Schedule 20
Finance (No. 2) Bill

Inheritance tax: rules for trusts etc

12:00 pm
Photo of Theresa Villiers

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

I beg to move amendment No. 230, in page 114, line 30 [Vol II], leave out ‘22nd March 2006' and insert ‘6th April 2007'.

Photo of John Butterfill

John Butterfill (Bournemouth West, Conservative)

With this it will be convenient to discuss the following amendments: No. 231, inpage 114, line 36 [Vol II], leave out ‘22nd March 2006' and insert ‘6th April 2007'.

No. 232, in page 114, line 40 [Vol II], leave out ‘22nd March 2006' and insert ‘6th April 2007'.

No. 233, in page 116, line 25 [Vol II], leave out‘22nd March 2006' and insert ‘6th April 2007'.

No. 234, in page 116, line 26 [Vol II], leave out‘22nd March 2006' and insert ‘6th April 2007'.

No. 235, in page 116, line 31 [Vol II], leave out‘22nd March 2006' and insert ‘6th April 2007'.

No. 236, in page 116, line 38 [Vol II], leave out‘22nd March 2006' and insert ‘6th April 2007'.

No. 237, in page 118, line 5 [Vol II], leave out‘22nd March 2006' and insert ‘6th April 2007'.

No. 238, in page 118, line 27 [Vol II], leave out‘22nd March 2006' and insert ‘6th April 2007'.

No. 239, in page 119, line 22 [Vol II], leave out‘22nd March 2006' and insert ‘6th April 2007'.

No. 240, in page 119, line 32 [Vol II], leave out‘22nd March 2006' and insert ‘6th April 2007'.

No. 241, in page 119, line 37 [Vol II], leave out‘22nd March 2006' and insert ‘6th April 2007'.

No. 242, in page 120, line 1 [Vol II], leave out‘22nd March 2006' and insert ‘6th April 2007'.

No. 243, in page 120, line 20 [Vol II], leave out‘22nd March 2006' and insert ‘6th April 2007'.

No. 244, in page 120, line 29 [Vol II], leave out‘22nd March 2006' and insert ‘6th April 2007'.

No. 245, in page 120, line 40 [Vol II], leave out‘22nd March 2006' and insert ‘6th April 2007'.

No. 246, in page 121, line 1 [Vol II], leave out‘22nd March 2006' and insert ‘6th April 2007'.

No. 247, in page 121, line 15 [Vol II], leave out‘22nd March 2006' and insert ‘6th April 2007'.

No. 248, in page 121, line 21 [Vol II], leave out‘22nd March 2006' and insert ‘6th April 2007'.

No. 249, in page 122, line 1 [Vol II], leave out‘22nd March 2006' and insert ‘6th April 2007'.

No. 250, in page 122, line 12 [Vol II], leave out‘22nd March 2006' and insert ‘6th April 2007'.

No. 251, in page 122, line 18 [Vol II], leave out‘22nd March 2006' and insert ‘6th April 2007'.

No. 252, in page 123, line 2 [Vol II], leave out‘22nd March 2006' and insert ‘6th April 2007'.

No. 253, in page 123, line 16 [Vol II], leave out‘22nd March 2006' and insert ‘6th April 2007'.

No. 255, in page 123, line 30 [Vol II], leave out‘22nd March 2006' and insert ‘6th April 2007'.

No. 256, in page 123, line 38 [Vol II], leave out‘22nd March 2006' and insert ‘6th April 2007'.

No. 257, in page 123, line 42 [Vol II], leave out‘22nd March 2006' and insert ‘6th April 2007'.

No. 259, in page 124, line 33 [Vol II], leave out‘22nd March 2006' and insert ‘6th April 2007'.

No. 260, in page 125, line 35 [Vol II], leave out‘22nd March 2006' and insert ‘6th April 2007'.

No. 261, in page 125, line 45 [Vol II], leave out‘22nd March 2006' and insert ‘6th April 2007'.

No. 262, in page 126, line 21 [Vol II], leave out‘22nd March 2006' and insert ‘6th April 2007'.

Photo of Theresa Villiers

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

These amendments would postpone a number of aspects of the schedule. I also tabled amendments Nos. 263 to 266; I thought that it was best to table a complete list, but they could not be selected, because they were not covered by the future years resolution. However, the amendments that have been selected are sufficiently coherent to stand on their own. I point out that, although the amendments selected would be sufficient to postpone a number of aspects of schedule 20, they would not have an impact on the operation of accumulation and maintenance trusts or the commencement date for provisions relating to such trusts as are set out in paragraphs 2 and 3 of the schedule; those paragraphs are not amended by the amendments.

The amendments would postpone the operation of schedule 20 in relation to setting up life interest trusts, and would also mean that the schedule applied only to deaths after 6 April 2007. Although it now looks as though a number of major flaws in the schedule will be resolved, or at least mitigated, as a result of the amendments tabled by the Paymaster General, I still urge the Committee and the Government seriously to consider a postponement.

I should like to use this debate on the amendments to highlight the plight of those bereaved since Budget day. They have been subjected to a sustained period of anxiety and uncertainty. On top of the distress that accompanies bereavement, they have had to wait to discover how they will be affected by the changes in schedule 20.

The Institute of Chartered Accountants points out:

“It has long been the convention that legislation will only take effect from Budget Day if sufficient information on the legislation can be made available to enable taxpayers to have reasonable certainty as to their position.

This convention was not observed in this case, and this must have caused real difficulty for bereaved relatives at a difficult time".

Who knows how much money such people have wasted on legal advice during that limbo period on trying to find out what their position was, and on making sense of the obscure and opaque drafting of the schedule?

A postponement would provide time to analyse the schedule and work out how it would operate in practice. Above all, it would lift a huge burden from families affected by recent bereavement. Those people have not been served well by a Government who published flawed proposals without consulting on them, and without thinking them through properly. The Government’s failure to mention those proposed changes during a lengthy and detailed consultation on the modernisation of trusts has caused huge resentment.

When John Cullinane of the Association of Taxation Technicians addressed the House of Lords onschedule 20, he said that if the Government’s intention

“was to change the principles on which this tax operates then clearly governments have a perfect right to do that...but then you would normally expect them to consult.”

John Whiting of PricewaterhouseCoopers made the same point in his evidence to that same House of Lords Committee. He expressed concern that the changes had come out of the blue. He repeated his concerns following the publication of the Government’s amendments last week, and in a press release said:

“Many of the anxieties and uncertainties that ordinary people have been experiencing since Budget Day could have been avoided if the Government had consulted on this in advance. People were put in the completely unacceptable position that they did not know the IHT that would affect their estates if they died after 21 March. The changes affecting deaths could have been delayed to allow for proper consultation and we very much hope this mistake will not be repeated.”

