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“We know that other parents in Scotland of modest means whose children suffer manic depression or problems such as drug addiction, alcoholism etc. have also set up IIP trusts. We need flexibility from limited funds to care for the surviving spouse as well as for a mentally sick (but not disabled) offspring. We write to ask you to seek to influence the legislation. We are concerned that trusts that have no tax avoidance intention or action will suffer unfairly large taxation...Our sole intention is to provide trustees to regulate my daughter’s income so that she does not make herself destitute by claiming her legal share of assets if they are not protected by an existing IIP trust.”
I hardly think that people in that position can be accused of engaging in a tax dodge, as the hon. Member for Wolverhampton, South-West (Rob Marris) suggested. Unless amended, the Bill will impose a 20 per cent. tax charge on capital plus a 6 per cent. tax charge every 10 years on a trust of this nature set up for a vulnerable person. The definition in the 2005 Act was subject to 12 years of consultation. It has a wide range of support among groups working with people with mental health difficulties, and I appeal to the Government to accept its incorporation into the Bill.
Turning to the second limb of the section 89 definition, the Low Incomes Tax Reform Group and its influential coalition point out that the benefits-related test is a very blunt instrument. In many cases, people with serious disabilities will not qualify for the middle or highest rate care components of disability living allowance as required by section 89. To qualify even for the middle rate—here I respond to the intervention by the hon. Member for Wolverhampton, South-West—someone must be so severely disabled that they require frequent attention or continual supervision throughout the day or night. In particular, the provision excludes beneficiaries under trusts set up for personal injury damages or to cover money from disaster funds, who may have a high mobility component and a lower care component of DLA—in other words, they may need an hour’s care a day or more but not frequent or continuous care. Surely such cases, where for example personal injury damages have been obtained, are exactly the type of situation in which a trust can be most useful, in that a large cash sum is received that has to be managed carefully to provide for the rest of the beneficiary’s life. Again, the Government want to slap a 20 per cent. up-front charge on those damages and a 6 per cent. charge on capital every 10 years. As the Society of Trust and Estate Practitioners points out, such people can ill afford to pay those new charges since the quantum of damages awarded to them has been carefully assessed to meet their needs for the rest of their life.
We should remember that the sums involved in such damages settlements and court cases are likely to be very significant. As they are intended to cover the rest of the claimant’s life, with the high cost of living with disability factored in, they may well exceed the inheritance tax thresholds. The Opposition have tabled cautious amendments to extend the scope of section 89 as regards those who can claim the lower rate of the care component. That would embrace many more disabled people. We urge the Government to accept those amendments in order to seize this last opportunity to prevent schedule 20 from penalising some of the most vulnerable and disadvantaged people in our community.
4.15 pm
Rob Marris: I declare an interest, in that I used to work for Thompson’s personal injury solicitors, who give money to my constituency Labour party. I point out to the hon. Lady that under her amendments some personal injury victims would get a windfall. When their awards were calculated the then tax regime would have been taken into account, and if she then ameliorated the tax regime, those individuals would get a windfall. Secondly, the Government are, rightly, encouraging PI victims with large settlements to take them as a series of staged payments, to put it in the vernacular, rather than in one large lump sum.
Mrs. Villiers: The point is that the courts have not taken the new tax regime into account. The changes will impact on existing trusts, so, far from a windfall, there will be a tax penalty. Even if the courts had been sharp enough to say, “We will look at what is in the Finance Bill and start tailoring compensation awards accordingly,” how are they supposed to know how the legislation will turn out? Only two days ago, the Government were still tabling amendments. They have tabled 50 amendments to schedule 20. It is completely impossible for any court in a PI case to have tailored its settlement to take into account the current tax regime because, quite frankly, no one knows what it is. The hon. Gentleman may shake his head, but he knows that that is a valid point. [Interruption.] Indeed, the Government have been making it up as they go along.
That brings me neatly to insurance, and a prime example of how the Government have been making it up as they go along. It has been a problem for them ever since they slipped out Budget note 25. They simply did not think through the impact of schedule 20 on millions of people who hold life insurance policies in trust. Writing insurance policies into trust has been considered best practice for many years because it means that money can be paid out to the family swiftly in the event of tragedy, without lengthy delays waiting for a grant of probate. It also means that it is simple and easy to change the beneficiaries under a policy to take account of changing family circumstances.
Data from the Association of British Insurers suggest that there are 22.5 million single premium and regular premium life policies in force, and anecdotal evidence indicates that about 20 per cent. are written in trust. The ABI estimated that about 4.5 million policies may have to be reviewed as a result of schedule 20. The families affected would be faced, at worst, with the threat of a punitive new tax bill, and at best with the need to review and amend their policies. Prudential and Standard Life both suspended the sale of life policies under trust because of the uncertainty surrounding the Finance Bill.
