Personal Finance Society news update from 8 June to 21 June 2016
on taxation, retirement planning and investments.
Taxation and Trusts
TAXATION AND TRUSTS
IHT claim successfully defended by financial
(AF1, RO3, JO2)
A financial adviser has successfully defended a claim brought by
two relatives of his now deceased client on the grounds that he
failed to tell the client that any outstanding loan due from a loan
trust would form part of the client's taxable estate on death.
In the case in question, the client, a Mrs Shemwell, had
inherited £300,000 from her sister in April 2011. Her intention was
to leave as much of this money as possible to two relatives, Claire
Hartley and Tim Herring, while protecting it from inheritance tax
as far as possible.
She consulted her usual financial adviser on this basis and was
advised to place £175,000 (representing the unused part of her
inheritance tax (IHT) nil rate band) into a discretionary trust and
put the remaining £125,000 into a loan trust naming the two
relatives as the only beneficiaries.
As is commonly known, under a loan trust while the capital
placed in the trust would form part of her estate on death, thus
being liable to IHT, any capital growth would be outside her estate
and thus pass to the beneficiaries free of IHT.
After the trusts had been set up, Mrs Shemwell decided to make a
new Will. She gave initial instructions to her solicitor at a
meeting at her home on 21 October 2011. Her financial adviser
attended the meeting, though only for a few minutes. Much of the
subsequent dispute was about what was said at this meeting, and
what was written on an aide-memoire by her adviser concerning the
values of the trusts.
The solicitor went on to draft the Will, but had not made any
enquiries about the terms or nature of the trusts and was not aware
of whether the funds held on trust would pass to the two relatives
directly on death. Instead, he wrote in legacies of £54,000 each
for Hartley and Herring on the assumption that they would also
receive £146,000 from the trusts.
Seven months later Mrs Shemwell died and Hartley and Herring
were disappointed to find that the money in the loan trust would be
subject to IHT after all, so they received significantly less money
than they had expected.
Hartley and Herring decided to sue both the financial adviser
and the solicitor practice for negligence - although their claim
against the solicitor practice was settled by mediation last
Leeds County Court has subsequently ruled on the claim against
the financial adviser. The judge dismissed the claim on the basis
that the financial adviser did not have a duty of care to the
claimants, as he had not been involved in the Will-making
However, the judge did say that the solicitor was negligent in
drawing up the Will because he hadn't determined exactly what would
happen to the trust assets and whether or not they would pass to
the claimants on Mrs Shemwell's death. The judge concluded that
relying on a short conversation and information contained in the
aide-memoire was not sufficient.
While in this particular case the judge ruled in favour of the
financial adviser, the case serves as an important reminder that
when acting in a professional capacity it is essential to "join up
all the planning." In particular, it is vital that the adviser
knows what planning the client has already undertaken as this could
have material implications on later financial planning strategies.
In the case of trusts (particularly loan trusts), it is also
important that attention is given to any implications that this
might have on the client's Will provisions. This gives the
financial adviser the perfect opportunity to work with the client's
legal advisers - which in turn opens up more business
Updated guidance on lasting powers of
(AF1, RO3, JO2)
The Law Society (England and Wales) has issued an updated
practice note on lasting powers of attorney which replaces the
December 2011 version.
The practice note is aimed at solicitors who advise clients on
drawing up a lasting power of attorney (LPA), and solicitors who
are acting as an attorney under an LPA.
The updated guidance includes:
- advice on assessing the donor's capacity;
- the risk of abuse;
- taking instructions;
- drafting and registering an LPA; and
- the situation regarding existing enduring powers of
Note the practice note does not deal with situations with an
international element, for example, using an LPA to sell a foreign
property, or a non-UK resident individual who wishes to make an
To view the practice note please click here.
Non-aggressive IHT planning
The proposed new DOTAS (Disclosure of Tax Avoidance Schemes) IHT
Hallmark and continued anti-avoidance crusade leaves advisers
well placed to plan and execute "acceptable" IHT Planning.
