Clause 80
Finance (No. 2) Bill
6:15 pm

Theresa Villiers (Shadow Chief Secretary To the Treasury, Treasury; Chipping Barnet, Conservative)

The Opposition have considerable sympathy with the Government’s efforts to target the particular type of reverter to settlor double trust arrangements that are the primary focus of the clause. However, we have certain reservations about the clause,  which I should express in the context of our views on the pre-owned assets regime as a whole. If I take the Committee through a couple of those general points on the regime, I can then go on to deal with clause 80 with some rapidity.

As far back as 1986, rules have existed to prevent people from opting out of inheritance tax by transferring title to their homes to their adult children while continuing to live in them. These have been colloquially described to me by some experts as

“having your cake and eating it arrangements”.

From 1986 onwards, the gift-with-reservation rules looked through such transfers and treated the house as part of the estate of the parent on death for inheritance tax purposes; hence, a Conservative Government made the first move against such arrangements. Therefore, there is clearly a degree of common ground in all parts of the House in respect of seeking to prevent people from avoiding inheritance tax using this type of scheme.

However, the Government’s pre-owned assets rules, which were an addition to the gift-with-reservation rules and which came into effect in April 2005, have provoked considerable controversy and anxiety amongst those affected by them. As veterans of the Committee may recall, in both 2004 and 2005 the Opposition expressed serious concerns about the pre-owned assets regime on the grounds that there was a risk that it would lead to double taxation and that the rules were drafted in such a way as to penalise a number of innocent transactions between family members. In respect of the first point on double taxation the key anxiety was that the arrangements that had to be dismantled as a result of the new pre-owned asset rules might be hit with a double inheritance tax charge. I acknowledge that the Government have heeded the warnings given on the matter by the Opposition and professionals, and I am grateful that they have moved to deal with the double taxation problem via secondary legislation. However, it is worth drawing to the attention of the Paymaster General and the Committee the fact that there are serious concerns whether the regulations published in December can deal effectively with the problem. Taking into account the impact of schedule 20, the Government appear to have provided in the regulations a relief that nobody can use. I illustrate that as follows.

The most serious double taxation problem under the pre-owned assets regime concerned the so-called home loan schemes, which involved an IOU held by the second of the two trusts that made up the scheme. Members who were on the Committee last year will recall that more than 30,000 people have entered such schemes, so it was and remains a significant issue for many. To unravel such a scheme in order not to fall into the POA regime or go back into inheritance tax—the Paymaster General acknowledged that that was entirely in order, even desirable, for those who have entered a trust—the second trust must release the IOU, the debt that was part of the original avoidance schemes targeted by the POA legislation.

After various representations, the Paymaster General agreed that there was a problem of double taxation in such cases. The December regulations specifically provide that double charges relief will be available for inheritance tax purposes if the debt is released. The aim of the regulations was to ensure that  if someone died within seven years of having entered a home loan scheme, the IHT charge would not be levied on the same economic value twice.

The problem occurs as a result of schedule 20 to the Bill. If the schedule is accepted unamended—I hope that it will not be—it will treat the release of the debt as an addition to the trust and an immediate 20 per cent. inheritance tax charge will be levied if the debt exceeds the inheritance tax nil rate band, which I am told it will in many cases. So people are getting relief from one inheritance tax charge as a result of the Paymaster General’s welcome December regulations, but it seems that they run into another because of schedule 20. We must bear in mind that many people did not unwind their schemes before the Budget because they had been waiting for the double charges regulations that came out in late December, and not all their arrangements and paperwork had been completed by March.

It would be welcome if the Paymaster General were prepared to look into the matter to see whether schedule 20 will have the impact that I have described. It seems odd that, having issued regulations to prevent double charging as a result of the release of the debt in a home loan scheme, the Treasury now seeks to impose an additional charge on the release of that debt. I hope that, having stated clearly that double taxation should not occur in the cases in question, the Paymaster General might consider amending either schedule 20 or the December regulations to ensure that they have the effect that I believe she wants.

The Opposition’s second reservation with the pre-owned assets rules is that there are a number of situations in which the ownership of property is transferred between family members without tax being the motivation. Those transfers could be caught by the pre-owned asset rules, which were so widely drafted as to cover all disposals of land and could therefore penalise such innocent transactions. Examples that have been brought to my attention include a situation in which one cohabitant gives money to her partner, who uses it to pay for the purchase of the house in which they both live. Even if they later marry, the donor cohabitant is caught by the pre-owned assets charge. Cohabitants would be well advised to re-examine all such transactions as far back as 1986, in case there is a danger of an unexpected pre-owned assets charge.

I acknowledge the Revenue’s willingness to move on the matter when representations have been made to it in the past to try to exclude such innocent transactions, but problems remain. A particular difficulty is caused if family members make arrangements that fall foul of the rules without having any idea of the tax consequences. They might require the informal arrangements that do not involve taking specialist tax advice on the pre-owned assets regime.

