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Adam Owens ATT

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Clients may sometimes want to give away assets to reduce their estate for Inheritance Tax (IHT) purposes. However, to be effective, the donor must not benefit from any asset gifted. This is not always possible – for example, where the donor relies on the income to fund their lifestyle. However, there is a way to get the best of both worlds by using a Discounted Gift Trust (DGT).

A DGT is a type of trust arrangement that enables a settlor to gift a lump sum into a trust whilst retaining the right to a regular payment.

The lump sum is typically invested, perhaps into an investment bond, and the trustees of the trust will make regular income payments to the settlor during their lifetime. It gives an opportunity at the outset to choose the payment level and its frequency. The underlying capital is then held on trust for the nominated beneficiaries.

The IHT implications of using a discretionary trust are discussed below. From an IHT perspective, the lump sum gift is separated into two parts:

The discount – an actuarial calculation is carried out to place a current day value on
the annual payments that the settlor can expect to receive. As this entitlement will cease on death, this element of the gift immediately falls outside of the settlor’s death estate.
The discount will depend on the level of payments that the settlor expects to receive. It will also depend on factors such as the settlor’s age and state of health. The longer the life expectancy, the more payments an individual is likely to receive, so the discount is likely to be larger.
The remainder – the lump sum less the amount of the discount is treated as a gift by the settlor. As this is a gift by the settlor to the trust, it is a chargeable lifetime transfer if a discretionary trust is used. However, providing this element falls within the available nil rate band (£325,000 less any chargeable transfers in the seven years before the DGT is set up) there is no immediate IHT consequences.
If the remainder value is in excess of the available nil rate band, there will be an immediate IHT charge at a rate of 20% of the amount above the nil rate band.
The value of the trust fund is not included within the estate of the beneficiaries.

IHT – on death

If the settlor dies within seven years of setting up the trust, the immediate tax charge will be recalculated using the full IHT tax rate of 40%.

IHT – exit charges

When money is paid out of the trust to the beneficiaries, either while the settlor is alive or after their death, there may be an exit charge. Where there is an exit charge, the maximum rate that will apply is currently 6%.

The regular payments made to the settlor are not subject to any exit charge.

Income Tax

Any income tax liability will depend on the investment product chosen.

Anyone thinking of using the DGT, must seek and rely on the advice of a suitable investment adviser and a suitable trust and tax practitioner.

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NIC Employment Allowance – an unjustified interpretation?

HMRC has taken the unusual step of launching Code of Practice 9 (“COP9“) investigations into users of Clavis Trust/Herald Employment & Recruitment Services Ltd (“HERS”) Employee Benefit Trusts. This means that HMRC suspects those businesses (and business owners) of fraud.

Fraud can cover a wide range of issues, but it always involves some sort of dishonesty. This can include deliberately concealing or withholding relevant facts or misrepresenting your tax affairs in some way. Taxpayers urgently need expert, experienced advice to defend their position.

As part of a COP9 investigation, taxpayers are offered the chance to tell HMRC everything that is wrong with their tax affairs under the terms of its Contractual Disclosure Facility (“CDF”). In return, HMRC will agree not to criminally investigate and will look to settle the matter on a civil basis (i.e. tax plus interest and penalties). However, taxpayers can only accept the terms of the CDF and protect themselves from a possible criminal investigation by admitting that their tax affairs are deliberately incorrect (i.e. that they have been dishonest). In most tax avoidance cases like the Clavis/HERS EBT scheme, taxpayers will have acted on advice and will have received assurances that everything they were doing was legal. They will be shocked to now find themselves accused of fraud and may well not understand why?!

The CDF offer and the protections it offers are only open for 60 days. Taxpayers need to carefully explore all their options before any documents are signed and returned. HMRC recognises the seriousness of the situation and strongly recommends that taxpayers seek expert advice from a specialist adviser who is familiar with COP9 (possibly in addition to their normal tax adviser).

COP9 cases are the most serious civil investigations undertaken by HMRC. If they are not handled correctly, the consequences can be extremely serious. OneE TDI Limited specialise in COP9 work and have settled a huge number of cases without any criminal investigation. We would be delighted to help. Please contact info@oneegroup.com or call 01204 559914.

