When we were originally setting up nil rate band discretionary trusts, before the transferable nil rate band came into effect, many were set up by way of equitable charges or loans, where the surviving spouse had property transferred to them, subject to the equitable charge. Under the terms of the equitable charge, index linking could be charged. Originally, the understanding was that if you index link the loan, capital gains tax would be payable but this would be at 28%. The Revenue challenged this and we were waiting on a test case where they were saying that income tax would be charged. In the event that it is income tax charged at 40% then it would not be worth imposing index linking, as it becomes the same as inheritance tax. My understanding was that the test case was never finalised (as in the family did a deal with HMRC) but I am not entirely certain and I have case now of an estate with an equitable charge where I need to decide whether to impose the index linking or not. Do you know whether any guidance has been issued by HMRC or know of anything which could assist me?
James Kessler QC and Charlotte Ford devote Appendix 4 of the latest (13th, December 2016) edition of Drafting Trusts and Will Trusts to this particular topic. They conclude “For (the reasons set out above) there is in our view no tax on the payment of the index-linked sum”, identifying that HMRC has backed down on challenges, perhaps due to the fact that only “small” amounts of tax have been at stake in any one case. However, JK & CF also observe “we are no closer to a judicial resolution of this issue”.
If HMRC are challenging a document drafted in the form in their book, JK & CF suggest a course of action.
These extracts need to be considered in the context of the Appendix as a whole, but indicate that, whilst the issue remains unresolved, HMRC might not have the appetite to pursue the question.
It strikes me that in many of the discussions around NRB trusts comprising an index-linked charge questions on taxation dominate, even where, say, the widow is not the mother of the other objects of the trust, such as the deceased’s children (e.g. she is a second or subsequent wife). It may be that in those cases discussed (on this forum) there is no conflict between the interests under the NRB trust and the surviving spouse/civil partner’s estate. Where this (e.g. the beneficiaries of the widow’s estate are the same as those who are intended to benefit under the NRB trust) is not the case, the question of taxation should be a secondary consideration. Any waiver of the contractual benefits under the charge will, in my example, benefit the widow’s own beneficiaries at the expense of the beneficiaries of the discretionary trust. This can lead to criticism of the trustees, especially if the relationship between the widow and the other objects of the NRB trust are strained.