In the News Bulletin covering the period 27 April to 10 May we
noted, in connection with the latest consultation on the proposed
new DOTAS Hallmark (issued in late April), the following:
'The conditions of the revised Hallmark, both of which need to
be met for an arrangement to be disclosable, are that:
- The main purposes, or one of the main purposes, of the
arrangements is to enable a person to obtain a tax advantage;
- The arrangements are contrived or abnormal or involve one or
more contrived or abnormal steps without which a tax advantage
could not be obtained
The latest consultation document provides examples of ordinary
tax planning arrangements which may result in a tax advantage yet
are not, in the eyes of the government, caught by the revised
Hallmark because they are not contrived or abnormal (and so fail to
meet the second condition). These include:
- Straightforward, outright gifts
- Lifetime transfers into flexible or discretionary trusts
- Investment into assets that qualify for relief from inheritance
- Arrangements that are within a statutory exemption - for
example paying full consideration for the continued use of land or
chattels that have been given away
Certain insurance-based arrangements, that could potentially be
caught, are specifically excepted under the revised draft
regulations. These are:
- Loan trusts - whether discretionary or bare and whether or not
there is an initial gift;
- Discounted gift schemes - again whether discretionary or bare
and whether established in conjunction with a life assurance or a
capital redemption policy;
- Flexible reversionary trusts - including arrangements where the
retained rights can be varied or defeated by the trustees; and
- Split or retained interest trusts
While we need the final regulations to be sure (consultation is
open until 13th July 2016), as it stands the new IHT
Hallmark would seem to leave financial planners well placed to plan
and execute IHT planning strategies that their clients can have
- will work and
- will not require a DOTAS reference number
The first benefit is obviously essential and most of the
strategies implemented by advisers have a long and impressive track
record of effectiveness.
Especially since the advent of the accelerated payment notice
(requiring an arrangement to have a DOTAS reference number) and the
consequential payment of an effective tax deposit 'on the basis
that the arrangement will fail', having a DOTAS reference number is
not the best form of marketing. So the wide range of arrangements
that (it seems) won't require one, is especially good news.
Against a background of continued government action against
schemes that it considers aggressive and against the spirit of
legislation and the intention of Parliament, IHT planning that you
can be relatively certain won't be attacked, has a good track
record of success and won't result in an accelerated payment notice
is not to be sniffed at.
And while we're talking about effective IHT planning don't
forget that the gift with reservation rules still exist and are
especially effective in relation to residential property. In this
case straightforward protection policies held in trust can do a
wonderful job of tax effectively providing for the liability on
assets that can't (for whatever reason) be gifted.
Discretionary trust taxation - A hidden tax
(AF1, RO3, JO2)
One unintended effect of the provisions in the Finance Bill 2016
dealing with the abolition of the tax credit on the tax pools will
cause problems for discretionary trusts receiving dividend income
if not put right before the Bill is enacted.
As is generally well known there was very little specific
information provided by HMRC prior to the new tax year regarding
the new trust rates of income tax, in particular the new dividend
rate, 38.1% with effect from 6 April 2016, now set by Finance Bill
2016. It now seems that indeed too little attention was paid by the
parliamentary draftsman to the implications of these changes for
The problem is with the wording of Finance Bill 2016, which
deals with the abolition of the dividend tax credit, which
currently has the effect of imposing a hidden tax charge for
discretionary trusts distributing dividends.
Section 498 Income Tax Act 2007 sets the amount of tax that can
be included in the tax pool. This sets the rate of tax that can
enter the tax pool for dividend income as the nominal rate defined
as 'a rate equal to the difference between the dividend trust rate
and the dividend ordinary rate'. This, of course, made perfect
sense for previous tax years, when the dividend tax credit (which
effectively franked dividend ordinary rate for accumulated income)
was not matched by an actual tax payment (until 5 April 2016).
As stated above, Finance Bill 2016 sets the dividend ordinary
rate at 7.5% and at the same time abolishes the 10% dividend tax
credit (available to reduce the tax liability on the dividend
income until 5 April 2016).
However, as from 6 April 2016 dividends are paid without a tax
credit so the trustees now have a liability at 7.5% on dividends
received within the standard rate band (equivalent of the dividend
ordinary rate) and 38.1% on any excess. The dividend allowance
available to individual taxpayers does not apply to trusts. So even
though the trustees physically pay 7.5% tax, on the current wording
the 7.5% does not go into the tax pool. It is only the difference
between 38.1% and 7.5%, ie only 30.6% that enters the tax pool.
This seems to be unintentional. We understand that
representations have been made to the Government so hopefully this
is amended when Finance Bill 2016 passes through Parliament.