The (Revised) DOTAS Consultation on IHT & Indirect Taxes

The Government has recently published the long-awaited follow-up to last year’s consultation on the extension to DOTAS to inheritance tax. As covered in an earlier article these rules were very broadly drafted, and could catch all manner of simple and “vanilla” tax planning. The government took heed of the industry’s concerns, and announced in their response that these rules would be refined – we now have the results of their efforts.

In addition to IHT, the consultation also proposes changing the rules on the disclosure of VAT avoidance schemes – essentially bringing this more into line with DOTAS – and further expanding its scope to also cover other indirect taxes (in particular gambling duties and insurance premium tax).

This article briefly summarises the consultation and the potential implications and/or effectiveness of the proposed rules.

DOTAS and IHT

Under the newly proposed rules DOTAS will apply to IHT arrangements if it would be reasonable to expect an informed observer (having studied the arrangements and having regard to all the relevant circumstances) to conclude the following conditions are met:

  1. The main purpose, or one of the main purposes, of the arrangements is to enable a person to obtain an IHT advantage; and
  2. The arrangements are contrived or abnormal or include one or more contrived or abnormal steps without which a tax advantage could not be obtained.

Perceptive readers may be surprised to find that, after months of deliberation, the changes appear to amount only to the removal of one of the three original conditions. This was certainly the most broadly drafted provision – and therefore its removal is welcome – but issues with regards to the unnecessary breadth of these rules, and uncertainty over how they will be applied, continue to persist.

Perhaps the easiest to highlight these issues is to consider those arrangements that government has felt the need to specifically exclude. From this we must infer that, without explicit exclusion, the Revenue believe they would be caught – or that there is at least sufficient uncertainty to warrant this exclusion.

The excluded arrangements include the following:

  • Loan trusts
  • Discounted gift schemes
  • Flexible reversionary interests
  • Split or retained interest trusts

It’s clear that the first condition will likely be met, as the IHT benefits of these structures are often a selling point. But is it fair to say that they are “abnormal” or “contrived”? Many would argue that this is not the case – these arrangements are often long-standing tax planning and therefore, it would seem fair to argue, fairly “normal” in nature, and many would argue that they are not contrived. Yet, as indicated by their exclusion, the Revenue appear to feel otherwise. If the Revenues view is that these rules catch arrangements as inoffensive as loan trusts, they would appear to be much broader than is required to target true avoidance arrangements.

This position is complicated further by the references in the consultation to “abusive” arrangements. We are informed that, by borrowing wording from the GAAR with regards to “abnormal” and “contrived” arrangements, non-abusive arrangements will not be caught (see para 4.5 of the consultation). Quite aside from the fact that DOTAS is supposed to target avoidance, rather than abuse, it’s also clear that, by this logic, the Revenue must surely perceive loan trusts as abusive! Quite clearly this cannot be correct.

In summary, although a step in the right direction, the consultation simply does not go far enough in ensuring non-avoidance arrangements are not caught, and in providing sufficient objectivity to give certainty over the potential scope of these rules.

Indirect Taxes and VADR

The consultation also proposes changes to the disclosure regime for indirect taxes. Essentially, the proposed changes are as follows:

  • To bring the regime for VAT and other indirect taxes into line with that forDOTAS by:
    • Moving the obligations for disclosure from the “user” of the scheme to the “promoter”
    • Changing the test from a “purpose” to a “benefit” test – in the context of the DOTAS consultation, it is telling that the reason given is that “purpose” is too subjective to be reliable (within the same document that a “purpose” test is proposed to be applied for IHT!)
    • Applying ongoing obligations for disclosure by the promoter – such as quarterly client lists
    • Integrate many of the same hallmarks as DOTAS (such as confidentiality, premium fee, standardized tax products, etc.)
    • Adopting the penalty model used under DOTAS
  • Removal of the “turnover threshold” to ensure that all arrangements are caught, regardless of the “size” of the user
  • Extending the indirect taxes under this regime to include insurance premium tax, gambling duties, and potentially landfill tax, climate change levy, etc.

