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The aim of the new clause is to ensure that husbands and wives continue to be free of the burden of inheritance tax when they transfer property to each other; to ensure that nothing in the Bill narrows the operation of the long-established spouse exemption from inheritance tax in section 18 of the Inheritance Tax Act 1984; and to ensure that all transfers covered by section 18 before Budget day will continue to be covered, regardless of other provisions in the Bill, including schedule 20. I am not sure that the Government are minded to accept new clause 1, but if they do so, my hon. Friend the Member for South-West Hertfordshire (Mr. Gauke) will wish to move amendment (c). The Opposition are happy to support that amendment, and hope to press the matter to vote, as it has the same general goal as new clause 1, but has more watertight drafting. In the unlikely event that new clause 1 and amendment (c) are accepted there would still be a number of significant problems with schedule 20, to which the Opposition propose to return in Committee.
Mrs. Villiers: The hon. Gentleman makes a very good point, which I have already taken on board. In my view, section 103 of the Finance Act 2005 means that new clause 1 covers civil partners as well. Essentially, section 103 and the related delegated legislation give civil partners in this context the same rights as spouses. If we solve the problem for spouses, we automatically solve it for civil partners, too.
The Opposition believe that it is vital to save the spouse exemption for husbands, wives and civil partners for the reasons that it was introduced in its present form by the Callaghan Government in 1975to reflect society's concern for the welfare of bereaved spouses, and to mitigate severe hardship when matrimonial homes had to be sold to pay the tax bill. There are two new modern reasons to reinforce the need to retain the exemption. The first has already been raised by the hon. Member for Rhondda (Chris Bryant). It is important to preserve the spouse exemption for civil partners, to whom it has only just been granted. As I said, if we are successful today in protecting spouses, section 103 of the Finance Act 2005 will protect civil partners. Secondly, rising house prices, particularly in London and the south-east mean that many more middle-income families are caught by inheritance tax, and could therefore be hit by the changes in the Bill.
"every walk of lifeteachers/nurses/engineers/computer professionals/office workers/ bank staff/engineers/manual workersanyone who lives in their own home in the South of England . . . police officers . . . Civil servants, local government officers, doctors . . . shopkeepers: retired people of moderate means who have been prudent . . . office managers . . . self-employed small business men
Mrs. Villiers: We are not talking about the bands of inheritance taxthat is not the debatebut about new additional and penal inheritance tax charges that will apply to circumstances that are now altogether free of inheritance tax.
However, trusts seldom give rise to any tax advantages whatever; they are generally tax-neutral. As the impressive coalition of professionals campaigning against these measures has pointed out, the trusts penalised by the Bill are generally motivated by unobjectionable non-tax objectives: family and social objectives, which will become prohibitively expensive as a result of the proposed measures.
Since estate duty was introduced in 1894, trusts have received broadly the same tax treatment as outright gifts. For example, under current rules, a gift on a flexible trust to a spouse, with the remainder going to children at the age of 25, is taxed in the same way as an outright gift of the property to the spouse, which is then passed on to her children on her death. Thus, the tax exemption means that no tax is charged on the first death, but the capital is charged at the full rate when the surviving spouse dies and the property passes to the children.
Far from removing some sort of privileged status, as the Paymaster General claimed on Second Reading, the Government are effectively proposing to introduce additional new and penal tax charges on trusts, treating them more harshly than an outright gift. The Chancellor is actually tearing up a 100-year consensus, repeated only recently by the Revenue in its attempt to maintain a tax system for trusts that does not provide artificial incentives to set up a trust, but equally avoids artificial obstacles to using trusts where they would bring significant non-tax benefits.
Before Budget day, section 18 of the Inheritance Tax Act 1984 exempted gifts on trusts to spouses in exactly the same way as the system operated for outright gifts and transfers. Unless the Bill is amended, it will become almost impossible to set up a trust for a spouse without losing the exemption, as it will incur an immediate inheritance tax charge on the death of the first spouse. The spousal exemption will survive only in cases falling under the definition of an immediate post-death interest, complying with six very narrow and restrictive conditions set out in the new section 49A of the 1984 Act, as proposed in schedule 20.
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No one has yet been able to say with certainty how the six opaquely drafted conditions will apply in practice. It seems clear that severe problems will be caused by conditions 1, 3 and 4. Condition 1 states that the gift must take effect by will or intestacy. That means that spouses will no longer be able to set up trusts for one another during their life time without incurring the new charges. A particular concern is that it is not clear that condition 1 will be satisfied where a trust has been established not under a will, but under a pension policy or death in service arrangements, leaving the threat of the new charges applying in those circumstances.
Condition 3 requires that the power to terminate the surviving spouse's life interest is exercised only by the spouse or with the spouse's permission. That sounds technically innocuous, but the net result is that a significant number of trusts created on divorce would fall outside the provisions of condition 3, with the risk of the new charges applying.
Condition 4 provides that the life interest for a surviving spouse will qualify for the exemption only if, following its termination, assets pass absolutely to the beneficiaries. With very limited exceptions, if the property remains in trust after the death of the live tenant, the spouse exemption will not apply. The net effect of those conditions is that, if there is any flexibility in the trust, the spousal exemption is lost and a bereaved spouse or civil partner will face an immediate inheritance tax bill.
Mr. Michael Fallon (Sevenoaks) (Con): Given that we are dealing either with divorce or the death of one spouse, which is more likely to be the man than the woman, is not the net effect of the restrictions effectively to penalise women rather than men?
Because of the rule against flexibility, the spouse exemption will be lost in virtually every case where a trust is set up. Until Budget day, a lawyer who drafted a trust without flexibility might easily find herself on the end of a negligence suit. Indeed, flexibility in trusts has been considered so important that Parliament specifically inserted flexibility into trusts via section 32 of the Trustee Act 1925. The Government's response is to say that if people want to keep their spouse exemption, they can change their wills or vary existing trusts and opt for outright gifts or the restrictive trusts that comply with the conditions that I have just outlined in the new section 49A, but this is not an adequate answer.
The proposals will have a disproportionate effect on many people who, for family reasonsnot for tax reasonsdo not wish to make outright gifts to their spouse. These people face the invidious choice between making arrangements that they believe are inappropriate for their family's welfare, or facing an unwelcome extra tax bill that could require the family home to be sold.
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