Tech talk

Budget - Trust Changes - TT17/06

TechTalk TT16/06 contained details of the Chancellor's Budget announcement that for trusts established on or after 22nd March 2006 (and additions of new assets to existing trusts) then it will no longer be possible to create a Potentially Exempt Transfer (PET) via an Accumulation & Maintenance trust or an Interest in Possession trust; unless the trust is established for a disabled person.

For investment bonds, we offer a range of Interest in Possession trusts. A common use of these was to create a PET typically with the Flexible Gift Trust or the SPILA Estate Planning Trust (Discounted Gift Trust). This TechTalk will consider how the proposals will impact on these arrangements where transfers now create chargeable transfers rather than PETs.

The new regime combines

• An immediate "entry" charge of 20% on lifetime transfers that exceed the IHT threshold into 'relevant property' trusts
  
• A 'periodic' tax charge of 6% on the value of the trust assets over the IHT threshold once every 10 years
  
• An 'exit' charge when funds are taken out of a trust between 10 year anniversaries.

(The annual exemption is ignored in the following examples).

Scenario 1

Single person who has made no previous gifts transfers £250,000 into a flexible gift trust on 1st May 2006. No access is retained by the client to the trust fund.

In 10 years time, no withdrawals have been taken, and the trust fund is valued at £450,000 with the NRB at that time £380,000. Assume then, that £50,000 is paid out of the trust just over 12 years after inception.

The initial gift of £250,000 will be a chargeable transfer but no immediate IHT is payable since the cumulative gifting total is below the Nil Rate Band (NRB).

Initial Reporting

Completion of Form IHT100 is required to inform HMRC about the gift. This is required within 12 months from the end of the month in which the transfer occurred.

This would only be unnecessary where the amount of the gift and other chargeable transfers made by the individual in the same tax year does not exceed £10,000 and the amount of the gift and any other chargeable transfers made by the individual in the ten year period ending on the date of the gift does not exceed £40,000.

Form IHT100 is the main form of account, and where a gift is being made, then completion of Event Form IHT100a is also required. Also, IHT 100 asks "were any insurance policies included in the transfer?" If the answer is 'yes', then Supplementary Page D43 also requires completion.

In the future (1st May 2016)

The 10 year charge is calculated on the 10th anniversary of the date of commencement of the trust, when the value of all the 'relevant property' in the trust immediately before the anniversary bears the charge.

The rate of tax is 30% of the effective rate applicable to a lifetime charge (20%). The effective rate is determined by reference to:

• Deemed chargeable transfer, and
  
• Deemed cumulative total

Deemed chargeable transfer

In this example, the deemed chargeable transfer is simply the value of the trust immediately before the 10 year anniversary, i.e. £450,000.

Deemed cumulative total

This is found by adding

• The cumulative total of the settlor in the 7 years prior to setting up the trust, i.e. £nil, and
  
• The amount assessed to the exit charge during the 10 year period prior to the 10 year anniversary, i.e. £nil

Rate of 10 year charge at 1st May 2016

Deemed chargeable transfer	£450,000
Deemed cumulative total	-
	£450,000
IHT @ Lifetime rates 20% x (£450,000 - £380,000)	£ 14,000
Effective rate = 14,000 / 450,000 = 3.11%
Rate of 10 year charge = 30% x 3.11% = 0.933%
10 year charge = 0.933% of £450,000	£ 4,200

Note that in such a simple example, the calculation of the effective rate was an unnecessary step; the tax has to be 6% of £70,000.

The fact that a 10 yearly charge is payable in this example must be countered by the fact that the trust fund of £450,000 is not inside the estate of any beneficiary. Under the pre-budget rules, the death of a beneficiary could have given rise to an IHT liability of up to £180,000 (£450,000 @ 40%).

1st June 2018

Assume that £50,000 is paid out of the trust on 1st May 2018.

When property leaves the trust at times other than a 10 year anniversary then the exit charging regime applies. Essentially it is a topping up charge calculated as a proportion of a 10 year charge. (HMRC often refer to it as 'proportionate charge' rather than 'exit charge').

Each year is divided into quarters which means that over a 10 year period there will be 40 quarters. Therefore if the trust is wound up at the end of its fifth year, the exit charge would be 20/40ths of a 10 year charge.

