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Mark McLaughlin CTA (Fellow), ATT TEP, outlines the HM Revenue & Customs consultation on the proposed relaxation of reporting requirements for lifetime gifts, terminations and settlements.

Mark McLaughlin

Proposed changes 

An effect of the Finance Act 2006 changes to inheritance tax (IHT) and trusts is that a significantly greater number of returns must be submitted to HM Revenue & Customs (HMRC) than before. With HMRC resources already stretched, the additional paperwork has been an unwelcome development for them. The changes have also increased the workload for practitioners, and the fees paid by their clients.

HMRC therefore intend alleviating the ‘paper chase’ of returns (or ‘accounts’, under IHTA 1984, s 216) which yield no IHT, and are consulting with professional bodies on changing the reporting requirements. The proposed changes can be found on their website (www.hmrc.gov.uk/cto/etes.htm), and comments on them should be sent to HMRC by the end of August (all references are to IHTA 1984, unless otherwise stated).

Lifetime gifts and terminations

Regulations currently excuse taxpayers from delivering an account to HMRC if certain thresholds are not exceeded and conditions are satisfied. In practical terms, the reporting thresholds have traditionally been set relatively low (The Inheritance Tax (Delivery of Accounts) (Excepted Transfers and Terminations) Regulations, SI 2002/1731):

• For individuals, chargeable transfers in any one tax year must not exceed £10,000, and cumulative transfers in the ten years preceding the transfer must not exceed £40,000;
• For terminations of an interest in possession (IIP), the life tenant must notify the trustees (under s 57(3)) of an IHT exemption (i.e. the annual or marriage or civil partnership exemption) which covers the whole transfer.

Changes to increase the reporting limits and ease the conditions for exception are to be welcomed, but have been a long time in coming. Even before FA 2006, it was difficult to see how the £10,000 and £40,000 thresholds in particular could be justified, other than perhaps as an exercise to monitor transfers made in the seven years before death. In addition, following FA 2006, terminations of an IIP will often be chargeable events within the ‘relevant property’ regime. HMRC’s proposal to align their treatment to those of excepted transfers is therefore a sensible step. 

The proposed extension to these regulations will introduce three tests to be satisfied for exception to apply to a chargeable transfer, or to an IIP termination which is not wholly exempt:

1. Value-based test

The gross value of the asset to the transferor, or the loss to the estate if greater, must not exceed a specified limit. HMRC proposes to apply a formula to determine this threshold (i.e. 30% below the IHT nil rate band) but rounded up to the nearest £5,000 where appropriate. For 2007/08, this threshold would therefore be £210,000.

2. Threshold test 

The value from test 1 must not exceed a ‘specified cash limit’, which HMRC propose would also be £210,000 for 2007/08, calculated on the same basis.

3. Cumulative test

The transferor’s cumulative chargeable lifetime transfers in the previous seven years, plus the latest transfer, must not exceed a specified cash limit. HMRC propose to change the percentage used in the above formula to 15% for this purpose, making the threshold £255,000 for 2007/08.

A formulaic approach has the advantage of causing the thresholds to increase in line with the nil rate band. However, the above value-based test may cause valuation issues to arise in some cases, in addition to requiring two separate values to be ascertained in respect of the same transaction.

Excepted settlements

HMRC also propose to excuse trustees from making returns of chargeable events involving no IHT liability, if certain conditions are satisfied. This will involve replacing The Inheritance Tax (Delivery of Accounts) (Excepted Settlements) Regulations, SI 2002/1732) with new regulations.

The proposed new rules will apply to trusts created from 27 March 1974, where there are no related settlements. Throughout the settlement’s existence, the settlor must have been UK domiciled and the trustees UK resident. In addition, the regulations would set a hypothetical gross value, which must be below a ‘cash limit’ (i.e. HMRC propose that the limit should be 30% below the IHT nil rate band, rounded to the nearest £5,000) for exception to apply.

The amount of the ‘hypothetical value’ will depend upon which of the following charges (to which the regulations will apply) is potentially subject to exception:

• Ten year anniversary charges (s 64);
• Charges at other times (s 65), e.g. exit charges before the first ten-yearly anniversary; and
• Charges (within s 71E) under the provisions for ‘age 18 to 25’ trusts (in s 71F).

However, the settlor’s cumulative chargeable transfers in the seven years before creating the settlement will feature in each case, apart from the exception test for exit charges after a ten-year charge (s 69). In those cases, HMRC propose that trustees will not be required to deliver an account in respect of settlements where the last ten-year charge satisfied the conditions, provided that there have since been no additions or no non-relevant property in the settlement.

Practical points

• The thresholds for asset values are gross, i.e. before deducting available liabilities, exemptions or reliefs. Thus a transfer of assets attracting 100% business or agricultural property relief remains reportable if the exception thresholds are exceeded. HMRC no doubt wish to examine cases in which deductions are claimed. However, a short return or written statement, from which HMRC could select a proportion for enquiry, would further reduce the compliance burden.
• HMRC intend that the new rules will apply to lifetime transfers into trust and chargeable events in respect of ‘relevant property trusts’ occurring from 6 April 2007, although comments on the proposals were only requested on 12 July. This means that any relaxation in reporting requirements will come too late for those diligent individuals and trustees who have already submitted returns.

Some individuals have previously transferred foreign property on discretionary trusts in order to submit an account to HMRC and claim foreign domicile (i.e. usually where there is a relatively small amount of IHT at stake), only to find that HMRC decline to consider the individual’s domicile status, and refrain from collecting the IHT liability. HMRC have recently resumed consideration of domicile cases, where the IHT at stake is more than £10,000 (Taxline (June 2007), contribution by Peter Vaines). If HMRC resources are as stretched as they appear to be, consideration should be given to applying a percentage in the above formula which is closer to the IHT threshold. Ten per cent is arguably a reasonable margin for errors and differences in valuation.