Taxation of Trusts

Question 1

Why are investment bonds such popular investment for trustees?

Answer 1

Because they are not deemed to be ‘income producing’ assets.

‘Income’ paid is treated as a return of capital, with 5% per annum cumulatively allowed on a tax deferred basis.

Question 2

There are downsides to life assurance-based investment bonds in trusts as well, mainly:

Answer 2

No scope to use either the beneficiaries’ or trustees’ annual CGT exemption, as CGT is not charged on investment bond gains.

No scope to use the beneficiaries’ dividend allowance (which may be available on income from certain trusts) as investment bonds do not pay out dividends.

Question 3

State X’s duties as a trustee under the Trustee Act 2000.

Answer 3

• Exercise reasonable care and diligence/duty of care/use care and skill that is reasonable/acting as a
  prudent businessperson.
• Ensure they are registered as the legal owners.
• Read and understand the trust deed/comply with terms of trust.
• Act impartially between the beneficiaries/in the best interests of all beneficiaries.
• Taking into account the tax position of the trust and the beneficiaries.
• Avoid conflicts of interest/keep own finances separate.
• Duty to invest any cash received into the trust appropriately, unless it is being paid out immediately.
• Invest trust money properly/standard investment criteria/taking advice/ diversifying.
• Monitor/review investments regularly.
• Keep proper accounts of all trust property/accurate records.
• Use the utmost diligence to avoid any loss/protect the trust property.
• Pay tax/self-assessment/tax enquiries/HM Revenue & Customs dealings.

Question 4

Outline to your client the investment duties of a trustee

Answer 4

• They should obtain and consider proper advice if they do not have the skills themselves.
• They have a duty of care to invest the assets as if they were their own, in the best interests of the beneficiaries.
• They need to take note of the standard investment criteria.
• Considering the suitability of the investments held in the trust.
• Ensuring that they are sufficiently diversified.
• There is a need to monitor and regularly review the investments.
• And make changes to the investments if appropriate to rebalance.

Question 5

One of the trustees believes that his fellow trustee is loosing mental capacity, and is wishing to step down from trustee duties. Explain in detail the actions he should take in order to achieve this.

Answer 5

• If mental capacity is maintained, then both trustees can retire as trustees.
• They would do this by executing a deed of retirement.
• If mental capacity is lost, the remaining trustee can remove and replace the trustee using powers given under the Trustee Act 1925 Section 36.
• If no trustee appointed, one can be appointed by the court.
• The trust cannot be left without a trustee.
• A new trustee would need to be appointed.
• Or a corporate trustee could be used.
• If there is land within the trust, then there must be at least 2 trustees unless using a corporate.

Question 6

What is meant by Absolute interest

Answer 6

The beneficiary has the beneficial ownership of both income and capital that cannot be altered

Question 7

What is meant by life interest

Answer 7

*They have a life interest, where the beneficiary is entitled to the income from, or the use of, the trust property but no the capital.
*They are are known as the life tenant.

Question 8

What is meant by Remaindermen

Answer 8

*The remaindermen are who the property passes to after the death of the life tenant.
*The life tenant’s interest could also end as a result of certain actions (for example if the life tenancy was set up in on the basis for m widow, unless or until she re-marries)

Question 9

What is meant by contingent beneficiary

Answer 9

*Is a beneficiary whose interest depends on the occurrence of a particular event, so they may in fact never benefit

Question 10

What are the conditions for the terms of a bare trust to be broken?

Answer 10

*All the beneficiaries can be ascertained.
*There is no possibility of further beneficiaries, so in an “all my children trust”, need to be sure that no more kids are expected or are as-yet unidentified.
*All the beneficiaries are of full age and capacity; no one under 18 or with mental capacity issues.
*And there is unanimous agreement of all the beneficiaries, so sibling disagreements won’t work here.

Question 11

What are the three certainties that must be present for a Trust to be created?

Answer 11

Words, Subject Matter, objects

Question 12

For a Will to be valid, it must normally be made by someone who is, what?

Answer 12

• over 18,
• of sound mind and
• under no pressure to make the Will.
• It must be in writing and
• signed
• in the presence of two independent witnesses,
• who must also sign.

Question 13

What are some problems of someone not having a Will?