Although at first glance it may appear that in some respects these changes would increase the obligations for disclosure by clients, as they will no longer have to provide full disclosure themselves – but instead only list a scheme reference number on their return – in reality the requirements will be less onerous (though admittedly more common).

Conclusion

In conclusion, the consultation sets out to significantly increase the scope of the DOTAS regulations. Whilst this should not in itself be a problem for practitioners if the rules did indeed target only avoidance arrangements and could be applied with certainty, where IHT is concerned in particular, this is simply not the case.

This represents a significant problem for practitioners that advise on IHT, as may types of “vanilla” planning may, or may not, be caught by these rules. Although the Revenue have confirmed that a degree of guidance will be provided over what they consider to be “contrived” or “abnormal” this cannot be comprehensive. Given the lack of consistency in the consultation itself it will be very difficult for practitioners to advise in this area with any reliability.

This has significant implications – lack of disclosure could open advisers to the risk of significant penalties under the DOTAS regime, whereas a “protective” disclosure is no longer a viable option given the potential implications for upfront payments under an accelerated payment notice (“APN”).   In the era of APNs there simply should not be scope for the degree of uncertainty in DOTAS, which these rules would appear to bring if brought in as currently drafted.

We would urge all advisers who advise in these areas to consider responding to the consultation to ensure that their views are represented – the deadline for responses is 13th July 2016. The consultation can be found at the following link:

https://www.gov.uk/government/consultations/strengthening-the-tax-avoidance-disclosure-regimes-for-indirect-taxes-and-inheritance-tax

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SDLT on “Additional Residential Dwellings”: What Your Clients Need to Know

The recent increase in stamp duty land tax (“SDLT”) on “additional residential dwellings” represents the latest in a series of measures introduced by the Government to “cash in” on a buoyant housing market. Recent changes in this area include: the restriction of mortgage interest relief on residential properties; the withdrawal of wear and tear allowance; the non-residents charge to capital gains tax (“CGT”); the exemption of residential property from the reduced rate of CGT; the annual tax on enveloped dwellings; amongst others.

The new SDLT rules took effect from April of this year onwards, imposing an additional 3% surcharge where applicable. This represents a not insignificant additional cost, which advisers may need to help clients consider when determining the economic viability of their acquisitions and investments. This article seeks to provide a helpful overview of these rules as they may apply to clients, the implications, and the reliefs and exemptions which may be available.

What type of acquisitions are targeted?

As noted purchases of “additional residential dwellings” are affected. Although we might think we know a “residential dwelling” when we see one, it is worth pointing out that this is not limited to typical investment properties, and includes buildings that are in the process of being adapted for use as a dwelling, “off-plan” purchases, and even holiday homes.

Commercial properties are, in general, unaffected, which is consistent with the Government’s more lenient approach elsewhere (such as the restrictions against mortgage deductibility). This includes “mixed-use” properties – such as a shop, with a flat above – something clients may wish to consider when planning future acquisitions.

What other conditions must be met for these rules to apply?

In general terms, the additional charge to SDLT will apply to acquisitions of residential property where:

i. the purchase price is £40,000 or more;
ii. the purchaser owns another residential property (with a market value of £40,000 or more) – regardless of where in the world this property is located; and
iii. the dwelling being purchased is not replacing the purchaser’s only or main residence.

In effect, this additional SDLT charge will apply to most residential property acquisitions for investment purposes (and a number of other acquisitions too). There are some limited exemptions for properties purchased whilst subject to a lease with more than 21 years to run, but these cases will be rare.

What else do clients need to be aware of?