The Institute of Chartered Accountants weighed in again, saying:

“It is wrong in principle that the most significant change to the IHT treatment of trusts for over 25 years should be introduced without any consultation.”

The Chartered Institute of Taxation said:

“The Bill includes a substantial tranche of legislation....that has been introduced without consultation and is deeply flawed...The non-attributed comments in the press by HM Treasury spokespersons that the professions and the life industry do not know what they are doing...only serves to undermine the consultation process on all matters, not just trusts.”

The Financial Times described the lack of consultation as “gratuitous and offensive”.

I have little doubt that if a consultation had been carried out, the Government would not have felt forced to introduce so many complex amendments to correct their own legislation. As I told the Committee on Tuesday, groups such as Mind have called for postponement of the proposals in order to reassess the definition of “disability” and its impact on those with mental health problems. We will hear later today that insurance industry representatives have also called for a delay to rethink the schedule’s highly problematic impact on life policies.

A delay would also assist in resolving other problematic issues relating to capital gains tax and income tax treatment of trusts, which I highlighted during debate on clauses 88 and 89. It would allow time  to assemble a comprehensive and comprehensible corpus of law on the taxation of trusts based on the principles set out in the modernisation of trusts project, and to get to grips with a new regime for taxation of trusts that remains deeply flawed despite the Government’s welcome if last-minute attempts to remedy its major failures.

Photo of Dawn Primarolo

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

Good morning, Sir John. The Government reject the amendments tabled by the Opposition, and if the hon. Member for Chipping Barnet (Mrs. Villiers) chooses to press them to a Division today, I shall ask my hon. Friends to oppose them.

The hon. Lady’s amendments suggest that we should delay. As Committee members will be aware, the legislation took effect for new settlements from Budget day. The reason, as I have said a number of times—individuals quoted by the hon. Lady know it full well and will recognise what I am about to say—is that the Government recognise that provisions have already been made for trusts existing before Budget day. We have provided a generous two-year transition period for pre-Budget trusts that will allow people to make changes to existing trusts until 6 April 2008. As long as people continue under the arrangements in place at the end of the transition period, the trusts will continue to receive pre-Budget treatment.

Therefore, there is no reason to postpone introduction. It would simply create an opportunity to set up trusts in the intervening period solely in order to benefit from the pre-Budget laws. That is commonly known as forestalling. Where avoidance is being dealt with, no Government consults before taking action. The previous Government did not.

The hon. Lady continues to disagree with the central point: the legislation before the House clearly lays out the main rules that will operate in inheritance tax, and the schedule will ensure that they operate. There is good reason for it, and there is no reason to delay. I reject the hon. Lady’s amendments.

9:15 am
Photo of Theresa Villiers

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

I am grateful for the Paymaster General’s remarks in response to my amendments. On the matter of forestalling, the Government had the option to do what they did in relation to the taxation of leases, for example. They could have announced that they intended to change the rules and that those changes would take effect from a certain date, thereby preventing any option to forestall. Then they could have published draft legislation for consultation, debate and discussion that would subsequently be enacted in legislation backdated to the earlier announcement.

That is one way that the Government could have prevented any forestalling and ensured at the same time that effective consultation had taken place. Even leaving that aside, one has to wonder how much forestalling would be enabled by the amendments. The Government’s only justification for their assertion that trusts are being used to shelter the wealth of the rich from inheritance tax has related to A and M trusts. As I pointed out, the proposals would not cover such trusts; they would still be covered by schedule 20 from the same date as is set down in the schedule.

If the Government believe that only £15 million will be raised by the proposals, the revenue lost as a result of forestalling could not be significant in any event. Most seriously of all, the key, most important group, which I have highlighted, are those who have died since Budget day. I simply cannot believe that people are so anxious to forestall legislation that they would be prepared to bring forward the date of their own deaths to come under the old regime rather than the new one. For those reasons, I should like to press my amendment to a Division.

Question put, That the amendment be made:—

The Committee divided: Ayes 8, Noes 17.

Question accordingly negatived.

Photo of Theresa Villiers

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

I beg to move amendment No. 300, in page 114, line 34 [Vol II], after ‘interest', insert ‘; or

(d) an immediate self-settled interest.'.

Photo of John Butterfill

John Butterfill (Bournemouth West, Conservative)

With this it will be convenient to discuss the following amendments: No. 301, inpage 116, line 37 [Vol II], at end insert—

‘49D Immediate self-settled interest

(1) Where a person “S” is beneficially entitled to an interest in possession in settled property, for the purposes of this Chapter that interest is an “immediate self-settled interest” only if the following conditions are satisfied.

(2) Condition 1 is that S is the settlor in relation to the settled property.

(3) Condition 2 is that S became beneficially entitled to the interest in possession on the creation of the settlement.

(4) Condition 3 is that—

(a) section 71A below does not apply to the property in which the interest subsists, and

(b) the interest is not a disabled person's interest.'.

No. 353, in page 119, line 26 [Vol II], at end insert

‘; and

(iv) not an immediate self-settled interest.'.

No. 302, in page 119, line 35 [Vol II], at end insert

‘; or

(c) an immediate self-settled interest.'.

No. 303, in page 119, line 42 [Vol II], at end insert

‘or an immediate self-settled interest'.

No. 304, in page 120, line 5 [Vol II], after ‘interest', insert

‘or an immediate self-settled interest'.

No. 305, in page 120, line 7 [Vol II], after ‘interest', insert

‘or an immediate self-settled interest'.

No. 306, in page 120, line 12 [Vol II], after ‘interest', insert

‘or an immediate self-settled interest'.

No. 307, in page 120, line 25 [Vol II], at end insert

‘or

(d) an immediate self-settled interest.'.

No. 308, in page 120, line 34 [Vol II], at end insert

‘or

(d) an immediate self-settled interest.'.

No. 309, in page 122, line 23 [Vol II], at end insert

‘or

(d) an immediate self-settled interest.'.

No. 310, in page 123, line 6 [Vol II], at end insert

‘and

(c) an immediate self-settled interest.'.

No. 311, in page 123, line 32 [Vol II], leave out ‘or'.

No. 312, in page 123, line 32 [Vol II], after first ‘interest', insert

‘or an immediate self-settled interest'.

No. 313, in page 123, line 39 [Vol II], leave out ‘or'.

No. 314, in page 123, line 40 [Vol II], after ‘interest', insert

‘or an immediate self-settled interest'.

No. 315, in page 125, line 40 [Vol II], at end insert

‘; or

(d) an immediate self-settled interest.'.

No. 316, in page 126, line 4 [Vol II], at end insert

‘; or

(c) an immediate self-settled interest.'.