Answer 13

*The deceased’s wishes are not catered for.
*The care and custody of minor children is not arranged.
*It can be inefficient for IHT purposes.
*Not all assets necessarily go to the spouse.
*For assets that pass to the spouse, there is no control over who will get the assets once that spouse dies, so children from a former marriage may miss out.

Question 14

How can a Will be revoked?

Answer 14

At any time by the person who made it, as whilst they are still alive it hasn’t come into force. They do this by either deliberately destroying it, or by making a new Will that states that all previous Wills are revoked.

Getting married or entering a civil partnership will also generally revoke a Will, unless there is a statement to say that the Will was made in consideration of marriage or partnership

Question 15

What effect does divorce have on a Will?

Answer 15

A divorce however will not revoke a Will. However, it will remove the ex-spouse as an executor and beneficiary, so any amount that would have gone to them would be distributed in accordance with the rest of the Will. All other elements will remain valid.

Question 16

What are the laws of intestacy where there are spouse/civil partner but no children

Answer 16

spouse/civil partner inherits everything

Question 17

What are the laws of intestacy where there are spouse/civil partner and children

Answer 17

Spouse takes chattels, £322,000 and half residual estate absolutely.

Children take remaining half absolutely

Question 18

What are the laws of intestacy where there are NO spouse/civil partner and children

Answer 18

• Would die intestate/intestacy rules would apply.
• as not married,
• the entire estate would pass to children/wife would receive nothing.
• As the children are minors/under 18,
• the assets would be held on statutory trust
• until they reach 18
• or marry under that age.

Question 19

spouse children and estate is worth £322,000

Answer 19

The husband, wife or civil partner gets all of the estate and is entitled to apply for probate.`

Question 20

spouse children and estate is worth more than £322,000

Answer 20

The husband, wife or civil partner gets:

up to £322,000 in assets, and half of the rest of the estate
all of the personal possessions of the deceased
The children of the deceased are entitled to a share of the half of the estate above £322,000.

Question 21

What is a deed of variation?

Answer 21

If the provisions of a Will or the distribution of assets under intestacy is not what the beneficiaries want or what is most effective for IHT purposes, then one option available is a Deed of Variation which will alter the terms of the distribution of assets.

Question 22

For a deed of variation to be used, there are several conditions that need to be met.

Answer 22

*All affected beneficiaries are over 18 and of sound mind.

*To be effective for IHT purposes, it must refer to the Will or intestacy being varied, It must be signed by all those who would or might have benefited from the original provisions (So that is anyone who is losing out due to the changes).

*It must be done within two years of death.

*There must be a statement that the variation is to have effect for IHT as if the deceased had made it.

*If the variation increases the amount of IHT payable, the deed must also be signed by the persona representatives (they can however only decline to sign if they don’t have sufficient assets to pay the additional tax).

*There must be no consideration for money or money’s worth (so no one can be paid off to make the change).

Question 23

What is the income tax impact if a parent uses a deed of variation to pass grandad’s money directly to the grandchildren?

Answer 23

If the child was a minor then a parent giving up their inheritance so that their child could benefit, would be caught by the income tax parental settlement rules, and any income received over £100 would be taxed on the parent.

To avoid this situation, where the changes are going to cause either income tax or CGT implications, then there may need to be a separate statement in the deed of variation, to ensure that it affects those taxes too.

Question 24

Difference between disclaimer and deed of variation

Answer 24

Rather than in a deed of variation where you are able to rewrite the rules and decide who gets the property, under a disclaimer, the property is just put back into the pot, and will go to whoever is next in line by virtue of the Will or intestacy. This means that the person giving up the inheritance has no choice of who will inherit the legacy.

Question 25

What do the executors of a Will/estate otherwise known as personal representative do?

Answer 25

*Administer the estate
*Collect any debts
*Pay the IHT
*Distribute the assets in accordance with the instructions in the Will.

Question 26

What enables an executor to administer the estate?

Answer 26

The executors must prove the Will in the Probate Registry to obtain a grant of probate. This enables them to administer the estate.

One of the key elements that is needed before probate to be granted, is that any IHT must have been paid.

Question 27

If there is no Will, what is the name of the person who administers the estate and what do they need to acquire to provide authority?

Answer 27

The Administrator

They would also need to approach the Probate Registry, but this time they would get a grant of letters of administration once the IHT had been paid.

