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Inheritance Tax

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04/03/2010

Pre-owned assets tax updated – 1 March 2009

Pre-Owned Assets Tax (POAT) was introduced by Schedule 15 of the Finance Act 2004. It imposed an annual income tax charge from 6 April 2005 in circumstances where taxpayers have successfully circumvented the inheritance tax (IHT) gifts with reservation rules, yet are still able to benefit from the asset transferred.

For intangibles such as insurance products two conditions have to be satisfied for the charge to apply:

i) the asset has to be subject to a settlement, and
ii) that settlement needs to be one under which the Settlor would be liable to tax on any income arising (broadly, a settlor-included trust).

The taxable benefit deemed to be retained is the value of the asset on a prescribed date multiplied by a prescribed rate of interest.

Valuation date

The valuation date was confirmed as 6 April for 2005 and will be the same for future years. Although the interest rate changed on 1 March 2009, the valuation date will still be 6 April.

Valuation rate

The valuation rate was confirmed as the official rate of interest:

Valuation Date Official rate of interest
6 April 2005 5%
6 April 2006 5%
6 April 2007 6.25%
6 April 2008 6.25%
6 April 2009 4.75%

What is the de minimis limit?

The de minimis limit has been confirmed as £5,000 or less. The de minimis limit is in regard to the deemed benefit, not the POAT liability.

How is the deemed benefit worked out?

The formula is:
Value of the Trust Fund at 6 April x valuation rate = deemed benefit

For example:
If the Trust Fund is valued at £70,000 on 6 April 2007 then:
£70,000 (value of Trust Fund) x 6.25% valuation rate = £4,375 (deemed benefit)
This is within the de minimis limit, therefore the POAT charge does not apply.
If the Trust Fund is valued at £105,500 on 6 April 2009 then:
£105,500 (value of Trust Fund) x 4.75% valuation rate = £5,011.25 (deemed benefit).
This is above the de minimis limit, therefore POAT charge applies to whole of deemed benefit.

How is the POAT applied?

The deemed benefit is added to taxable income and then multiplied by the individual's marginal income tax rate.

For example:
£5,011.25 (the deemed benefit) is added to taxable income of £12,000. As this is within the basic rate tax bracket, the applicable rate would be 20%.
Therefore, the POAT charge is £5,011.25 x 20% = £1,002.25.

What if the settlor no longer enjoys a deemed benefit within the assessable tax year?

If the Settlor does not enjoy a deemed benefit for a complete year from 6 April 2009 then a proportionate POAT charge will apply.

Step 1: Calculate the deemed benefit amount on 6 April 2009
For example: £110,000 x 4.75% = £5,225.00 deemed benefit.

Step 2: Is the deemed benefit greater than the de minimis limit?
If it is, a POAT charge may apply. If not, a POAT charge will not apply.
For example: Deemed benefit = £5,225.00 POAT charge may apply.

Step 3: Calculate how many days the POAT charge would apply since 6 April 2009 and apply the proportionate formula.
Deemed benefit x number of days held since 6 April 2007/365.
For example: We will assume the POAT charge applies until 6 July 2009, so for 92 days £5,225.00 x 92/365 = £1,317.00.
This is under the de minimis level of £5,000 so no tax would be due in this example.

Does POAT apply to my client?

Where your client has either a:

  • Skandia Settlor Beneficiary Trust,
  • Royal Skandia Lifetime Trust,
  • or Royal Skandia Trust Company Power of Appointment Trust including Settlor, the following flowcharts show which options your client has available.

These flowcharts assume:

  • the Pre-Owned Assets Tax de minimis limit is exceeded
  • the inheritance tax nil-rate band is exceeded.

Where the Trust is created before 20 June 2003

Trust created before 20 June 2003 (click image to enlarge)

Trust craeted before 20 June 2003

Where the Trust is created after 20 June 2003

Trust created after 20 June 2003 (clieck image to enlarge)

Trust created after 20 June 2003

The steps

Example: Settlor creates Trust and assigns contract to Trustees appointed under the Trust.

The steps

What is the process required to make an election?

The Settlor should complete IHT 500 (a form provided by HM Revenue & Customs) to elect that the Trust should be treated as a Gift with Reservation of Benefit. Further guidance and a helpline number is available on the HM Revenue & Customs website. The election must be made before 31 January in the year following the first year in which you are liable to pay the income tax charge. For example, in order to avoid suffering the Pre-Owned Assets Tax charge in respect of tax year 2008/09, the election must have been made before 31 January 2010.

Legislation was introduced in the Finance Act 2007 which allows HMRC to accept elections for IHT treatment in certain circumstances after the relevant filing date. (Sch66 FA 2007).

Trusts created before 20 June 2003

Steps one and two

While the Trust remains in force, from 6 April 2005 it becomes liable to the new Pre-Owned Assets Tax charge. This is because the Settlor is able to benefit from the Trust Fund but the scheme would not be caught by the Gift with Reservation of Benefit provisions.

By electing that the Trust Fund be treated as a Gift with Reservation of Benefit before 31 January, it is possible to avoid being liable for the Pre-Owned Assets Tax charge (a charge to income tax) for the previous tax year.

Electing the Trust to be treated as a Gift with Reservation of Benefit will mean the entire value of the Trust Fund will fall into the Settlor’s estate for IHT on his/her death.