The £50,000 paid out of the trust on 1st May 2018 constitutes an 'exit charge between 10 year anniversaries'. It is calculated as follows:

8/40 x 0.933% x £50,000 = £93

Scenario 2

Single person who has made no previous gifts transfers £350,000 into a flexible gift trust on 1st May 2006. The person makes no further gifts, and dies 9 years later on 1st May 2015 when the trust fund is valued at £590,000. The funds are then paid out to beneficiaries when the NRB is £360,000.

This initial gift will be a chargeable transfer with immediate IHT payable. The transferor is primarily accountable for the tax, but it may also be payable by the transferee (i.e. the trustees in this case). Where tax is paid by the transferor then this also diminishes his estate (as well as the gift itself) and is technically a further transfer of value! This involves what is known as a 'grossing up' procedure which essentially increases the tax bill since the loss to the settlor's estate is more than just the lump sum gift. For the purposes of this TechTalk, we will ignore this complication and assume the tax is not borne by the transferor.

Value of gift		£350,000
NRB		(£285,000)
		£ 65,000
IHT @ 20% =	£13,000

Since the transfer occurred after 5 April and before 1 October, the tax must be paid by the end of April 2007.

Under present law, you do not have to calculate the tax that is due. Instead, the forms as described in Scenario 1 need completion and HMRC will calculate the tax for you (you can however calculate it yourself if you wish, and complete form IHT100WS).

Death of settlor (1st May 2015)

The chargeable transfer made 9 years prior to death is ignored in the IHT calculation. Also, the value of the trust fund is not within his estate for IHT purposes. Incidentally, if death had occurred within 7 years, then IHT would have been payable on the initial gift and taper relief would have reduced any tax due if death occurred between 3 and 7 years after gift.

Funds paid out of trust following death of settlor

This transfer will fall under the rules of an 'exit charge before first ten-year anniversary'. In this example, it is calculated as follows

Deemed Chargeable Transfer (original amount)		£350,000
Deemed Cumulative Total (prior to original gift)		Nil
		£350,000
IHT = £350,000 less £360,000 (NRB) =	Nil

Therefore, no exit charge due.

Scenario 3

Single person made a PET on 1st May 2004 of £200,000. On 1st May 2006 that person then invested £300,000 into a Discounted Gift Trust where the proposed discount calculated actuarially is £50,000. Assume the settlor is still alive at the time of the 10 year charge at 1st May 2016.

The discounted gift of £250,000 will be a chargeable transfer but no immediate IHT is payable since the cumulative gifting total is below the NRB. A PET is ignored in calculating a taxpayer's cumulative total unless and until the individual dies within the seven years following the gift. If the transfer on 1st May 2004 had been a chargeable transfer then it would have been taxed at 0% (within the NRB) but the second transfer would have triggered a lifetime charge since the cumulative total would have stood at £200,000.

If the individual in this example were to die within seven years of making the PET (i.e. before 1st May 2011), then the PET is reclassified as a chargeable transfer made at the date of the gift. The cumulative total of the taxpayer would therefore need to be amended on the basis of a cumulative total of £200,000.

As detailed above, when a chargeable transfer arises, there is a seven year cumulation period running back from it. Accordingly it may be necessary to know what transfers the taxpayer made over a 14 year period! (see example at end of bulletin).

Initial Reporting

As per Scenario 1, despite the fact that no immediate IHT is payable, the chargeable transfer still needs to be reported.

In the future (1st May 2016)

The 10 year charge will then be calculated on the value of the 'relevant property' in the trust at the time. This will comprise the value of the settled property. What is the value of the settled property though?

Within the SPILA Estate Planning Trust the "Settlor's Right", i.e. the right to the future payments is a settlement for IHT purposes. Similarly, the "trust fund" for the beneficiaries will comprise a settlement for IHT purposes. It may be therefore that both "settlements" are potentially subject to the 10 year anniversary charge!

If this is correct, then actuarial valuations would be necessary to determine the value of the relevant property comprising

• the Settlor's right to 'income' and
  
• the value of the beneficiaries interests in the trust.

If the value of 'relevant property' then exceeds the NRB at that time, then the calculation will proceed as per Scenario 1. If below the NRB then no 10 yearly charge will arise.

Graeme Robb -  March 2006

Example: 14 Year Cumulation

Chargeable transfer made in 2000
PET made in 2003
Taxpayer dies 2010

To calculate tax on death estate, period 2003 - 2010 is relevant.

To calculate tax on failed 2003 PET, the period 1996 - 2003 is relevant.

Therefore, in total the period 1996 to 2010 is under consideration - 14 years!