Question 28

What are the features of a Bare trust?

Answer 28

*Also known as an absolute trust
*Beneficiary has immediate right to capital & income held in the trust.
*Beneficiaries cannot be changed.
*Commonly used to hold assets transferred to minors, which they can access at 18.
*Hold assets for specific individuals for a specific time period.
*Benefits are taxed on the beneficiary tax position, so can use the beneficiary’s available allowances and exemptions.

Question 29

What are the features of a Vulnerable Beneficiary Trust

Answer 29

*Trust set up for disabled persons who cannot look after their own affairs, or those classed as vulnerable.
*Vulnerable beneficiaries are either disabled persons, or what are known as relevant minor children.
*Trusts have special tax status. The end result is hat the benefits are taxed based on the beneficiary’s tax position, and the trust can go on past the age of 18.

Question 30

What are the features of a life interest and interest in possession trust?

Answer 30

*The beneficiary has an immediate and automatic right to the INCOME from the trust, or USE of the trust assets, for the remainder of their life or until a specified event.
*This income beneficiary or life tenant often have no rights over the capital held in the trust.
*Rights to capital usually revert to others, known as remainderman.

Question 31

what are the features of a flexible trust

Answer 31

*present right to income or capital from the trust, however the trust is flexible, so the beneficiaries can be changed.
*Set up with a default beneficiary, who will benefit from the trusts assets.
*Also be potential beneficiaries.
*Date of 22nd March 2006 is important for these trusts, as prior to this date transfers in would have been a PET, post this date they are a CLT.

Flexible trusts are similar to a fully Discretionary Trust, except that alongside a wide class of potential beneficiaries, there must be at least one named default beneficiary. Flexible Trusts with default beneficiaries set up in the settlor’s lifetime from 22 March 2006 onwards are treated in exactly the same way as Discretionary Trusts for Inheritance Tax purposes.

Different Inheritance Tax rules apply to older Trusts set up by 21 March 2006 that meet specified criteria and some Will Trusts. All post-21 March 2006 lifetime trusts of this type are taxed in the same way as fully Discretionary Trusts for Inheritance Tax and Capital Gains Tax purposes.

Question 32

What are the features of a discretionary trust

Answer 32

*There is initially no beneficiary entitled to the income or capital from the trust, but potential beneficiaries that can benefit if the trustees decide.
*The trustees have full discretion as to how to use the trust income & capital.
*There are generally several potential beneficiaries available to receive benefits from the trust, at the discretion of the trustees
*Some trusts dictate that income must be paid to certain beneficiaries, but the trustees retain discretion as to how and when to pay.
*These types of trusts have always been classed as CLTs at outset.

Question 33

Explain briefly the Income Tax implications of establishing a discretionary trust using a Deed of Variation (DOV).

Answer 33

• A beneficiary who sets up a Discretionary Trust by means of such a deed will be treated as the “settlor” for the purposes of income tax.
• As the trust is deemed to be settlor interested for Income Tax purposes
• any income received into the trust will be taxed at settlor’s rate of Income Tax
• whether they receive it or not.
• Can use the PSA and Dividend Allowance (DA).
• The trustees pay tax at the trust rates on behalf of settlor.
• Settlor receives a tax credit/Income Tax could be recovered from HM Revenue & Customs (HMRC).

Question 34

Explain the IHT implications for the settlor and deceased’s estate if a discretionary trust is established using a DOV.

Answer 34

• Settlor is not treated as having made a transfer of value for IHT.
• The transfer is treated as if it had come directly from deceased’s estate for IHT purposes.
• A discretionary trust cannot benefit from a RNRB
• as the trust property will not pass to a direct descendant.
• Increased IHT liability on deceased’s estate.

Question 35

What are the features of Accumulation and maintenance trusts

Answer 35

*There is a special type of discretionary trust.
*It used to enjoy beneficial IHT treatment.
*No A&M trusts formed since the financial act 2006 enjoy extra IHT advantages.
*These trusts were used to accumulate income until the beneficiary reached a certain age, which couldn’t be later than 25.
*The funds could also be used to pay for the maintenance, education or for the benefits of the beneficiaries.
*Prior to 2006 they used to be PETs, but would not be CLTs

Question 36

What are the conditions for a Married Woman’s property act trust to apply?