No. 317, in page 126, line 33 [Vol II], at end insert—

‘ “immediate self-settled interest” means an immediate self-settled interest for the purposes of Chapter 2 of Part 3 (see section 49D above)'.

No. 318, in page 127, line 13 [Vol II], at end insert—

‘(iii) an immediate self-settled interest within the meaning given by section 49D of that Act, or'.

Photo of Theresa Villiers

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

One of the more troubling aspects of schedule 20 is that the new inheritance tax charges will apply even when a person sets up a life interest trust for his or her own benefit.

Photo of Iain Wright

Iain Wright (PPS (Ms Rosie Winterton, Minister of State), Department of Health; Hartlepool, Labour)

On a point of order, Sir John. My understanding is that notes are not meant to be passed between Members of Parliament and people sitting in the Public Gallery, but that is going on at the moment. May I seek your guidance on that?

Photo of John Butterfill

John Butterfill (Bournemouth West, Conservative)

Yes, you may. What is going on at the moment is improper, in that a Committee member is conferring openly with someone in the Public Gallery. That is not permitted. It is not permitted for people in  the Public Gallery to try to make contact with Members during the currency of the Committee. Committee members are permitted to leave the Committee and talk to people who may be advising them; that has always been permitted. However, at the moment, someone in the Public Gallery is standing talking to a Committee member. That is not permitted. If anything of that nature occurs during the progress of this Committee, I shall order the Public Gallery to be cleared.

Would the hon. Member please return to his seat, and would people in the Public Gallery desist from making open contact with Committee members? It is permitted for notes to be conveyed to Committee members, but they must leave the Committee in order for that to be done.

Photo of David Gauke

David Gauke (South West Hertfordshire, Conservative)

Sir John, may I just apologise and note your comments?

Photo of Theresa Villiers

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

May I also join my hon. Friend the Member for South-West Hertfordshire (Mr. Gauke) in offering my profound apologies? I was in receipt of notes that I had requested, and I can only put that down to the fact that I was unaware of the rules on this matter. I am grateful to the hon. Member for Hartlepool (Mr. Wright) for making the point of order and to you, Sir John, for pointing out the error that I have made.

To return to the subject of the amendments, self-settled trusts attract the new charges because, for obvious reasons, they are set up during the lifetime of the settlor. Schedule 20, as drafted, applies the 20 per cent. entry charge and the 6 per cent. periodic charge to all such lifetime trusts. As we have discussed in the debate on the disability amendments, Government amendment No. 388 allows for self-settlement in certain limited circumstances, but few people will be able to rely on that provision. Only those who can demonstrate that they are within the narrow definition of “disabled” contained in section 89, or have a condition that will lead to their falling into that category in future, will be able to do so. The amendments in this group would allow anyone to self-settle without attracting the schedule 20 charges. Self-settled trusts would thus stay out of the new regime and remain governed by the old regime.

Amendment No. 301 introduces a new section 49D, setting out the concept of “an immediate self-settled interest” as a further form of trust exempted from the proposed new IHT charges. Like immediate post-death interests, the trust property in an immediate self-settled trust would be deemed to be part of the estate of the settlor/beneficiary and IHT would be paid on the death of the beneficiary, as it is with life-interest trusts at present.

It seems odd, to say the least, to apply IHT—a tax based on instances where property passes from one person to another—to the situation where no genuine transfer of ownership is taking place at all.

Photo of Rob Marris

Rob Marris (Wolverhampton South West, Labour)

Can the hon. Lady explain a little bit more? If there is no genuine change of ownership, to use her words, why would someone set up such a trust?

Photo of Theresa Villiers

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

I shall come to that to explain people’s motivation in such situations.

On the face of it, hon. Members might wonder why people would want to set up those trusts, but many vulnerable individuals find the option of self-settlement helpful. The Chartered Institute of Taxation says:

“There are many categories of person who, for their own protection (and not for any tax reason), wish to settle assets on themselves, giving themselves an immediate interest in possession. This may be desirable for example for people suffering from mental or emotional instability (falling short of mental incapacity) and also for persons facing advancing age and early signs of degenerative illness.”

It seems unfair to impose punitive extra charges on vulnerable people who are doing their best to manage their condition and provide responsibly for their future.

People who struggle with addiction often use such trusts to stop themselves dissipating their assets when they face times when they are unable to control their addiction. The hon. Member for Ludlow (Mr. Dunne) was justified in labelling schedule 20 as a possible charter for drug dealers.

Those with degenerative diseases, such as multiple sclerosis, HIV and Parkinson’s, may also wish to place their assets in a trust for themselves to provide for instances where their capacity to manage their own property in the future may be diminished. As I said, this problem seems to be mitigated by the Government’s amendments, but, as has also been discussed in relation to the debate on section 89 trusts, those with fluctuating conditions, such as manic depression or schizophrenia, may also wish to self-settle to provide for periods when their capacity is impaired.

The Paymaster General asserted that such cases could be covered, because the trust could be set up during a period of impaired capacity. That is helpful when a third party sets up a trust for a person with a disability or impaired capacity, but we are discussing situations in which people decide to set up the trust themselves. They will only qualify for the carve-out when their capacity is impaired, but if their capacity is impaired they will not be able to set up the trust.

Photo of Rob Marris

Rob Marris (Wolverhampton South West, Labour)

What is to stop someone saying, “I get a bit depressed from time to time, so I shall declare myself vulnerable and set up this kind of trust, and avoid some tax”?

Photo of Theresa Villiers

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

Setting up the trust will not avoid any tax at all. All that such people are trying to do is to protect their assets when their condition affects their ability to manage their property effectively. Irrational and exuberant spending that is completely unrelated to the individual’s budget is a recognised symptom of, for example, manic depression—that has been medically proven as a symptom of depression in many cases, and a self-settled trust is an important way of dealing with such problems. The hon. Gentleman may recall my quotation from the charity Rethink, which emphasised the serious debt problems in which the mentally ill can find themselves as a result of their condition. Such problems would be significantly mitigated by the ability to self-settle.

Others who might wish to self-settle include those who have unexpectedly inherited a large sum of money  and are concerned that they may not be able to manage it properly or that they could fall prey to pressure from friends and relatives to give it away. Such people should be able to retain the option of self-settlement without incurring a tax penalty.

A solicitor who responded to the Law Society survey on schedule 20 recounted a cautionary tale concerning an 18-year-old who inherited a large sum of money from her father. The father died intestate and the funds passed to her absolutely. A year later she had managed to get through £750,000 of the inheritance with virtually nothing to show for it at the end. The lawyer was concerned that it had all gone on “loans” to people who claimed acquaintance with the beneficiary and her family. In the light of such cases the Government should be encouraging self-settlement, rather than penalising it.