In an age in which pensioners are increasingly asset rich and cash poor, we must bear in mind that their children might well want to help them to realise some of their wealth by buying a share of the equity in their parents’ homes. If such arrangements are entered into by a parent and a bank, there is no problem, but if that kind of equity-release arrangement is set up between family members, it triggers the POAT rules. It does not  matter if the sale was at a commercial price, because the pre-owned asset tax still applies on the cash element, even if it will attract inheritance tax on the parent's death.

If the Government wish to stop people from giving away cash raised by equity release, they could easily provide for that. It seems odd that where two members of a family live together and one gives the other a share in the house, the donor is not caught by the reservation of benefit rules or the POAT rules. However, if the donor has insufficient resources to make the gift and instead sells the interest to the other person living there, whether or not at full value, the transaction is subject to the pre-owned asset rules. Those are our reservations about the framework as a whole.

I turn to the clause itself. I can see why the Revenue would want to target the double trust reverter to settlor trusts that are the focus of clause 80, as such schemes were clearly aimed at getting around the IHT rules. I certainly prefer the more targeted approach in the clause to the broad-ranging attack in schedule 20 on a whole range of trusts, most of which have nothing to do with tax. As I made plain in my opening for the official Opposition on Second Reading, we are prepared to work constructively with the Government in their efforts to target artificial schemes that may use trusts to avoid tax, as long as the legislation is specifically targeted on such artificial schemes.

The majority of trusts hit by the clause seem to fall into that category, so we approach it with a degree of sympathy, but we have some concerns. First, the clause has a retrospective effect in that it applies to existing arrangements. That point is not as serious in this case as it is in relation to schedule 20, because one would think that those entering into such schemes probably had an idea that they were likely to attract the attention of the Revenue at some point. None the less, it is still a concern that this will be one of a number of occasions on which the Government have introduced legislation that is, in effect, retrospective.

Our second and more serious concern is about the scope of the provision. As with the overall pre-owned asset regime structure, there seems to be at least some evidence that the width of the drafting could catch some innocent transactions. I would be grateful if the Paymaster General considered the point made by the Institute of Chartered Accountants, which states:

“The mischief at which the clause is aimed is where property is part of an individual’s estate as a result of section 49 IHTA 1984 but will revert to a settlor when that interest comes to an end on death.”

The institute goes on to recommend that the clause should be more specifically aimed because it currently denies

“the benefit of the relief where an individual has the relevant property in his estate even where the revertor to settlor exemption is not available.”

The Chartered Institute of Taxation has expressed similar concerns. Having spoken to its representatives, I know that, in essence, its worry is as follows. Let us take an example in which H sets up a trust for his wife for life, into which he puts an interest in a house. He might have done that some years ago—perhaps in the late 1980s—for various reasons, some of which might involve tax and some of which might not. It might have been part of an arrangement to make provision for the  wife as part of a matrimonial settlement. So, the wife initially has an interest in possession. Subsequently, she dies and the property reverts back to H. No IHT would be payable at that point because of the spouse exemption. H takes a qualifying interest in possession and the property is part of his estate for the purposes of section 49 of the Inheritance Tax Act 1984. On his death, IHT would be payable in the normal way, because there is no double trust arrangement that gives rise to the reverter to settlor exemption in section 54.

The settlement was set up by H and no one else, so no loophole is being used. In essence, the value of the house is subject to normal inheritance tax charges. However, under clause 80, H would, from 5 December, be liable to the pre-owned assets tax, because the new paragraph 11(11) to schedule 15 of the FinanceAct 2004 has been breached. This property was once part of his estate and he now has an interest in possession in it again. The net result of this rather complicated arrangement is that both the pre-owned assets regime and inheritance tax apply and we have a double taxation situation.

I do not have enough empirical knowledge to know how common these trusts might be, but I hope that the Paymaster General will agree to look at this area as it is clearly not the Government’s intention to inflict both the pre-owned assets tax and inheritance tax on the same arrangement. I hope that the Government will consider amending the clause or looking at it again to ensure that it targets only the double trust reverterto settler arrangements, which are specifically designed to exploit the loophole in section 54, and not the type of situations that I have described. Certainly as the Chartered Institute of Taxation points out, the scope of the clause seems to go rather beyond the press release in the Budget report. Perhaps it would be possible to tighten up the drafting in order to ensure that it focuses on the artificial schemes that I believe the Paymaster General has in mind.

John Butterfill (Bournemouth West, Conservative)

At this point, may I say to hon. Members that I hope that this will not turn into a debate on schedule 20? It would be rather premature to have that debate.

Dawn Primarolo (Paymaster General, HM Treasury; Bristol South, Labour)

Indeed, Sir John. I should point out to the hon. Lady that, whatever she might think, the changes contained in the clause are completely unrelated to the issue she referred to. This is a free-standing clause directed at artificial trust arrangements that are designed to get round both IHT gift with reservation rules and the pre-owned asset income tax charge. The problem when professional bodies write complex examples is that it is difficult to know whether they are giving real examples or are seeking to punch a hole in the legislation by describing a theoretical position. I have seen little evidence that her examples refer to common behaviour.