If the Finance Bill were to remain in its original form, the
effect would be an additional tax charge for trusts paying the
dividend trust rate, ie primarily discretionary trusts. Not only
unintended, that would surely go against all logic as it would deny
a tax credit for tax actually paid. Let us hope that common sense
and logic prevail. In the meantime there is some confusion in the
professional press, with some assuming that this extra tax is a
fait accompli, and others ignoring the current Finance Bill wording
on the grounds that an amendment is certain.
Offshore funds and spousal transfers
(AF4, RO2, FA7, CF2)
We had the question posed recently as to what the income tax and
capital gains tax implications would be on a transfer of
shares/units in an offshore non-reporting fund between spouses,
particularly in respect of any offshore income gain.
For UK tax purposes offshore funds can be broadly split into
'reporting' funds and 'non-reporting' funds. Their main
features are as follows:-
A reporting fund is taxed in much the same way as a UK unit
trust/OEIC so any income that arises, whether distributed or
accumulated, is subject to income tax on the investor and any gains
are subject to capital gains tax. When shares/units are
transferred between spouses/civil partners living together, as
defined in section 1011 Income Tax Act 2007, then the transfer is
said to be on a 'no gain, no loss' basis so the transferee spouse
acquires the shares/units at the transferor's base cost.
Capital gains tax is therefore deferred until sale by the
transferee spouse. There are no income tax implications on
A non-reporting fund is one that does not have reporting
status. The assets of the fund do not produce any taxable
income subject to income tax, or capital gains subject to capital
gains tax, in the hands of the investor. Instead, generally
all income and capital gains arising from investments underlying
the fund will be accumulated to increase the value of the
shares/units. For this reason taxation of the investment is
deferred until a disposal is made.
(a) Income tax - general
When an investor disposes of shares in the fund then there will
be a disposal of the shares/units for the purposes of income tax if
the disposal ranks as a disposal for the purposes of the Taxation
of Chargeable Gains Act 1992. Any gain arising is known as an
'offshore income gain' (OIG). The gain will be calculated based on
capital gains tax principles but with two important
(i) The capital gains tax annual exempt amount is not available
to offset against the gain.
(ii) Death is a chargeable occasion. This means that an
OIG can arise on the death of an investor as a disposal is then
deemed to take place for income tax purposes. However, there
will be no disposal for capital gains tax purposes.
As stated above, despite using capital gains tax principles to
calculate the gain, it will be charged to income tax. If the
calculation gives rise to a loss it counts as a nil OIG. For
income tax purposes, no loss arises although the loss may be
treated as a loss for capital gains tax purposes.
(b) Capital gains tax - general
In addition to the income tax calculation, a capital gains tax
calculation also has to be carried out. Any OIG subject to
income tax is deducted from the proceeds for capital gains tax
purposes which means, in most cases, that there will be no gain
subject to capital gains tax and a loss may arise.
(c) Gifting of shares/units to a spouse
When shares/units of a non-reporting fund are gifted, whether a
gain arises depends substantially on the relationship of the donee
to the donor. As stated above, where the gift is to someone other
than the donor's spouse/civil partner, the disposal is deemed to
have taken place at full market value and the OIG can be calculated
by deducting the cost.
On the other hand, if the donee is the donor's spouse/civil
partner, and the spouses/civil partners are living together, the
disposal will not be one that gives rise to an OIG. This is
because under the capital gains tax rules the donee spouse will be
deemed to acquire the non-reporting fund holding at the donor's
acquisition cost under the 'no loss, no gain' principle. Any
gain is, in effect, held over to the donee.
On subsequent disposal by the donee spouse (otherwise than on a
disposal back to the donee's spouse), any gain will be calculated
by reference to the difference between the disposal proceeds and
the value of the investment when the donor acquired it (and not
when the donee acquired it). Any gain would be an OIG and
subject to the rules described above.
The fundamental tax planning quality of a non-reporting fund is
that a personal tax liability can be deferred until actual
encashment of the shares/units. The deferral period can be
extended tax effectively by transfers between spouses/civil
partners. This may also enable the receiving spouse to use
his/her personal allowance and/or lower rates of income tax to
offset against the taxable OIG.