Answer 36

The policy within this trust must be a life assurance policy, taken out by either a man or woman on their own life on a single life basis. The policy must be for the benefit of a spouse, civil partner, or children of the assured.

Question 37

Benefits of a MWPA trust?

Answer 37

Trusts often protect the assets from creditors in the case of bankruptcy, however, most trusts can still be challenged if it is thought that there was intention to defraud the creditors.

The MWPA however is unique in that a policy within a MWPA trust can’t be challenged by the Trustee in Bankruptcy, so has complete protection from creditors.

Question 38

Why is the 22nd March 2006 important?

Answer 38

This was a date that what is now known as the relevant property regime was introduced.

Question 39

Not in the regime?

Answer 39

Immediate post death interest trust.

Interest in possession trust created before 22nd March 2006

Bare trusts

Disabled trusts

Question 40

What is in the regime?

Answer 40

*Interest in possession trusts, created by lifetime transfers on or AFTER 22ND MARCH 2006.
*Flexible Trusts
*Discretionary Trusts

Where a trust is in the relevant property regime, then transfers into these are classed as CLTs.

These transfers may, if they exceed the cumulative value of the nil rate band after any exemptions, be chargeable to lifetime IHT.

As CLTs, the trust is liable to income tax and CGT in its own right and may also be subject to periodic and exit charges.

Question 41

what are the implications of the Regime?

Answer 41

Pre-22 March 2006 the only transfers that counted as CLTs were those to Discretionary trusts. Everything else was either exempt or, for transfers into trusts, a PET.

As 2006 is now most definitely over 7 years ago, these pre-2006 PETs would now be well and truly out of the settlor’s estate for IHT purposes.

The problem occurs if there is a change in beneficiary.

Question 42

Why does a problem occurs if there is a change in beneficiary?

Answer 42

if the flexibility allowed within trusts is used to change beneficiaries, this can create a transfer for IHT purposes; something that was in the estate of one person gets transferred so becomes part of the estate of someone else.

Regardless of the fact the beneficiary is not likely to make the decision to no longer benefit from the trust, it is as if the existing beneficiary is transferring assets to a new beneficiary.

This is a new transfer for IHT purposes. So, trustees making such decisions on these older trusts can affect both the outgoing and new beneficiaries’ estate calculations.

Question 43

This regime is also important to understand whose estate the assets are in…explain this…

Answer 43

Those in the regime are effectively not in anyone’s estate as, although there are potential beneficiaries, until the trustees actually pay out to a beneficiary, the money is within the trust.

Whereas all those not in regime would be within the beneficiary’s estate. So, with a bare trust, although held for administrational purposes within a trust, the money belongs to the beneficiary. If they should pass away, then the full value of the trust would count as part of their estate. It’s the same for all the other not in regime trusts.

Question 44

Tax treatment of Bare trusts, including relevant property regime treatment.

Answer 44

Asset and income belong to the beneficiary.

Any income is therefore taxable as the beneficiary’s income. They can use any relevant allowances, PSA etc.

Lifetime transfers into this type of trust are an out of regime transfer and classed as a PET.

No immediate IHT charge and no liability to periodic or exit charges.

If this type of trust is created on death, then there is no lifetime transfer at all.

Care needs to be taken on who is setting up this trust. If the gift is from a parent to a minor child, and the trust generates more than £100 income in a tax year, this would be taxed on the parent under parental settlement rules.

Question 45

Tax treatment of Life interest / interest in possession trusts trusts, including relevant property regime treatment.

Answer 45

Transfers into new lifetime trusts set up on this basis will be CLTs. What sets them apart from Discretionary trusts is that they have one or more beneficiaries that have a right to the trust income as and when it arises.

For those within the regime (so post 22 March 2006), the income and gains within the trust, are taxed on the trustees.

This tax is paid at basic rate, but these types of trust do not have any personal allowance, PSA, or dividend allowance, so all the income would be taxed at 20% or 8.75% dependent on the source of income.

If they are a basic rate taxpayer, they will have no further tax to pay, however if a higher or additional rate taxpayer, then additional income tax will be payable.

Trustees of these trusts are not liable to higher rate tax no matter how high the income is.

The source of this income is ‘maintained’ - if the income generated within the trust and then paid out interest, then it is treated as interest in the hands of the beneficiary. Vice Verse dividends.