Self-settlement is also highly important for US citizens who work in the United Kingdom. US citizens tend to be advised to settle their assets on the basis of what is called a living revocable trust. Again, that has nothing to do with tax—it is to avoid extremely complicated probate procedures. On the death of the settlor, such trusts typically confer a life interest onthe surviving spouse, with gifts into certain trusts for the benefit of children. The difficulty caused by schedule 20 relates to the timing of inheritance tax liability, because as drafted the schedule gives rise to problems both for Americans who had a living revocable trust in place before Budget day, and for those who might wish to set one up in the future.

For those who already have trusts the problem is twofold. The life interest granted to a spouse under such a trust would invariably be too flexible to comply with condition 4 of section 49A. Under schedule 20 as drafted, that would be enough to take it outside the definition of an immediate post-death interest. The spouse exemption would be lost and the new, 20 per cent. entry charge and 6 per cent. periodic charge would be triggered. The problem would be resolved by the amendments that I and the Paymaster General have tabled to section 49A to delete that condition.

However, there is a further problem that the amendments will not solve. On the death of a first spouse, the second spouse gets her life interest to the assets by an appointment under the trust, not under the husband’s will. Although the spouse is setting up a life interest for his spouse that takes effect upon his death, that cannot be an immediate post-death interest because it does not arise under the will, nor is it a transitional serial interest, so the new charges would apply.

The point is also relevant to amendment No. 229, which will be addressed later. However, that amendment would solve the problem only for trusts already in operation. Those US citizens who did not have living revocable trusts set up before Budget day face a further difficulty. They are settling assets on themselves and thus the act of setting up the trust will trigger the new charges, because it is a lifetime trust.

Therefore, we have another example of where the spouse exemption is undermined because the inheritance  tax charge is brought forward to the point at which the trust is set up. Rather than applying on the death of the second spouse, it will apply on the death of the first spouse or when the trust is set up, depending on whether it post-dated or predated Budget day.

The loss of the exemption could cause all the harsh results that we will no doubt examine in relation to the amendments on the definition of “immediate post-death interest”. Another particular problem is caused in this context. Under the pre-Budget rules, US estate tax and UK IHT arose at the same time. No tax was payable on the death of the first spouse but both bit on the death of the second. Under the double-taxation treaty between the UK and the US, tax paid in one jurisdiction could be credited against the tax liability in the other.

As I have explained, schedule 20 operates to bring forward the liability to UK IHT, either to the date when the trust was set up or on the death of the first spouse. At that point there is, as yet, no liability to pay US estate tax, because that does not arise until the death of the second spouse. Therefore there is no US tax liability against which to credit the UK IHT paid, and the effect of the schedule is to leave US citizens working in the UK with a double tax charge—to both IHT and estate tax.

9:30 am
Photo of Rob Marris

Rob Marris (Wolverhampton South West, Labour)

Surely the cases that the hon. Lady is outlining involve US citizens who are habitually resident in the UK. In those circumstances, could they not rewrite the will within two years of death, just as any habitually resident UK person could do? That would get around this.

Photo of Theresa Villiers

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

That would not be effective in getting around things, because these trusts are set up before the death takes place. If they are contained in a will, they go into probate. That is the problem. It is not a tax issue for Americans; the probate issues are the problem. They have to take the assets out of their estate before they die. I understand that in many circumstances US citizens remain subject to tax in the United States despite the fact that they are working in the UK.

The rules provide a further problem for UK-based Americans, if they are married to non-US citizens. Where an American is married to a non-American spouse, US tax law provides that the spouse exemption will not apply to bequests under a will that passes property outright to a spouse. For the spouse exemption to apply, the property that is to go to the spouse must be placed into what is known as a qualifying domestic trust—or QDOT—the purpose of which is to keep the assets within the US tax regime and prevent their going offshore.

The original draft of Schedule 20 gave rise to a problem, since the type of life interest set up under a QDOT would be sufficiently flexible to fall foul of condition 4. While that problem would be resolved by the amendments tabled by myself and the Paymaster General, the bar on self-settlements causes a problem and has yet to be addressed.

If a QDOT is not set up in a will, US law permits the surviving spouse to transfer the assets received on the death of the US spouse into a QDOT. That takes effect  as a result of self-settlement, because the assets are passed to the spouse and she therefore sets up the QDOT over them to bring them into the tax law regime.

If the surviving spouse is faced with an inheritance tax charge at that point, because she has self-settled, there is again a disjunction between the US tax liability, which arises on her death, and the UK IHT liability, which arises immediately on entry to the QDOT. Hence, the spouse in that case could be left facing a double taxation bill.

I appeal to the Government on this issue for the sake of many vulnerable people who simply wish to act responsibly to protect themselves from their own weakness. I urge the Committee to accept the amendments that have been tabled in my name and those of my hon. Friends.

Photo of Dawn Primarolo

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

In speaking to the amendments, the hon. Member for Chipping Barnet made a special case for the provision for self-settlement trusts. It is worth reminding the Committee of the context of such matters. Clause 157 and schedule 20 are being introduced to counter IHT avoidance. Trusts set up during a person’s life have been used for such avoidance, so the Government are restricting the situations in which they can be set up and receive tax-favoured treatment. I am not saying that the trusts cannot be set up in the circumstances described by the hon. Lady; that is a matter for the individual. The question is whether they should receive special tax treatment, but she has not made a case for that. My constituents would be interested in the concept that rich drug addicts require special treatment and tax relief. As tragic as that is, I do not undermine its importance because I know from experience in my constituency how drug addiction can destroy individuals’ families and communities and none of them has had access to tax relief.

Photo of Theresa Villiers

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

The Paymaster General persists in saying that schedule 20 charges bring the treatment of certain trusts into line with the mainstream treatment of trusts. That is not the case. It has been a long-standing provision of tax law that the law should look through the trust and treat the transfer in the same way as the transfer outright. Hence, life interest trusts of the sort that we are discussing today have always been treated in the same way as outright transfers of assets. Therefore, the inheritance tax bites on death. I am not asking for special treatment for those who wish to self-settle, but for them to remain within the mainstream rules and not be subjected to harsh new punitive measures designed for discretionary trusts, which are quite different.

Photo of Dawn Primarolo

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

I beg to differ from the hon. Lady. I have made my point clear about the discretionary trust rules. She is entitled to repeat her argument and I am entitled to repeat the Government’s position regardless of her views and the views of members of the legal profession who advise clients. I repeat that a case has not been made for special treatment.

As the hon. Lady identified, in the past self-settlements have been used for various reasons. She referred to wealthy drug addicts who put money away to prevent it from being used to fuel their addiction. They are not prevented from taking such action—

Mrs. Villiersrose—

Photo of Dawn Primarolo

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

No. I shall finish my point and then the hon. Lady can reply. However, the trusts are used in other ways such as to prevent creditors from having access to individuals who become bankrupt or to prevent taxation burdens in other countries from applying and setting up trusts to shelter on that basis. If people decide that that is what they will do, the central question is whether they should be entitled to special tax relief. The Government’s view is that they should not.

