will be paid by Harry.

• In step 3, on 31 March 2008, Dick dies and instead of Harry, the trustees appoint Dick’s wife as main beneficiary. The spousal exemption means that there will be no chargeable transfer and TSI will continue, with the trust remaining in the old regime. In fact, the same would be true even if Dick had died after 5 April 2008.

In all the above examples, when the trustees remove a main beneficiary, they should also consider removing this person from the list of potential beneficiaries as well to ensure the gift with reservation rules are not infringed.

However, is it necessarily a bad thing to allow the trust to be taxed under the new regime? Possibly not - the maximum IHT charge of 6% every 10 years under the relevant property rules may, in some circumstances, be more favourable than had the interest in the trust been included in the deceased beneficiary’s estate under the old rules. In addition, under the new rules, beneficiaries can now be changed without there being a transfer of value.

This is something that trustees and their advisers may want to look at having considered the individual circumstances of the trust.

For more technical information, please visit the Techzone area of adviserzone.

Any reference to legislation and tax is based on Standard Life's understanding of United Kingdom law and HM Revenue & Customs practice at the date of production of this article. These may be subject to change in the future. Tax rates and reliefs may be altered. No Guarantees are given regarding the effectiveness of any arrangements entered into on the basis of these comments.

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