Initially, the Government’s reaction was denial. They denied that there was a problem. They issued a guidance note and dismissed the furore as scaremongering. However, following the Bill’s publication, it was clear that there was no specific exclusion for life policies. Kevin Martin, the Law Society president, confirmed that millions of life policies would still be caught. Julie Hutchinson of Standard Life expressed the concerns of many when she said:
“We’re extremely disappointed that the clear statements in the guidance note are not carried into effect in the bill itself and will be making further representations via the ABI on this retrospective effect issue”.
The concerns that I set out on Second Reading were brushed aside, then a few weeks later, in Committee, the Government suddenly tabled a set of deeply obscure and complex amendments. Although I welcome the Government’s change of heart on that, as on so many other aspects of schedule 20, a number of serious problems remain. As Colin Jelly of Skandia Life pointed out, the Government’s amendments in Committee were only a small, albeit a welcome, step in the right direction. He said:
“A significant number of people are still likely to be affected by the changes and the government is doing nothing more than tinkering at the edges of the proposed legislation.”
The carve-out introduced by the Government in Committee does not cover all pre-Budget day policies. It therefore contravenes the Treasury’s guidance note of 7 April and the statement made to the House by the then Chief Secretary on Second Reading that
“no one who wrote a life insurance policy in trust before Budget day will have to pay a new inheritance tax charge as a result of these changes.”—[ Official Report, 24 April 2006; Vol. 445, c. 369.]
This statement is still not true. The new charges will still apply to pre-Budget day policies where there is a change of beneficiaries, except where that change results from death. If, for example, a new baby is added to a policy, that will amount to a new settlement and will trigger the new penal schedule 20 regime. Furthermore, where an interest in possession is removed from someone who remains a beneficiary, the new reservation of benefit rules in paragraph 33 of the schedule mean that the trust could be liable for a 40 per cent. inheritance tax charge on the death of the former life tenant.
Because of those gaps in the protection provided by the Government amendments that were made in Committee, substantial numbers of people—perhaps millions—will have to review their policies. Even more worryingly, the Government’s climbdown in Committee does nothing to assist life insurance policies written into trust after Budget day, all of which will be subject to the new regime and charges. Having originally thought that no policies would be affected at all, the Government appear to be happy that some policies will be caught by the new charges from now on. Almost by accident, they have proposed to introduce significant new taxes on life insurance policies that will operate in an arbitrary way when the 6 per cent. charge is levied on the 10-year anniversary of the trust.
Sir Nicholas Winterton: Why does my hon. Friend think that the Government are against saving, which is for the benefit not only of an individual family but of the country? The measures appear to accuse people of avoiding inheritance tax—I personally believe that inheritance tax is a pernicious second tax, which I would abolish altogether—but why is it wrong to save for insurance policies related to a trust?
Mrs. Villiers:
To be fair to the Paymaster General and the Government, I do not think that they are actively against saving, and I do not believe that their
motivation in schedule 20 is to try to discourage saving. However, the reality is that the new charges are a tax on thrift, prudence and responsible behaviour, which is why the Opposition oppose the new inheritance tax charges.
Dawn Primarolo: But does the hon. Lady agree with her hon. Friend the Member for Macclesfield (Sir Nicholas Winterton) that inheritance tax should be abolished—yes or no?
Mrs. Villiers: We have made it clear that we are not making promises to cut taxes at present. We accept the long-term importance of reductions in taxes, but—
Mrs. Villiers: I will give way to the right hon. Lady in a moment.
We have promised to share the proceeds of growth between real increases in public spending and reduced borrowing and taxes over the economic cycle.
Dawn Primarolo: If the hon. Lady is not making any commitments at all, bearing in mind what her hon. Friend the Member for Macclesfield said about abolishing inheritance tax, will she give him an undertaking that she will consider the matter and inform him and the House in due course?
Mrs. Villiers: Our tax reform commission is looking at all those issues, and it will report very soon.
We are not discussing the current inheritance tax regime, however, but penal new inheritance tax for people who use trusts to provide responsibly for their future and for the future of their family. The new taxes will operate in an arbitrary way, because the value of the life insurance policy —[ Interruption. ]
Mr. Speaker: Order. The Economic Secretary should not interrupt the hon. Lady, because it is unfair.
Mrs. Villiers: Thank you very much, Mr. Speaker.
Sir Nicholas Winterton: I am not seeking a commitment from my hon. Friend that we should abolish inheritance tax. I was expressing a view as an independent Conservative—the tax is pernicious, and we should consider abolishing it in due course—but I was not asking her to give a commitment.
Mrs. Villiers: I am grateful to my hon. Friend.
Returning to the subject of the debate, the arbitrary operation of schedule 20 in relation to life insurance policies arises because those policies depend on the health of the person insured. They have virtually no market value unless the insured person is very ill or terminally ill. If the 10-year anniversary occurs when they are fit and healthy, the value of the policy is minimal, and inheritance tax is not payable, because its value is likely to be below the nil rate band.