The hon. Lady explained at length the difficulty of some United States citizens, although they would need to be particularly wealthy. She said that they might be exposed to both US and UK taxes. I understand her point. She talked about QDOTs, too, which take us into the highly complex area of what US legislation requires. However much we share those concerns, surely we cannot allow them to pull all of the UK regime out of shape. Our rules are designed primarily for UK citizens. The majority of people will not face US tax issues. Further, I say to the hon. Lady that I do not believe that it is impossible for a US citizen to find adequate solutions to the tax matters that she has been discussing.

Finally, I do not accept the central proposition that we should amend UK legislation for that area, despite my sympathy for the complexities that those individuals face. It is not the only area of the tax system in which the interaction between what the US requires of their citizens, wherever they are in the world, and whatever the tax regime is, whether it be the UK or any other European one, throws up huge complexities. However that is not a matter for this schedule. If people want to use trusts for other purposes, they can still do so.

We remind the Committee that with regard to those arrangements about the actual sum going in, no IHT is due if the assets in the trust are less than the zero threshold, that is £285,000 rising to £325,000 in 2009. We are not talking about small amounts of money.

However, the Government agreed that the subject of the disabled was different and we have had debates on that. We had that debate during our discussion of Government amendment No. 388. I was clear on the question of particular examples such as degenerative diseases. Manic depression was another example that Opposition Members gave. The question was whether the individual “expected to”. The phrase relates to someone simply “expected” not to be able to make financial decisions in the future on wealth. That is covered in Amendment No. 388 and we have discussed that extensively.

In summary, I regret to tell the hon. Lady again that I cannot accept her amendments. Lifetime settlements can be used for avoidance. I see no reason at all why self-settlements should receive tax-favoured treatment. The non-tax favoured trusts are quite suitable and we have explained why that is so under special circumstances and that is entirely appropriate. If the hon. Lady does want to press her amendments to a Division, I will ask my hon. Friends to oppose them.

Photo of Theresa Villiers

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

As I said in my intervention, the Opposition are not asking for special favourable treatment for those trusts, merely a retention of the orthodox and long-established tax relief that has served this country for many years.

I repeat that people’s motivation for setting up trusts is to enable them to protect their property from themselves and not from their creditors. The Insolvency Act prevents such attempts from being successful anyway. Therefore, I cannot see that that would be a motivation in setting up self-settled trusts. The Paymaster General asserts that such trusts have been used for avoidance but has produced no evidence as to how they could possibly be used for avoidance.

The Paymaster General rightly says that we should not draft our tax system based solely on the needs of US citizens. However, it is an important matter for our competitiveness to ensure that our tax system does not unnecessarily penalise US citizens, many of whom are important to maintaining the competitiveness of this country by bringing inward investment into the country. The Paymaster General said that it was unreasonable to ask for the law to be amended to deal with problems faced by US citizens. I am not calling for the law to be amended at all; it should stay as it is. All I ask is that the Government do not bring in legislation that puts those practical difficulties in the way of not only Americans, but a number of the most vulnerable people in our society.

The Paymaster General also referred repeatedly to the fact that the nil rate band is £285,000 and that the provisions would only ever affect the very wealthiest. However, she fails to take account of or point out the fact that once the nil rate band is used, it is gone for ever. If a trust has been set up and the nil rate band has been used up, there will be none left on the death of the individual; inheritance tax at 40 per cent. will be paid on the whole of their estate.

Regardless of the opinions of Labour Members about house prices and the impact of inheritance tax, there are many people in this country whose overall estate is more than £285,000. I should like to press my amendment to a Division.

Question put, That the amendment be made:—

The Committee divided: Ayes 8, Noes 19.

Question accordingly negatived.

9:45 am
Photo of Theresa Villiers

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

I beg to move amendment No. 319, in page 114, line 34 [Vol II], after ‘interest', insert ‘, or

(d) a relationship breakdown settlement interest.'.

Photo of John Butterfill

John Butterfill (Bournemouth West, Conservative)

With this it will be convenient to discuss the following amendments:

No. 320, in page 116, line 37 [Vol II], at end insert—

‘49D Relationship breakdown settlement interest

(1) Where a person (“L”) is beneficially entitled to an interest in possession in settled property, for the purposes of this Chapter that interest is a “relationship breakdown settlement interest” only if the following conditions are satisfied.

(2) Condition 1 is that the settlement was effected, or if there was a prior settlement it was confirmed or varied by a court order in proceedings for the following types of provision—

(a) financial relief for the parties to a marriage and any children of the family in connection with proceedings for divorce, nullity of marriage or judicial separation including, but not limited to, property adjustment orders or variation of settlement orders under section 24 of the Matrimonial Causes Act 1973; or

(b) financial relief for the parties of a civil partnership in connection with proceedings for dissolution of the civil partnership including, but not limited to, property adjustment orders or variation of settlement orders under Schedule 5 of the Civil Partnership Act 2004; or

(c) where a marriage has been dissolved or annulled or the parties to a marriage have been legally separated, by means of judicial or other proceedings in an overseas country and the divorce, annulment or legal separation is entitled to be recognised as valid in England and Wales, financial relief for the parties to the marriage and any children of the family including, but not limited to, property adjustment orders or variation of settlement orders under section 17 of the Matrimonial and Family Proceedings Act 1984; or

(d) financial relief for the benefit of a child including, but not limited to, a transfer or settlement of property under paragraph 1 of Schedule 1 of the ChildrenAct 1989.

(3) Condition 2 is that L became beneficially entitled to the interest in possession on the court order coming into effect.

(4) Condition 3 is that—

(a) section 71A below does not apply to the property in which the interest subsists, and

(b) the interest is not a disabled person's interest.'.

No. 321, in page 119, line 26 [Vol II], at end insert

‘, and

(iv) not a relationship breakdown settlement interest.”.'.

No. 322, in page 119, line 35 [Vol II], at end insert

‘, or

(c) a relationship breakdown settlement interest.”.'.

No. 323, in page 120, line 25 [Vol II], at end insert

‘, or

(d) a relationship breakdown settlement interest.”.'.

No. 324, in page 120, line 34 [Vol II], at end insert

‘, or

(d) a relationship breakdown settlement interest.”.'.

No. 325, in page 121, line 19 [Vol II], at end insert

‘, or

(c) a relationship breakdown settlement interest.”.'.

No. 326, in page 122, line 5 [Vol II], at end insert

‘, or

(c) a relationship breakdown settlement interest.”.'.