Let us take the example of the person who provided cash so that his mother could buy a house. The mother dies and leaves the house, interest and possession to her son who is then caught by the income tax charge. Let us look at how unlikely that would be. It would require the person in question to make a significant gift to somebody else to purchase an asset, only to have it resettled upon them under the person’s will within  seven years and then take up occupation and receive an imputed benefit of more than the de minimis limit of £5,000 per annum. The amendments that we have made to the election provision would enable the person to elect out of the income tax charge. The relationships that have been suggested seem somewhat unlikely, but even so the answer is for the person to elect out of the income tax charge if their interest also forms part of their estate for IHT purposes.

The hon. Lady gave a further example and I am aware that representations have been made to the HMRC about it. It is in connection with elderly parents being caught if they do not have enough property to be liable for IHT. They sell their house and give money to their children to convert part of their house into a granny flat. I believe that that was discussed during the debates on pre-owned assets. I have asked the HMRC, under those circumstances, to monitor the situation so that we can see whether that is an issue and whether it will create difficulties with the pre-owned assets. Should that be the case, I would be prepared to reconsider the matter.

I remind the Committee, however, that the pre-owned asset rules are targeted at those who use contrived structures to avoid paying inheritance tax—that still stands. I was amazed at some of the examples in defence of the individuals who claimed that they were not trying to avoid inheritance tax. Often that paves the way to a clear indication that that is exactly what they were trying to do.

The hon. Lady also said that innocent cases could be caught by the provisions. With the exception of the case that I flagged up in which there is discussion with representative bodies and which I am asking the HMRC to monitor carefully—the legislation was not intended to apply to such a case—the truth is that it is incredibly unlikely—it still has not been asserted—that innocent cases will be affected by the pre-owned assets regulations, even in the cases that she mentioned.

Great care is always necessary in such matters, but the fact is that the reason for the exemptions, and hence for the clause, is to ensure that individuals do not sidestep income tax or the IHT charges and do not avoid income tax charged to the pre-owned assets or the inheritance tax. I see you smiling, Sir John, but given the arguments that were advanced in the introduction of the pre-owned assets, I am sure that you understand that I am not particularly attracted to such action.

I am sure that we will have a lot of time to discuss the matter during consideration of later clauses, but I can assure the hon. Lady that care is taken over the interaction of the legislation. If she is seeking an assurance from me that I shall continue to do that in the course of this Finance Bill, I can give her that assurance. However, perhaps some of the points that she made today would be more appropriately explored at a later stage.

Theresa Villiers (Shadow Chief Secretary To the Treasury, Treasury; Chipping Barnet, Conservative)

I acknowledge that that issue is separate from schedule 20, which is why I did not seek to  advance issues on schedule 20 apart from where I felt that there might be a difficulty with its interaction with some of the pre-owned asset regimes. I refute the suggestion that I was seeking to punch a hole in the legislation. I made it plain that I was not seeking to defend the double trusts reverter to settlor arrangements.

Dawn Primarolo (Paymaster General, HM Treasury; Bristol South, Labour)

I was not suggesting for a minute that the hon. Lady was seeking to punch a hole in the legislation. If I thought that that was the case, I would have been much clearer and said it to her directly. I was referring to the examples constructed, which often inadvertently have that effect. So unless she dreamed them up herself, I am not accusing her of such a thing.

Theresa Villiers (Shadow Chief Secretary To the Treasury, Treasury; Chipping Barnet, Conservative)

Turning to those examples, I think that the Paymaster General referred to one given by the professional bodies to which I do not think that I referred. I did not refer to any of the examples in which a parent passed a property to a child and the child then sets up a trust. I referred to one example in which an individual sets up a trust for his spouse. Again, I emphasise that I acknowledge that there are significant problems when a property is transferred to a child and a trust is set up. They seem to be at the heart of the double trust situations, which the clause is targeting. As I have said on several occasions, I can understand why the Government want to target them. The situation that I described is subtly different. There is no double trust and no attempt to exploit the loophole that is provided by section 54. That can be done by setting up a double trust. It would be useful for the Paymaster General to bear that in mind.

Lastly, I welcome the Paymaster General’s indication that she is prepared to monitor situations where, for example, an elderly parent sells a share in the equity of their home. As I said, she and the Revenue have shown a welcome degree of flexibility in trying to remove innocent transactions from the scope of these proceedings. I know that there was a particular concern about loans between family members triggering the pre-owned assets regime. I gather that, through extra statutory mechanisms, it looks like that anxiety is being averted. I am pleased to hear that that approach, which tries to ensure that innocent transactions stay out of a very penal pre-owned asset regime, is continuing in relation to some of the examples that I mentioned.

I sign off by saying that, in the complicated example I raised, the real problem was the double taxation charge. Regardless of what one thinks about the motivation for setting up a trust, I hope that the Paymaster General would agree that one of the things we do not want to come out of this measure is that people end up in the pre-owned assets regime and pay inheritance tax. It should be one or the other.