The government intends to legislate to counter the effect of Barclays Wealth Trustees (Jersey) Ltd & M Dreelan v HMRC.
The proposed legislation will confirm that any property added to an excluded property settlement after the settlor becomes deemed domiciled in the UK will be subject to UK inheritance tax. It may also mean that property transferred between settlements will be subject to inheritance tax if the settlor of the recipient trust is deemed domiciled at the time of the transfer.
Dreelan
The inheritance tax legislation provides that foreign property in a settlement is ‘excluded property’ – not subject to inheritance tax – as long as the settlor was not UK domiciled (or deemed domiciled) at the time the settlement was ‘made’. Where property is transferred between settlements, the settlor of the recipient settlement must also have been non-UK domiciled (or deemed domiciled) when the recipient settlement was ‘made’.
HMRC has historically taken the view that a settlor ‘makes’ a new settlement each time he adds property to an existing settlement. On that basis, property added to a settlement after the settlor became deemed domiciled (whether directly or by transfer from another excluded property trust) would never qualify as excluded property.
The Court of Appeal rejected that view in Dreelan [2017] EWCA Civ 1512. It held that a settlement is ‘made’ when it is first established and not every time there is an addition to the settlement. For a full overview of that case, see here. The logical conclusion of the Court of Appeal’s reasoning in Dreelan is that a settlor could continue adding property to an excluded property trust even after becoming deemed domiciled.
To avoid the implications of the Dreelan case, the government now intends to amend the inheritance tax legislation in Finance Bill 2019-20.
Additions to excluded property settlements
The first amendment will confirm that property added to a settlement after the settlor becomes deemed domiciled is ‘relevant property’ (i.e. subject to inheritance tax), even if the addition is to an existing excluded property settlement.
This will be a retrospective change, in that any property added to a settlement while the settlor was deemed domiciled will be relevant property after the legislation comes into effect (expected to be 6 April 2020), regardless of when the property was added.
This is unlikely to have a major impact, as most advisors cautioned against adding property to a settlement after becoming deemed domiciled, even in light of the Dreelan case. If there are any affected settlements, the trustees could consider distributing the added property (assuming it can be identified) before this legislation comes into force, to avoid an inheritance tax exit charge.
Transfers between settlements
The second amendment will be to impose additional excluded property tests on property transferred between settlements. The government has not specified what those additional tests will be, but it seems likely (in light of Dreelan) that transferred property will only be excluded property if the settlor of the recipient trust is not UK domiciled or deemed domiciled at the date of the transfer.
This could lead to the illogical outcome that transferring property from one excluded property settlement to another would mean the transferred property loses its excluded property status. This may make it more attractive to amend an existing settlement rather than transfer property into a different settlement.
The government has indicated that this change will only affect transfers made after the legislation comes into effect, so if there is a need to do this, trustees could consider transferring property between excluded property settlements before April 2020. However, this should be avoided where the recipient settlement is a protected settlement for income and capital gains tax purposes, as the transfer would cause the recipient settlement to lose its protected status.
Conclusions
The key message is that settlors should generally avoid making any additions to their settlements after they become deemed domiciled, as the added property will be subject to inheritance tax.
The position on transfers between settlements is less clear for the time being, but settlors who are establishing or reviewing trust structures now should not assume that they will have complete flexibility to transfer funds between their settlements in the future. We will know more about this proposed amendment when the draft Finance Bill 2019-20 is published next year.
Nicholas Harries, partner, Charlotte Kynaston, barrister & Robin Vos, solicitor, Macfarlanes
The government intends to legislate to counter the effect of Barclays Wealth Trustees (Jersey) Ltd & M Dreelan v HMRC.
The proposed legislation will confirm that any property added to an excluded property settlement after the settlor becomes deemed domiciled in the UK will be subject to UK inheritance tax. It may also mean that property transferred between settlements will be subject to inheritance tax if the settlor of the recipient trust is deemed domiciled at the time of the transfer.
Dreelan
The inheritance tax legislation provides that foreign property in a settlement is ‘excluded property’ – not subject to inheritance tax – as long as the settlor was not UK domiciled (or deemed domiciled) at the time the settlement was ‘made’. Where property is transferred between settlements, the settlor of the recipient settlement must also have been non-UK domiciled (or deemed domiciled) when the recipient settlement was ‘made’.
HMRC has historically taken the view that a settlor ‘makes’ a new settlement each time he adds property to an existing settlement. On that basis, property added to a settlement after the settlor became deemed domiciled (whether directly or by transfer from another excluded property trust) would never qualify as excluded property.
The Court of Appeal rejected that view in Dreelan [2017] EWCA Civ 1512. It held that a settlement is ‘made’ when it is first established and not every time there is an addition to the settlement. For a full overview of that case, see here. The logical conclusion of the Court of Appeal’s reasoning in Dreelan is that a settlor could continue adding property to an excluded property trust even after becoming deemed domiciled.
To avoid the implications of the Dreelan case, the government now intends to amend the inheritance tax legislation in Finance Bill 2019-20.
Additions to excluded property settlements
The first amendment will confirm that property added to a settlement after the settlor becomes deemed domiciled is ‘relevant property’ (i.e. subject to inheritance tax), even if the addition is to an existing excluded property settlement.
This will be a retrospective change, in that any property added to a settlement while the settlor was deemed domiciled will be relevant property after the legislation comes into effect (expected to be 6 April 2020), regardless of when the property was added.
This is unlikely to have a major impact, as most advisors cautioned against adding property to a settlement after becoming deemed domiciled, even in light of the Dreelan case. If there are any affected settlements, the trustees could consider distributing the added property (assuming it can be identified) before this legislation comes into force, to avoid an inheritance tax exit charge.
Transfers between settlements
The second amendment will be to impose additional excluded property tests on property transferred between settlements. The government has not specified what those additional tests will be, but it seems likely (in light of Dreelan) that transferred property will only be excluded property if the settlor of the recipient trust is not UK domiciled or deemed domiciled at the date of the transfer.
This could lead to the illogical outcome that transferring property from one excluded property settlement to another would mean the transferred property loses its excluded property status. This may make it more attractive to amend an existing settlement rather than transfer property into a different settlement.
The government has indicated that this change will only affect transfers made after the legislation comes into effect, so if there is a need to do this, trustees could consider transferring property between excluded property settlements before April 2020. However, this should be avoided where the recipient settlement is a protected settlement for income and capital gains tax purposes, as the transfer would cause the recipient settlement to lose its protected status.
Conclusions
The key message is that settlors should generally avoid making any additions to their settlements after they become deemed domiciled, as the added property will be subject to inheritance tax.
The position on transfers between settlements is less clear for the time being, but settlors who are establishing or reviewing trust structures now should not assume that they will have complete flexibility to transfer funds between their settlements in the future. We will know more about this proposed amendment when the draft Finance Bill 2019-20 is published next year.
Nicholas Harries, partner, Charlotte Kynaston, barrister & Robin Vos, solicitor, Macfarlanes