Question 46

For life interest / interest in possession trusts, Is there a way of ‘missing out’ the trust and paying income directly to the beneficiary?

Answer 46

Yes, the income provider (bank, company, fund etc) pays the income direct to the beneficiary.

Question 47

For life interest / interest in possession trusts, what is the treatment of CGT?

Answer 47

For any capital gains made within the trust, the trustees would be liable to pay on any chargeable gains.

Trust can offset gains using CGT allowance which is half of the personal allowance, so £1,500 in 2024/25

taxed at higher rates 20/24

Question 48

What is the CGT treatment of a settlor placing assets into trust?

Answer 48

Transferring assets into a trust is a disposal for CGT purposes for the settlor.

The market value of the assets at the date of the transfer is used to calculate the gain, and therefore the potential CGT payable by the settlor.

However, as we mentioned in the CGT chapter, it may be possible for the settlor to claim holdover relief to avoid a tax liability arising at that time.

Question 49

For a qualifying IPP trust, how is CGT treated on the death of the beneficiary?

Answer 49

• There will be no CGT liability.
• The base cost of the assets will be reset to the market value
• on the date of death.
• If the trustees sell assets within the trust following death
• this would be subject to CGT
• if the gain exceeds the trustees annual exempt amount.

For qualifying IPPs the trust assets are treated as if they belonged to the life tenant.

Question 50

What is holdover relief?

Answer 50

No CGT becomes payable at the time of the gift. The payment of the tax is deferred until the ‘new’ owner disposes of the asset. It effectively means that the new owner uses the original owner’s acquisition cost when working out the gain when they themselves dispose of the asset.

Another way of looking at it is that the acquisition cost of the receiver is lowered by the amount of the held-over gain.

Holdover relief can be applied more than once!

Holdover relief is available for any property being placed into trust (but not into bare trusts) and was available before 22 March 2006.

Question 51

How is holdover relief used when assets leave a trust to the hands of the beneficiary?

Answer 51

This possibility of deferring tax also applies to the trustees when assets are transferred to a beneficiary. For this, the holdover election must be made jointly by the trustees and the beneficiary.

Question 52

What is an Immediate post death interest in possession trust / Will trusts

Answer 52

As we covered earlier, an immediate post death interest in possession trust or IPDI trust only comes into force on death, and therefore is not a lifetime transfer. It is often brought into force due to a Will, hence its other name of a Will trust.

In many ways, an IPDI is like a ‘normal’ interest in possession trust.

The key for an IPDI is it is not part of the relevant property trust regime, so does not have any periodic or exit charges, and the value of the trust is in the life tenant’s estate on their death (think about married couple, husband’s estate passed to wife, house in trust for benefit of kids, but forms part of her estate).

As no lifetime transfer of the assets has happened, none of the nil rate band or residence nil rate band has been used, so these are still able to be used. Also, the transfer of first spouses’ band can be used on second death.

Question 53

What is the non-IHT consideration surround Will Trusts and tenant’s in common?

Answer 53

In our earlier example, Blake and Monika had their property set up as tenants in common, then used a Will trust to pass their half to their children, whilst allowing the surviving spouse to stay in the property until death.

This has the effect that the surviving spouse legally does not own the property outright; it is jointly owned with the trustees. This makes it difficult for local authorities to force a sale in the event of needing to pay for long term care, as the individual only owns half a house.

Question 54

Tax treatments of discretionary trusts?

Answer 54

Transfers into discretionary trusts have always been CLTs.

Trustees are responsible for declaring and paying income tax on income received by the trust.

For income tax the trust has an ‘income exemption’ which as shown on the tax tables is £500 for this tax year.

After this initial income, then the rates charged jump immediately to additional rates i.e., 45% or 39.35%.

The first thing to note is that trustees of a discretionary trust must have paid 45% income tax on any income before they distribute it.

Even if the income came into the trust as interest or dividends, that’s not what it is when it’s paid out. In effect, it loses its original nature, and instead is paid out as trust income, net of 45% and with a tax credit for the amount paid.

Because it is not divided into our ESDL classifications, it means that the beneficiary is not able to set this income against any of their allowances.