The March of negative yields continues
(AF4, RO2, FA7, CF2)
As if to coincide with the launch of "Alice Through the Looking
Glass", negative yields have continued to spread through the global
fixed interest markets.
In the News Bulletin covering the period 2 March to 15 March we
commented on the spread of negative yields around the world. At the
time Japan had just issued 10-year government bonds with a yield of
-0.024% and we raised the question of who would buy such bonds
offering a guaranteed long-term loss. The answer is given in the
table below - a canny trader. Japanese 10-year government bonds now
yield -0.17%, so there was a profit to be made by investing back in
In May the stock of global sovereign debt with negative yields
surpassed €10 trillion for the first time, according to Fitch
Ratings. Japan, the biggest G7 debtor, had the largest share and
there were 14 countries with negative government bond yields.
Switzerland's longest dated government bonds, with 21 years until
redemption, are in negative yield territory. Two weeks ago it was
reported that the Swiss National Bank plans to sell a 13-year bond
with a 0% coupon.
Two weeks ago also saw the European Central Bank (ECB) kick off
the next stage of its quantitative easing programme with initial
purchases of corporate, as opposed to government, bonds. The
promise of such a committed buyer has already pushed the market
weighted average yield on euro-denominated corporate bonds below
1%, near record lows. It has also encouraged issues of "Reverse
Yankees" - US corporates, such as Johnson & Johnson, issuing
euro-denominated bonds as a source of cheap financing.
How much lower can yields go? There is no experience on which to
base such an answer and, not so long ago, even the idea of negative
yields would have seemed delusional. One interesting straw in the
wind is a recent Reuters report that Commerzbank, one of Germany's
biggest banks, is examining the practicalities of hoarding cash in
its vaults rather than making deposits with the ECB that earn
-0.4%. This raises a variety of difficult questions, not least how
to insure and transport large volumes of paper money (€1bn in €200
notes weighs about 5.5 tonnes).
So far the UK and sterling have not been touched by negative
yields, although sterling has been weakening. As the table shows,
even though UK government bond rates are at historic lows, gilt
yields are relatively attractive for euro and yen investors.
Nevertheless, UK rates have fallen since the start of the year as
the spectre of US rate rises has receded. If, as press comments
suggest, the Bank of England is looking to cut rates in the event
of a Brexit vote, it has plenty of scope to do so before gilt
yields hit (ironically) European levels.
Updated HMRC guidance issued on RAS reclaims and the
(AF3, RO4, RO8, JO5, FA2, AF3, CF4)
HMRC has issued updated guidance on the operation of relief
at source reclaims, the Scottish Rate of Income tax and the 5 April
guidance for pension scheme administrators operating relief at
source (RAS) tax reclaims has been updated to reflect the two-year
easement for RAS claims at the rest of the UK basic rate and not
the Scottish Rate of Income Tax (SRIT) until April 2018.
The easement currently means, irrespective of there being any
difference in the SRIT with that of the UK basic rate of income
tax, scheme administrators can make their RAS claims on the basis
of the UK rate up until 5 April 2018. Prior to 6 April 2018, HMRC
will make any adjustments that might be needed will be made by HMRC
through the individual's Self-Assessment return or through their
However, from 6 April 2018, scheme administrators and pension
providers will have to make changes to their IT systems and be able
to identify "Scottish taxpayers" so as to enable them to claim RAS
at the correct rate.
P.O. Announces new approach to published
(AF3, RO4, RO8, JO5, FA2, AF3, CF4)
Pensions Ombudsman Service has recently announced new
approach to published decisions whereby they will also publish
certain adjudicators opinions.
The Pensions Ombudsman Service has announced that it has begun to publish
opinions issued by its adjudicators as well as formal Ombudsman
Opinions will be published on the Pensions Ombudsman Service
website if they are appealed to the Ombudsman or Deputy Ombudsman
or are considered to be of interest. The Ombudsman Service has also
introduced anonymisation for all new published decisions, meaning
that the names of complainants and any other identifying personal
data will generally be removed.
Claire Ryan, Legal Director at the Pensions Ombudsman Service,
said: "The publication of a wider range of our decisions reinforces
our intention to be open, transparent and accountable to the
public. Our new policy on anonymisation reflects the prevailing
approach of dispute handling schemes towards increased protection
of personal information, while maintaining transparency in
demonstrating our work and findings and giving guidance to the
industry and consumers."