Clause 110 - Inheritance tax

Finance Bill – in a Public Bill Committee at 4:30 pm on 10 June 2014.

Alert me about debates like this

Question proposed, That the clause stand part of the Bill.

Photo of Gary Streeter Gary Streeter Conservative, South West Devon

With this it will be convenient to discuss schedule 21.

Photo of Shabana Mahmood Shabana Mahmood Shadow Minister (Treasury)

The clause does four things. First, the threshold for a zero rate of inheritance tax, which is frozen at £325,000, is extended until 2017-18. Secondly, it enables borrowed funds in a foreign currency bank account to be treated in a similar way to how excluded properties—property overseas where the person beneficially entitled to that property is non-UK domiciled—is treated. Filing and payments dates for inheritance tax trust charges will be aligned; as a result of the clause, trustees of property settlements must now file and pay the tax due six months after the end of the month when the chargeable event happened. The measure also introduces a new provision to treat income arising in relevant property trusts that remain undistributed for more than five years as part of the trust capital when calculating the 10-year anniversary charges. That aspect of the measure has raised the most comment, in particular from taxation specialists.

Changes made to the treatment of trusts in Finance Act 2006 brought in a new relevant property regime. Apart from a few exceptions, all settled property, including assets such as money, shares, houses or land, in most kinds of trusts will be relevant property. In addition to the inheritance tax payable when assets are transferred into them, trusts containing relevant property pay inheritance tax when assets are transferred out of the trust, which is the exit charge; the trust reaches a 10-year anniversary of when it was set up, which is the periodic charge; and the trust comes to an end.

HMRC has always taken the view that income retained for too long should not receive that special treatment, but it has been difficult to determine a legal basis for how long is too long. The clause attempts to do that by introducing a deemed rule: retained income will be deemed to be capital if it has been held for more than five years. It is important to note a number of things. First, time before 6 April 2014 will be counted, so any income already held could be subject to charge immediately—for example, if there were a 10-year anniversary on 7 April 2014. Secondly, the deeming rule will apply only for inheritance tax purposes; the income will still be income for all other tax purposes, in particular income tax. Thirdly, deeming rules will apply only for the purposes of 10-yearly charges and not exit charges, meaning that trustees distributing the income will need to consider only the income tax issue, and not potential inheritance tax issues at the same time. Fourthly, when a rule applies at a 10-yearly anniversary, the income will be deemed to have been capped for the whole of the previous 10 years.

As I said, both the Chartered Institute of Taxation and the Institute of Chartered Accountants in England and Wales have concerns about that aspect of the measures introduced by the clause. Both organisations agree that from their perspective, it seems to be change for the sake of change. Indeed, the CIOT goes further, saying that it feels that it has much more to do with raising revenue than with tax simplification, although I note that the tax information impact note states that the measure is expected to have negligible impact on the Exchequer.

Given those concerns about the changes to the 10-year anniversary charge, it would be helpful if the Minister, in his comments on the clause, could outline in detail what problem he is trying to solve. What did he have in mind when the clause was introduced? That might allay the concerns of the CIOT and the ICAEW. It would also be helpful if he could explain to the Committee whether he shares the ICAEW’s concerns that trustees might now be forced to decide about distributing trust income on the basis of an impending tax charge rather than the needs of the beneficiaries.

A little more broadly, there are also concerns that the measure is creating a further mismatch between trust law and tax law. It would be helpful to have the Minister’s comments on the present slight differences in treatment between trust law and tax law measures, and whether he has any intention of making those more uniform.

Photo of David Gauke David Gauke The Exchequer Secretary

Clause 110 and schedule 21 make reforms to inheritance tax. First, the clause freezes the inheritance tax threshold until 2017-18 to help pay for the capping of social care costs. Secondly, the clause aligns the filing dates for reporting the tax liability and payment dates for charges on relevant property trusts and clarifies how income arising in such trusts is treated for inheritance tax purposes if it is undistributed for more than five years. Finally, the clause prevents people from avoiding inheritance tax through the use of foreign currency UK bank accounts.

Clause 110 and schedule 21 help fund social care reforms. In February 2013, the Government announced a package of reforms to the funding of social care, providing financial support for 100,000 more people a  year. To help fund the changes, the Government announced at Budget 2013 that the inheritance tax threshold will be frozen until 2017-18.