No. 327, in page 122, line 23 [Vol II], at end insert

‘, or

(d) a relationship breakdown settlement interest.”.'.

No. 328, in page 123, line 6 [Vol II], at end insert

‘, and

(iv) not a relationship breakdown settlement interest.'.

No. 329, in page 123, line 32 [Vol II], after first ‘interest', insert

‘, a relationship breakdown settlement interest'.

No. 330, in page 125, line 11 [Vol II], after ‘interest', insert ‘, or

(iii) a relationship breakdown settlement interest.'.

No. 331, in page 125, line 17 [Vol II], after second ‘interest', insert

‘or relationship breakdown settlement interest'.

No. 332, in page 125, line 20 [Vol II], after ‘interest', insert

‘or relationship breakdown settlement interest'.

No. 333, in page 125, line 27 [Vol II], leave out ‘neither' and insert ‘not'.

No. 334, in page 125, line 27 [Vol II], leave out ‘nor' and insert ‘or'.

No. 335, in page 125, line 28 [Vol II], after ‘interest', insert

‘or a relationship breakdown settlement interest.'.

No. 336, in page 125, line 40 [Vol II], at end insert

‘, or

(d) a relationship breakdown settlement interest.” '.

No. 337, in page 126, line 33 [Vol II], at end insert—

‘ “relationship breakdown settlement interest” means a relationship breakdown settlement interest for the purposes of Chapter 2 of Part 3 (see section 49D above);” '.

No. 338, in page 127, line 13 [Vol II], at end insert—

‘(iii) a relationship breakdown settlement interest within the meaning given by section 49D of that Act, or'.

No. 339, in page 128, line 9 [Vol II], after ‘interest', insert ‘or,

(iii) a relationship breakdown settlement interest.'.

Photo of Theresa Villiers

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

With the changes proposed inschedule 20, there is a danger that an inheritance tax bill could be added to all the other deep pain and suffering caused by divorce and relationship breakdown. Trusts set up on a relationship breakdown cannot fall within the new charges’ immediate post-death interest exemption because they are set up inter vivos—during the lifetime of the settlor, when both partners are still alive.

It seems that section 10 of the Inheritance TaxAct 1984 will prevent the imposition of the 20 per cent. entry charge to a trust set up on divorce, although I would be grateful if the Paymaster General confirmed that understanding. However, section 10 does not appear to save such a trust from the periodic 6 per cent. charge or the proportionate exit charge when the trust comes to an end.

Amendments Nos. 319 to 337 seek to prevent the imposition of any new IHT charges in that context by providing that trusts set up as a result of a relationship breakdown will be covered by the old regime. Amendment No. 320 would add a new section 49D containing a further category of life interest trust in  addition to the immediate post-death interest, which would continue to be treated as part of the estate of the life tenant, taxed accordingly and dealt with by existing rules for life interest trusts. That would place such trusts outside the scope of the new charges proposed in schedule 20.

Trusts are an important and useful tool in dealing with the sad consequences of relationship breakdown. They can be set up by the courts under section 24(1)(b) of the Matrimonial Causes Act 1973 or schedule 1 of the Children Act 1989. Trusts have been used in the divorce courts for many years, and will no doubt be of assistance when the courts adjudicate on the breakdown of civil partnerships as well. They are particularly important for those of middle incomes and modest means who have children to maintain but insufficient assets to allow for a clean-break settlement.

Christopher McCall, the Queen’s counsel to whom I referred in Committee of the whole House, is a man with a long and distinguished record of assisting the Revenue in preventing and clamping down on artificial and aggressive avoidance schemes. He is quite clear about trusts’ usefulness in the family context:

“The profession is clear that [trust] arrangements are very far from being strangers to the family courts. Such arrangements are not so much the province of the very wealthy (who, having adequate assets for the purpose, may be expected to prefer the form of capital provision which maximises the advantages of the clean break approach) but those who, though they have enough money to worry about matrimonial rules for financial provision, lack the means to do so on the basis of pure outright provision. Such individuals are of course those in the poorest position to meet extra burdens of costs, let alone taxation arising out of the tragedy of matrimonial breakdown.”

The most common trust used in the divorce courts is the Mesher order, which gives the spouse with primary responsibility for the children the right to live in the former matrimonial home or a new home bought under the divorce proceedings until any one of three triggering events occurs: she remarries, she dies or the children finish their education. I am told that the Revenue has indicated that such situations could be covered by granting a charge over the property in favour of the non-resident spouse that can be enforced in the event of one of the three triggering events.

Tim Galloway, a trusts expert from the leading firm of solicitors Charles Russell, wrote to me:

“Legal charges are not suitable to deal in all circumstances with provision for minor children on relationship breakdown, particularly in cases involving unmarried couples. In those circumstances, trusts provide a vital and flexible means of balancing the conflicting needs and wishes of those involved.”

The charge route can lead to a greater capital gains tax charge, leaving fewer resources for a family already facing the financial penalties of divorce. The family courts might also make arrangements that, although not expressly labelled as such, involve a trust and would therefore fall foul of the new rules.

Some lawyers certainly believe that any arrangement giving a spouse occupation rights terminating on a particular event will be viewed as a trust and taxed accordingly, whatever label the court chooses to place on that arrangement. Even if the court calls it a charge, it might well be considered a trust by the Revenue and taxed accordingly.

Photo of Rob Marris

Rob Marris (Wolverhampton South West, Labour)

How does the charge lead to capital gains tax?

Photo of Theresa Villiers

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

I am not sure on the detail of that; I am happy to come back to the hon. Gentleman on that point, but I am advised that the charge can lead to capital gains tax problems.

As well as Mesher orders, there are two other ways in which the new inheritance tax regime could hit divorcing couples. First, existing family settlements may need to be varied so that property can be divided between the spouses—for example, in order to appoint one of the spouses to a life interest in the fund. It seems that the new inheritance tax charges would apply in that case. Indeed, such arrangements would attract a more significant penalty, because section 10 of the Inheritance Tax Act 1984 will not protect such a variation from the 20 per cent. entry charges, so the trust would bear that charge as well as the periodic one.

The problem might be mitigated by amendmentNo. 229, which would allow someone to appoint a spouse to a life interest within the transitional serial interest regime. Secondly, trusts can be used to help resolve disputes between divorcing spouses and civil partners before they get to a courtroom. One spouse may be more willing to reach an agreement that involves transferring assets if the other spouse does not have unrestricted control over them. I know that the Paymaster General is particularly concerned about arrangements that pass assets but retain a degree of control, but such a facility can help couples to reach an agreement, particularly in cases where one spouse has met another partner. For instance, someone may be prepared to agree a transfer of significant assets to their ex-spouse if a trust is set up to ensure that those assets eventually pass to the children of the marriage.

