Last year set the scene for 2013 in several ways. There were more newspaper headlines about tax in 2012 than I can ever remember seeing. This real focus on what you might call the citizenship aspects of how you approach your finances has brought with it a new level of scrutiny for many individuals and companies.
This theme of transparency also carries through to the Retail Distribution Review (RDR). The way financial advice is paid for was transformed on the last day of 2012. It has brought with it some finer points of inheritance tax detail which are relevant when you advise on the creation of new trusts or advise trustees on an ongoing basis. More on that later in the case study.
The chancellor’s Autumn Statement will have ripple effects to come in terms of how clients choose to save for later life. With the different ‘pots’ available, the role of the investment bond is once again in focus, given the future restrictions on the lifetime and annual allowances.
Residence and domicile are important for different reasons in 2013. First, the statutory residence test, which aims to create clear rules and greater certainty on tax residency, arrives on 6 April. Introduced at the same time will be new inheritance tax rules which affect those who are married to someone who is not UK-domiciled.
The exemption for non-dom spouses will be linked to the nil-rate band, currently £325,000. This is a significant increase from the £55,000 limit that has been in place since 1982. There will also be an option for a non-dom spouse to elect to be treat-ed as UK-domiciled. This will give them equal treatment to UK-domiciled married couples and an unlimited spousal exemption. Making the election, though, brings the non-dom spouse’s worldwide assets into the UK inheritance tax net.
Pension saving
The annual allowance for saving into a pension with tax relief was reduced from £255,000 to £50,000 from 6 April, 2011. For those advising high earners, this had already prompted broader discussions around how best to save for later life.
From 6 April, 2014, the figure falls again to £40,000 (although the effects could be felt earlier, depending on the pension input period in specific cases). Only 1% of people will be affected, according to Government figures. For those who are, and are looking for somewhere else to save, an offshore bond is one option.
An offshore bond would allow greater flexibility when it comes to wealth transfer too, since it can be assigned to an individual or a trust. Access can be shared at an earlier point than a pension – it all depends on the client’s preferences.
Tax avoidance
From football clubs to global internet brands to television presenters, the tax compliance record of companies and individuals is under a media spotlight as never before.
We know from the November 2012 National Audit Office (NAO) report on tackling marketed avoidance schemes that HMRC is being asked to do more to tackle “highly contrived schemes”. Does this all translate into anything relevant for advisers working with families? You bet it does. Welcome to the new world of the general anti-avoidance rule (GAAR), which we’ll be inhabiting from 6 April, 2013.
Any battle over the word ‘avoidance’ and which side of the line it falls on is not energy well spent. The NAO acknowledges that avoidance is legal, but that’s not really where the debate sits now.
HMRC has recently defined its terms when it comes to tax evasion, avoidance and planning. Evasion is criminal. Avoidance is “bending the rules of the tax system to gain a tax advantage that Parliament never intended”. Whereas tax planning involves using tax reliefs for the purpose for which they were intended. Here, HMRC uses the examples of an ISA and tax relief on pension contributions.
When it comes to investment bonds and how they are taxed, measures in 2012 and 2013 tightened up the rules. The revised time apportionment rules are being introduced and we’ve already seen Government action to stop aggressive use of investment bonds, wheregains were left behind in certain segments. This is a flavour of the interventionist approach we can expect to see more of in 2013 and beyond.
An HMRC announcement in December also set the scene for 2013, with monthly plans including the recruitment required to support the specialist tax investigation work being proposed. Trust experts are mentioned as part of a specialist HMRC team to be in place by April 2013 to deal with offshore assets. This is to begin work in May 2013 to identify offshore trusts being used to hide income and wealth overseas.
RDR and trusts
For those who are advising clients in the UK, we are now in the post-RDR world. There’s a point of detail to watch when working with clients who set up trusts.
Estate planning advice given to the settlor may result in a recommendation to establish a trust. Advice may also be given to trustees on how to invest cash gifted to the trust. There are two distinct clients here, and fee note processes should reflect the advice given to each.
But sometimes a trust may be established by the gift of an asset rather than cash. For example, if the settlor gifts an investment bond to the trustees, the fee falls to the settlor to pay. In this situation, the settler will have made the investment decisions too.
This means the trustees are responsible only for future fees relating to ongoing investment advice. Even then, the settlor could choose to pay for the ongoing advice fees due by the trustees. This would be a chargeable event or potentially exempt transfer (PET) for inheritance tax (IHT) depending on the type of trust, but could be covered by the annual exemption of £3,000.
Looking at how these issues are dealt with elsewhere, in many trusts where the sole asset is residential property, it is not uncommon to see a settler paying for ongoing fees or the ten-year anniversary IHT charge, given the lack of liquidity in the trust.
This further reduces the settlor’s estate for IHT purposes, which can be helpful. The only point to watch is the record-keeping around the extra gifts made for IHT purposes.
Case study
A quick summary of the advice issues will highlight the inheritance tax points.
Let’s assume a Mr Smith has £102,000 for the overall exercise of taking financial advice and setting up a trust. A £2,000 fee is due for his personal financial advice including the trust recommendation, and an advice fee of £1,000 is payable by the trustees. The trustees took the investment decision about the funds to select in the bond (since it was a gift of cash, not a gift of a bond). Compare the following three options for paying fees. Only the first two make sense for IHT purposes:
Option 1
The settlor and the trustees each pay their own fees.
Mr Smith pays his £2,000 fee, and the trustees pay their £1,000 fee from the £100,000 gifted to them. In this scenario, no inheritance tax issues arise.
Option 2
The settlor pays all fees.
Mr Smith pays for both financial advice fees, which come to £3,000 in total. This leaves £99,000 to be gifted to the trust. But don’t forget, Mr Smith has also made an extra gift of £1,000 since he settled a liability on behalf of the trustees. From an IHT perspective, keep an eye on the record-keeping. There will be a seven-year clock ticking relating to that £1,000, even though the money never actually hits the trust. The £1,000 gift will be a chargeable transfer (if the trust is discretionary) or a PET (if an absolute trust is used).
Option 3
The trustees pay all fees.
What you don’t want is for the trustees to pay Mr Smith’s £2,000 fee using the trust fund. This could result in a gift with reservation of benefit. Standard Life’s updated trust wordings address this point by (in this example) allocating £2,000 to a separate pot that is not added to the trust fund, where the settlor is just writing one cheque for the whole exercise.
Adjusting
There will be a period of adjustment as everyone gets used to the RDR way of operating. But one thing is more constant: the needs of families today in terms of how they want to pass on their wealth as part of their financial planning. Do they want to leave it all to be passed on after death, or make lifetime gifts? We found that 57% of customers in a 2012 survey wanted to do a bit of both. That’s an advice need asking to be met. Can you afford to ignore it?
Julie Hutchison is head of international technical insight at Standard Life International