The rules are complex, and it is of course not possible to provide all the detail in a brief article, but some points that are worth noting are:

  • These rules apply somewhat unfairly to married couples / civil partners, as their property ownership is aggregated. If one individual owns a residential property, whilst their spouse / partner acquires another, they will typically find themselves within these rules.
  • Where a purchase is made jointly, the additional SDLT charge will apply to the whole transaction if any one of the purchasers, when considered individually, would be caught by these rules.
  • The “replacement” of a main residence requires a disposal, which must take place within three years (before or after) the acquisition. This ensures that clients cannot simply “hop” between newly acquired “homes” to avoid the SDLT charge. Where the replacement occurs after the new property is acquired, the additional SDLT will be refunded. Whether the acquired property qualifies as a “main residence” is a question of fact, with the HMRC Guidance in this area providing some useful indicators from case law.
  • Some purchases, which one might not expect to be caught, can still fall within these rules. Consider an individual owning one or more rental property for investment (or even a holiday home abroad), but – perhaps due to the changing nature of their employment – is only now acquiring a residential property as their home. This transaction meets the conditions set out above, so will face the additional SDLT charge, even though the property is genuinely to be used as a main residence.
  • The exemption initially suggested for companies owning more than 10 residential properties was not introduced into law – no such exemptions are available.
  • Limited companies and certain types of trusts are within the scope of these rules regardless of the number of properties they own, meaning that the first residential property purchased by these entities will be caught.

Are there any ways to reduce the impact of these changes?

There are certain transactions that will necessarily fall outside the scope of this new SDLT charge, but this will typically be limited to where the acquisition consideration is less than £40,000, or where a property replaces the main residence. However, some reliefs are available:

  1. Firstly, where more than one property is purchased in a single transaction multiple dwellings relief may be available (see examples below) – this ensures that the “average” cost is used when calculating the SDLT charge, which can significantly reduce the liability.
  2. Secondly, there are scenarios in which it will be possible to avail of the lower “commercial” rates of SDLT (see examples below). This includes “mixed use” properties (such as the flat above the shop, as outlined above); purchases of more than six individual dwellings in a single transaction; and certain “linked” purchases of both commercial and residential property.
  3. Thirdly, where considering the implications of acquisition on incorporation by a connected company, it may be possible to ensure that no charge to SDLT applies whatsoever through the appropriate use of the “sum of lower proportions” rules, which apply to partnerships.

Where a significant charge to SDLT is likely to arise advice should be sought on the best way to structure the transaction, and the reliefs that may be available, to reduce costs on acquisition.

Summary

In summary the charge to SDLT on additional residential dwellings will increase the cost of future acquisitions for many taxpayers, and will have to be considered when considering future acquisitions. Where the purchase cannot be structured to reduce the tax cost and/or whether it is considered to be too costly, clients may wish to consider using their funds to invest in commercial properties, pay down existing lending, or invest in other asset classes.

Examples

Impact of Changes – comparison of acquisition of a “residential dwelling” for £300,000 – unaffected taxpayer (i.e. first purchase) / affected taxpayer (i.e. Landlord).

Unaffected Taxpayer Affected Taxpayer (i.e. Landlord)
SDLT Rate: SDLT Rate:
0% on the first £125k £0.00 3% on the first £125k £3,750.00
2% on the next £125k £2,500.00 2% on the next £125k £6,250.00
5% on final £50k £2,500.00 5% on final £50k £4,000.00
£5,000.00 £14,000.00

In this instance the landlord faces an additional £9,000 in acquisition costs (or, in other words, has seen his SDLT bill increase by roughly 200%).

Potential Reliefs – acquisition of 6 residential properties, with a total value of £2.5million:

 Multiple Dwellings Relief:-  Deemed Commercial:-
Avg Price (£2.5mill / 6):  £                  416,666.67
SDLT Rate: SDLT Rate:
0%  £                               –
3% on the first £125k  £                      3,750.00 0%  £                   –
5% on the next £125k  £                      6,250.00 2%  £          2,000.00
8% on final £166,666  £                    13,333.33 5%  £      112,500.00
  £                    23,333.33 (x 6)
£                   140,000.00   £       114,500.00

In this example use of the “deemed commercial” rules saves £25,500 in SDLT on acquisition.

OneE Group is a recognised supplier of the National Landlords Association, providing responsible tax advice to landlords throughout the UK. If your client would benefit from having a discussion with one of our specialist tax advisors, please get in touch via email or call us on 01204 559 914 to arrange a no obligation consultation, free of charge.