In conclusion, divorce and relationship breakdown already cause enough misery. I appeal to the Paymaster General and the Government to make absolutely sure that they do not inflict an IHT bill on those going through that difficult and distressing process.

Photo of Dawn Primarolo

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

There has been a great deal of declaring of interests this morning. I am not sure whether I have to declare one, as I am divorced. I absolutely concur with the hon. Lady that divorce is a difficult and emotional period, and at no point was it suggested to me that I use a trust. In fact, it was a clean break, which I have to recommend. A clean break is the way to proceed. That goes to the heart of the matter.

In one of the hon. Lady’s arguments, she pleaded legal advice. I am not a lawyer, but the legal advice given to me was of the contrary view, although I do not think that it particularly advances net understanding of the issues around divorce. Every Committee member will either know someone who has experienced divorce or, if they are unlucky, have experienced it themselves.

The point is clear: the hon. Lady says that trusts are a vital tool, essential in the handling of divorce settlements. I do not deny that some people might say that it is useful, but it is not essential, and that is the point—whether it is essential. There are clear reasons, normally advocated by Opposition Members, for sticking to the principle enshrined in the schedule. That principle is to recognise the exceptions, and to recognise that trusts are useful—people use them for a variety of reasons—but not essential, and so should not be in an exceptional regime.  I shall tell the hon. Lady the legal advice that I heard from family lawyers with extensive experience of handling divorce and related issues. Also, we need only consider the cases that occasionally hit the headlines, where the question is how much that clean break should cost. The lawyers tell me that trusts are seldom used in modern divorce settlements and are not part of standard practice.

I do not deny that a trust might be used on divorce, but it would be likely to be chosen to deliver the outcome sought and to provide the additional benefit of saving some inheritance tax. I understand that. However, the hon. Lady’s central argument is that it is essential and unavoidable. It is not essential. That choice is rarely made, but when it is made, it is for the precise reasons that I have continued to advance in respect of some uses of the exemptions that are rather wider than the legislation intends. I do not accept her argument and I will ask my hon. Friends to oppose the amendment, should she choose to press it to a vote.

10:00 am
Photo of Rob Marris

Rob Marris (Wolverhampton South West, Labour)

I think that I understand the arguments advanced by the hon. Member for Chipping Barnet, but there seems to be a slight contradiction in Conservative party policy. Party policies change over the years, of course. However, the proposal appears to be aimed at helping the rich. I know that the hon. Lady said it was for middle-income families, and so on. I am not talking about the super-rich, but about what I shall call the well-to-do.

The previous Government, led by the party that the hon. Lady now supports and may have supported then, abolished tax relief on maintenance payments for children, which did not just affect the very rich or well-to-do, but almost anyone with taxable income. That measure went way down the income scale. That tax assistance for families who were sadly getting divorced was withdrawn by her party when it was in government. It seems that she is advancing proposals today that might at least suit the well-off. I suspect that only the pretty rich would have such spare assets around. That is what the Conservatives want to stand for—the rich. When there was a tax relief that affected almost everybody, they withdrew it.

I bow to the hon. Lady’s legal knowledge on this matter, about which she has been briefed, although she did not know the answer to my previous question. However, I should like to know whether a Mesher order is legally for tax purposes a trust. It is many years since I practised family law, but I understand that Mesher orders are going out of style.

Photo of Theresa Villiers

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

The answer to the hon. Gentleman’s first question is yes. When there is a Mesher order, it is legally for tax purposes a trust. The point that I was making is that any similar arrangement where there isa right to occupy the property that terminates when a certain event happens is, arguably for tax purposes, a trust as well.

The hon. Gentleman criticised a previous Conservative Administration for their approach on child maintenance. It lies ill in the mouth of someone on the Labour Benches talk about this issue, given the disaster at the Child Support Agency.

Photo of Dawn Primarolo

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

Who created it?

Photo of Theresa Villiers

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

The Government have had nine years to get the CSA sorted out. I recall that they voted—[Interruption.]

Photo of John Butterfill

John Butterfill (Bournemouth West, Conservative)

Order. There is too much noise. It is quite difficult for me to hear what the hon. Lady is saying and it is even more difficult for the Hansard writer.

Photo of Theresa Villiers

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

The Government have had nine years to sort out the CSA, which I recall that they voted for in the first place.

Turning to the Paymaster General’s comments, I agree that a clean break is the most desirable outcome. I am not divorced; I soon shall be. I shall have a clean-break settlement. People who have the assets available to make outright provision for a clean break will do so as a matter of preference for all sorts or reasons—emotional and financial—but for many people, that is not possible.

The Paymaster General says that such a trust is useful but not essential. I contest that, because of the possibility that I mentioned that the replacement arrangements that perform a similar function might be construed as trusts by the Revenue anyway. If that legal understanding is right, the tool in question is indeed an essential one. Even if that understanding is incorrect, it is still unnecessary, unwise and undesirable to impose new penal tax charges on a useful tool that assists people in dealing with the misery, unhappiness and financial difficulties that are caused by divorce.

I close by repeating that we do not seek special tax treatment in this case; we are merely trying to retain such trusts in the tax regime as it has operated for many years, for the sake of helping civil partners and spouses who are dealing with a relationship breakdown. I want to press the amendment to a vote.

Question put, That the amendment be made:—

The Committee divided: Ayes 6, Noes 18.

Question accordingly negatived.

Photo of Theresa Villiers

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

I beg to move amendment No. 226, page 115, line 12 [Vol II], leave out from beginning to end of line 25.

Photo of John Butterfill

John Butterfill (Bournemouth West, Conservative)

With this it will be convenient to discuss the following: Government amendment No. 359

Amendment No. 227, page 115, line 26 [Vol II], leave out ‘5' and insert ‘3'.

No. 228, page 115, line 30 [Vol II], leave out from beginning to end of line 18 on page 116.

Government amendments Nos. 360, 36, 368 and 370.

Photo of Theresa Villiers

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

This group of amendments concerns paragraph 5 of schedule 20, which would insert a new section 49A into the Inheritance Tax Act 1984. The new section is of crucial importance in schedule 20’s proposed new system for the taxation of trusts, because it contains the definition of the immediate post-death interest to which reference has been made several times in the debates on the schedule. Schedule 20 provides henceforth that any life interest trust that falls outside the definition of an immediate post-death interest will be brought within the punitive tax regime that operates for discretionary trusts—namely a 20 per cent. charge on capital when the trust is set up, with a further 6 per cent. periodic charge every 10 years.

As I set out at some length in debate in the Committee of the whole House, the restrictive definition set out in the new section 49A—and in particular conditions 3 and 4—will mean that virtually every single will across this nation that left property to a spouse for life would fall outside the IPDI definition and would therefore be subject to the new charges.