If, however, the insured person becomes seriously or terminally ill just before that 10-year anniversary occurs, that could push the value of the policy above the threshold and the IHT charge will apply. At this point there is no property in the trust to pay the tax, and the insured person faces an unwelcome extra tax bill at a time when their possibly terminal illness presumably means they are too ill to work. Remember, the proceeds generated by such policies must be very considerable to give bereaved families a sufficient income on which to live, so it is entirely possible that a tax charge will be triggered in this situation. Not only is schedule 20 a tax on prudence, but in this instance it is a tax on terminal illness as well.
Opposition amendments Nos. 3 and 4 would take policies such as term insurance, whole life insurance and critical illness cover out of the scope of the new charges. The amendments are drafted to take out policies that insure against a specific risk or tragic event, such as early death or critical illness hitting the family’s principal breadwinner. They are designed to leave other insurance policies, which are essentially savings-based, within the new schedule 20 framework. The ABI expressed support for similar amendments tabled in Committee, stating:
“We are particularly concerned about the impact”—
“on individuals buying life insurance to protect dependants from financial hardship following death or serious illness...It is important that people should be encouraged to take financially responsible steps to protect their dependants from hardship in the event of a tragedy. The tax system should not create disincentives for prudence by introducing unnecessary tax charges. Life insurance offers valuable financial protection for individuals and their family in the event of an early death or serious ill-health, which can have dramatic adverse consequences particularly if the life insured is the main or only income provider. It provides the means for those even on modest incomes to be self-reliant and not dependent on the state for hand-outs.”
John Bercow: Naturally, we await the Paymaster General’s response with eager anticipation, bated breath and beads of sweat upon our brows, but as I hear my hon. Friend develop the argument against the measures that the Government are proposing, it beggars belief that Ministers can propose a manifestly callous and mean-spirited provision. Was it dreamed up by some parsimonious official or is it the preferred position of members of Her Majesty’s Government?
Mrs. Villiers: No doubt the Paymaster General can respond for herself, but I fear the Government did not think through their proposals or did not understand their consequences.
Most people in Britain are hopelessly underinsured. Those who insure are far less likely to fall back on benefits and state support than those who do not. Slapping arbitrary punitive new taxes on those who seek to make provision for death or serious illness to the main breadwinner makes no sense. It penalises thrift and prudent behaviour, and we hope the Government will support our amendments.
The last set of Opposition amendments would remove the threat that an increased tax bill could be added by schedule 20 to all the other unhappiness that
occurs in divorce cases. I refer to Mr. Ian Buckley of Rathbone solicitors, who explains the problem as follows:
“The current trend of family breakdown and multiple marriages has resulted in the increased use of trusts. They provide a fair and workable solution in the division of assets in circumstances of both death and divorce. They are widely used in the divorce courts and the inflexible arrangements in the new rules outline will be a poor substitute.”
Following the raft of Government amendments moved in Committee, the Chartered Institute of Taxation states:
“Overall we give the changes one and a half cheers—there are still things to be done. We now need the Government to show they have listened to all of our arguments about the defects in these proposals, and to make similar changes”
where schedule 20 impacts on divorce.
In this context, trusts are used to give the spouse with the main child care responsibilities the right to live in the family home until the children finish their education. At this point the home is sold and the proceeds divided between the former spouses. Such arrangements will be protected from the 20 per cent. entry charge of schedule 20 by section 10 of the Inheritance Tax Act 1984, but not from the 6 per cent. periodic charge.
The Treasury seems to assume that everyone can have a clean-break settlement. If they are able to do so, most people will indeed prefer a clean-break settlement for various reasons, emotional as well as financial. However, not everyone can afford a clean-break settlement. Trusts are an invaluable aid in making the assets of one household stretch to cover two. The people who will be penalised in this context, as in all the other contexts where schedule 20 applies, are those who have sufficient assets for them to come within the inheritance tax net, but not enough for them to have sufficient capital to spare for outright transfers and a clean-break settlement—the sort of people of modest means who have been hit all too often by the Chancellor’s stealth taxes.
Remember that we are referring to homes here, and in many cases, particularly in London and the south-east, the value of those homes will exceed the inheritance tax threshold.
Mr. John Redwood (Wokingham) (Con): My hon. Friend makes a good case for there being a number of great difficulties that vulnerable people will face as a result of this legislation. Would it not be easier for the Government just to drop all these proposals on trusts and go back to where we started?
4.30 pm
Mrs. Villiers: That would indeed be a highly desirable result and the Government still have the opportunity to do that if they so wish. I certainly hope that they do. This is the Minister’s last chance to save divorcing couples and people in a civil partnership facing relationship breakdown from an unwelcome new tax charge, and I hope that she will seize that opportunity.
The Government went badly wrong with schedule 20. Their preconceptions about trusts and the people who use them were fraught with misunderstanding
and, frankly, with prejudice. The Star Group of solicitors, expert in the field of trusts, points out the simple truth that has somehow eluded the Government, that
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