Clause 110 and schedule 21 make changes to the inheritance provisions to give effect to the freeze, meaning that the threshold will remain at £325,000 for individuals and up to £650,000 for surviving spouses and civil partners. Freezing the inheritance tax threshold provides a simple and fair way to ensure that those with the largest estates, who are most likely to benefit from the reforms, help fund them.

Clause 110 and schedule 21 also introduce changes that will help to simplify how trusts calculate and pay tax. Inheritance tax payment and filing dates can appear confusing and inconsistent. The time limits for paying inheritance tax charges can range from six months after the month in which the transfer or anniversary occurred to almost a year after the chargeable event. Furthermore, in many trusts, the trustees have the power to accumulate or add undistributed income that arises in the trusts to the capital of the trust. In those circumstances, there is little doubt about the correct treatment for the calculation of inheritance tax charges, but it can be different where income remains undistributed for long periods and the trustees have not made any formal accumulation, or where the trust deeds do not stipulate when an accumulation must take place. In such cases, there can be uncertainty about how the calculation should be undertaken, resulting in questions to or correspondence with HMRC to establish acceptable treatment.

The changes made by clause 110 and schedule 21 align the filing and payment dates for inheritance tax charges and make the inheritance tax treatment of retained trust income clearer for trustees and practitioners. From 6 April this year, the date by which trustees of relevant property trusts must deliver an inheritance tax account and pay any tax due will be six months after a chargeable event such as a transfer out of the trust or the trust’s 10-year anniversary. The changes will also mean that any income arising in relevant property trusts that has remained undistributed for more than five years at the date of the trust’s 10-year anniversary will be treated as part of the trust’s capital for the purposes of the 10-year anniversary charge.

I will respond to questions from the hon. Member for Birmingham, Ladywood and set out in a little more detail what the measure is intended to do. As matters stand, it is advantageous for trustees to retain undistributed income in the income account for long periods rather than formally accumulate it as capital, because it will escape IHT on a 10-year anniversary and will also have the benefit of the tax credit for income tax purposes if distributed. Where income has been retained for many years and trustees maintain that they have not yet decided whether to accumulate or distribute income, HMRC challenges the analysis, but without recourse to litigation it is not clear what the true legal position is.

The new legislation does not affect the trustees’ powers to accumulate or distribute income but is simply a deeming rule for IHT purposes. The deeming rule provides certainty about the IHT treatment of retained income and avoids long-running disputes between the taxpayer and HMRC.

I was asked whether the measure will cause trustees to distribute income so as to minimise tax rather than meet the needs of beneficiaries. The purpose of the measure is to provide certainty and clarity for trustees. It remains for the trustee to make commercial decisions about what is best for the beneficiaries. On whether the measure will cause a further mismatch between tax law and trust law, it is worth pointing out that the measure applies only to IHT charges. It stops any avoidance of the 10-year charge. That is its purpose.

I turn now to the final aspect of the clause and schedule, which is the change to the way certain foreign currency accounts are treated for inheritance tax. New rules introduced in the Finance Act 2013 disallow a deduction for a liability for the value of an estate if it has been used to acquire or maintain excluded property, which is not chargeable to inheritance tax. The rules prevent a double deduction and stop avoidance schemes that exploited that tax advantage. HMRC became aware of a loophole that allowed non-residents and non-domiciled individuals to get round the new rules by using a bank account denominated in a foreign currency. Deposits in such accounts are disregarded for inheritance tax purposes, yet are not excluded property. They would therefore not be caught by the new rules and so could be used to gain the same tax advantage that the rules in the 2013 Act were designed to remove.

The changes made by the clause will treat funds in disregarded foreign currency UK bank accounts in a similar way to excluded property, meaning that a deduction for any liability will be disallowed where borrowed funds have been deposited in such accounts so that they are not chargeable to inheritance tax on death. The changes will affect only those individuals who are non-domiciled and non-resident when they die and who have deposited borrowed sums in UK bank accounts denominated in a foreign currency. The changes are expected to affect only about 75 estates a year, but will protect revenue by ensuring that the anti-avoidance rules introduced in the 2013 Act continue to apply.

The freeze in the inheritance tax threshold will help to fund important reforms, which will limit social care costs and benefit many older people. The clause also simplifies the payment and filing rules for relevant property trusts and will ensure that the anti-avoidance rules relating to the treatment of liabilities cannot be sidestepped. I hope that the clause and schedule will stand part of the Bill.

Question put and agreed to.

Clause 110 accordingly ordered to stand part of the Bill.

Schedule 21 agreed to.