The Paymaster General dismissed my concerns about conditions 3 and 4 outright. What is more, as I set out in my introductory remarks, she dismissed them in very robust terms. She said that there was nothing in the Bill that affected the spouse exemption under normal inheritance tax rules. On the amendments to protect the spouse exemption she said:

“All the new clauses and amendments before us are unnecessary, because what is asserted will happen will not, in fact.”

She said of the life interest trust for spouses:

“No further flexible power is necessary in the trust, because it has delivered its objective.” —[Official Report, 2 May 2006; Vol. 445, c. 870-1.]

She said, of my remarks:

“The hon. Lady does not know what she is talking about.”—[Official Report, 2 May 2006; Vol. 445, c. 868.]

I was therefore somewhat surprised to see the Paymaster General table amendment No. 359 last Thursday because its effect is identical to that of my amendment No. 226.

Photo of Dawn Primarolo

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

May I put it on record that I apologise to the hon. Lady? I think that I should have phrased my remarks better. That is a point to her.

Photo of Theresa Villiers

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

I very much appreciate the Paymaster General’s gracious comment. Indeed, I would very much welcome her name on my amendment. I welcome her change of heart for the sake of millions of ordinary people who, were it not for the amendment, would face the hassle of rewriting their will and huge anxiety about  the new tax charges that could have forced their bereaved spouse to sell their home to pay for this latest hit on hard-working and prudent families in middle England.

The amendments that the Paymaster General and I have proposed are important because they will preserve the long-standing principle that inheritance tax should not be paid on property that passes between husbands and wives. That principle has been a fundamental part of the way that the IHT regime has operated since 1894 and reflects the recognition of the harshness of forcing a bereaved spouse to sell the family home to meet an inheritance tax bill.

The importance of the spouse exemption has recently been recognised in its extension to the gay community with the introduction of civil partnerships by section 103 of the Finance Act 2005. Contrary to the Paymaster General’s assertions, the existing law does not grant privileged tax treatment to life interest trusts. Under pre-Budget rules, in line with another long-standing principle of tax law, they are taxed in the same way as outright gifts.

If a will sets up a life interest for a spouse, it is treated as part of the estate of that spouse. It therefore receives the protection of the spouse exemption and the property is subjected to IHT on the second death, not the first. Far from, as the Paymaster General initially claimed, aligning the treatment of life interest trusts with the normal tax regime for trusts, schedule 20, as drafted, would bring them within the so-called “relevant property regime” and subject them to the punitive tax regime used for discretionary trusts.

For many years, there has been a special regime for discretionary trusts because, under such trusts, there was no triggering death to which to pin the IHT charge as the property could not be identified with any one particular beneficiary. No such problem arises in the case of interest in possession trusts. The impact of schedule 20 would therefore have been to impose a harsher tax regime than would have applied had the property been transferred to the spouse outright. That goes against the long-standing principle, recently reaffirmed by the Treasury in its consultation on the modernisation of trusts, in which one of the Government’s stated goal was:

“A tax system for trusts that does not provide artificial incentives to set up a trust but equally, avoids artificial obstacles to using trusts where they would bring significant non-tax benefits.”

Trusts are typically used, for example, in the instance that we are talking about here, when a second marriage has taken place. A standard will that is made by thousands, if not millions, of people in this country provides that the assets are left on trust for the widow—the second wife—during her lifetime. On her death or remarriage, the assets pass to the children of the husband’s first marriage. Unless the amendments are adopted, the spouse exemption will be lost in this case, and tensions between step-parent and stepchildren could make it impossible to agree a variation of the will to try to retrieve the spouse exemption.

During the debate in the Committee of the whole House, the Paymaster General asserted that the spouse  exemption would not be affected by schedule 20. I am pleased that she has changed her approach. Presumably her initial statement was based on a belief that such an arrangement could be made to comply with the six conditions included in the definition of immediate post-death interest that are set out in new section 49A.

Turning to the problematic conditions 3 and 4, it is essential that the Committee adopt either my amendment or that put forward by the Paymaster General to delete them. Those conditions would prevent any but the most inflexible trust from qualifying as an immediate post-death interest, and some professionals believe that it would be virtually impossible for any trust to satisfy those conditions. Condition 3 provides that the life tenant must have the power to veto any proposal by the trustees to terminate her life interest. I shall explore that later. It poses particular problems for the Muslim community, which we shall consider in relation to amendment No. 359.

Condition 4, however, causes even greater difficulties, not just for minority communities but for society as a whole. It provides that a trust will count as an immediate post-death interest only if one of four events occurs when the life interest comes to an end: the property must pass to a charity, a trust for a bereaved minor, a trust for a disabled person or—this is the key problem—a person who will become absolutely entitled to the property in which the interest subsists. The problem with that definition is the absolutist way in which it is phrased.

The legislation is drafted in such a way as to impose a charge not when an offending event actually happens but when it is a mere possibility. So if there is any possibility that the property might not vest in somebody absolutely when the life interest comes to an end, the new charges apply. A number of professionals have expressed doubt as to whether condition 4 can ever be satisfied. The Institute of Chartered Accountants gives the following example to illustrate the problem: W leaves his property on trust for his second wife with the remainder of his estate going to his adult children. At first sight, that looks to be within condition 4, but can we say that the children will definitely become entitled to the remainder estate? What happens if they die before their stepmother? It is difficult to say that they will become absolutely entitled.

An even more serious concern arises in relation to section 32 of the Trustee Act 1925. I acknowledge that the hon. Member for Wolverhampton, South-West caught me out on capital gains tax, but I think that I was able to give him pause for thought when we discussed section 32 on Tuesday. The problem, as I adverted to then, is that, unless it is specifically excluded, section 32 inserts a term into all trusts giving the trustees the power to advance up to half the capital.

The case of Pilkington v IRC established as far back as 1964 that the statutory power gave trustees the right to transfer up to half that capital into a new trust. Section 32, therefore, authorises the application of trust property in ways that go beyond those permitted by condition 4, including postponing vesting of the interest in remainder beneficiaries. On the face of it, that would seem to be enough to cause condition 4 to be breached. As I said on Tuesday, that is of crucial  importance because section 32 applies to the statutory trusts that arise on intestacy.

Unless the section 32 point is dealt with, the new charges will bite on trusts set up on intestacy. There is explicit provision in schedule 20 to prevent section 32 powers from causing a problem in the context of a trust  for a bereaved minor in new section 71A(4), but there is no express provision to make the same saving in relation to IIP trusts.

Debate adjourned.—[Mr. Heppell.]

Adjourned accordingly at twenty minutes pastTen o’clock till this day at fifteen minutes to Two o’clock.