Trusts created after 20 June 2003

Step one

While the Trust remains in force and is at step one, from 6 April 2005 it becomes liable to the new Pre-Owned Assets Tax charge. This is because the Settlor is able to benefit from the Trust Fund but the scheme would not be caught by the Gift with Reservation of Benefit provisions, which do not apply.

By electing that the Trust Fund be treated as a Gift with Reservation of Benefit before 31 January, it is possible to avoid being liable for the Pre-Owned Assets Tax charge (a charge to income tax) for the previous tax year.

Step two

While the Trust remains in force and is at step two, it is within the Gift with Reservation of Benefit Rules. The Pre-Owned Assets Tax charge will therefore not apply.

How to exclude the settlor as a beneficiary of a trust

What is the process required to exclude the settlor from the trust?

Where Royal Skandia Trust Company are the Trustees, the Settlor confirms in writing to the Trustees stating that the Settlor wishes to be permanently excluded from being a Beneficiary of the Trust. The Trustees will complete an instrument in writing. For Skandia Settlor Beneficiary Trusts and Royal Skandia Lifetime Trusts the Trustees complete a ‘Deed of Exclusion’*.

Trusts created before 20 June 2003

Steps one and two

While the Trust remains in force, from 6 April 2005 it becomes liable to the new Pre-Owned Asset Tax charge. This is because the Settlor is able to benefit from the Trust Fund but the scheme would not fall within the Gift with Reservation of Benefit provisions.

After 6 April 2005, by excluding the Settlor from benefiting from the Trust Fund it is possible to avoid any further Pre-Owned Asset Tax charge (a charge to income tax). This will have no IHT implications for the Settlor. However, a proportionate Pre-Owned Asset Tax charge will apply until the Settlor is excluded.

Trusts created after 20 June 2003

Step one

While the Trust remains in force and it is at step one, from 6 April 2005 it becomes liable to the new Pre-Owned Asset Tax charge. This is because the Settlor is able to benefit from the Trust Fund but the scheme would not fall within the Gift with Reservation of Benefit provisions, which do not apply.

After 6 April 2005, by excluding the Settlor from benefiting from the Trust Fund it is possible to avoid any further Pre-Owned Asset Tax charge (a charge to income tax). This will have no IHT implications for the Settlor. However, a proportionate Pre-Owned Asset Tax charge will apply until the Settlor is excluded.

Step two

While the Trust remains in force and is at step two, it will be within the Gift with Reservation of Benefit Rules. The Pre-Owned Assets Tax charge will therefore not apply.

Excluding the Settlor would have the effect of bringing the reservation to an end and thus the trust fund would be a potentially exempt transfer by the Settlor at this time.

How to terminate a trust

What is the process required to terminate the trust?

The Trustees complete a Deed of Appointment and Assignment of the Trust Fund in favour of the Settlor, which reverts the legal and beneficial ownership of the contract to the Settlor outside of the Trust. As there is no Trust property any longer, the Trust will automatically be terminated.

Trusts created before 20 June 2003

Steps one and two

While the Trust remains in force, from 6 April 2005 it becomes liable to the new Pre-Owned Asset Tax charge. This is because the Settlor is able to benefit from the Trust Fund but the scheme would not be caught by the Gift with Reservation of Benefit provisions.

By terminating the Trust in favour of the Settlor it is possible to avoid any further liability to the Pre-Owned Asset Tax charge (a charge to income tax).

The transfer of value created by appointment of the Trust Fund from the beneficiary to the Settlor would normally qualify for exemption under Section 54 of the Inheritance Tax Act 1984, more commonly known as the ‘revertor to Settlor’ exemption. Therefore no immediate or potential liability to inheritance tax would arise. The Trustees vesting the legal and beneficial ownership in the Settlor as beneficiary will terminate the Trust. This means the value of the Trust Fund will form part of the Settlor’s estate for inheritance tax purposes, but the transaction has no other income tax or inheritance tax implications.

Trusts created after 20 June 2003

Step one

While the Trust remains in force and it is at step one, from 6 April 2005 it becomes liable to the new Pre-Owned Asset Tax charge. This is because the Settlor is able to benefit from the Trust Fund but the scheme would not be caught by the Gift with Reservation of Benefit provisions, which do not apply.

By terminating the Trust in favour of the Settlor it is possible to avoid any further liability to the Pre-Owned Asset Tax charge (a charge to income tax).

The transfer of value created by appointment of the Trust Fund from the beneficiary to the Settlor would normally qualify for exemption under Section 54 of the Inheritance Tax Act 1984, more commonly known as the ‘revertor to Settlor’ exemption. Therefore no immediate or potential liability to inheritance tax would arise. The Trustees vesting the legal and beneficial ownership in the Settlor as beneficiary will terminate the Trust. This means the value of the Trust Fund will form part of the Settlor’s estate for inheritance tax purposes, but the transaction has no other income tax or inheritance tax implications.

Step two

While the Trust remains in force and is at step two, it will be within the Gift with Reservation of Benefit Rules. The Pre-Owned Assets Tax charge will therefore not apply.

*Available from Skandia

Skandia does not accept any liability for any action taken or refrained from being taken on the basis of information contained in this or any related article.

This article is based on Skandia’s interpretation of the law and HM Revenue & Customs practice as at March 2010. We believe this interpretation is correct, but cannot guarantee it. Tax relief and the tax treatment of investment funds may change.

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