Where the trustees have paid less than this, as they may have with the standard rate band or having some dividend income, then they need to make an additional tax payment just before they issue the income to top up the tax paid to 45%. They can allocate the funds with the full 45% tax credit.

45% tax credit is given whether it is divs or income. The transfer of assets into and out of trust will be a disposal for CGT, but tax may be deferred using holdover relief

The beneficiary can reclaim some of this tax if they are not an additional rate taxpayer, and their personal allowance can be used in this calculation.

CGT is 20% (24%), have 50% Annual Exemption, can use hold over relief.

Question 55

The Jones family discretionary trust pays out the following income:

£2,000 rental income
£900 dividend income

What is the income tax paid by the trust and what is the tax credit available to the beneficiary?

Answer 55

As the trust generated more than £500 of income, the income exemption is not allowed.

£2,000 at 45% = £900
£900 at 39.35% = £354.15

Total tax paid = £1,254.15
Net income available = (£2,900 - £1,254.15) = £1,645.85.

Net income paid to the beneficiary is £1,645.85 with a 45% deemed tax credit.

This makes the gross payment £1,645.85 / 0.55 = £2,992.45 with a tax credit of (£2,992.45 * 0.45) = £1,346.60.

This tax credit is (£1,346.60 - £1,254.15) £92.45 less than paid, therefore the trustees will have to find the cash to pay this to HMRC.

Question 56

Who can qualify for a vulnerable/disabled trust?

Answer 56

Relevant minor:

*A child who has not yet attained the age of 18 and at least one of whose parents has died.

Disabled person:

*A person unable to administer their own property or manage their affairs because of a mental illness within the meaning of the mental health act 183.
*A person in receipt of either attendance allowance or disability living allowance based on entitlement to the mobility component at the higher rate.
*Any person receiving personal independence payment.

Question 57

How would a trust secure the favourable tax treatment of a vulnerable beneficiary trust?

Answer 57

Both the trustees and vulnerable person (or their attorney) must make a joint election not more than 12 months after the 31 January following the end of the tax year concerned. So, for the 2023/24 tax year, this would make it the 31 January 2026.

The trustees must calculate two amounts:

*The amount of taxation for the trust in the normal way,
*The amount of tax that the vulnerable beneficiary would pay.

They then deduct the tax the beneficiary would pay from the full tax bill of the trust, and then claim a relief that reduces their tax bill by the amount of this difference.

Question 58

What is a loan trust

Answer 58

A loan trust allows the settlor to retain access to capital, whilst ensuring that any growth on that capital remains outside of their estate for IHT purposes. It effectively creates a line in the sand, stopping the IHT situation getting worse.

Question 59

When is a loan trust suitable?

Answer 59

It is ideal if an individual wishes to cap their potential IHT liability, whilst retaining access to the original capital, as they think they need it in the future.

Question 60

Steps of setting up a loan trust?

Answer 60

The settlor transfers money into a trust, but rather than a gift, this is a loan to the trustees. The trustees then invest this money into an investment bond.

The trustees may make loan repayments to the settlor, and if this is done, this is generally using the 5% withdrawal facility on the bond. At any time, the settlor can demand any part of their loan back, and on death any remaining loan balance would be called in as part of the estate calculation.

Question 61

IHT treatment of transfer of funds into a loan trust?

Answer 61

As no gift has been given, there is no transfer of value for IHT purposes, so it is neither a CLT nor a PET, and so there are not going to be any periodic or exit charges. The only element of the investment that is truly owned by the trust for the benefit of the beneficiaries is the growth.

Question 62

Negatives of a loan trust?

Answer 62

The tax-saving is very low, limited only to saving any growth on the money going into the estate. In fact, if the settlor were to die in the early years, the saving would be negligible.

The benefits can also be negated if any loan repayments received back aren’t spent, as then the value is just transferred back to the estate and growth would build up on that money within the estate.

Question 63

Explain how a discounted gift trust would be established and how it would
meet an individual’s need for income.

Answer 63

• Person invests an amount of money into a bond that is written under trust.
• Under the trust they retain the right to receive a series of fixed capital sums on pre-selected dates using the 5% tax deferred withdrawal facility.
• The trustees provide these payments to the individual as a return of capital.
• Any growth in the value of the bond will be outside of her estate for IHT purposes.

Question 64

(i) Describe five advantages and five disadvantages of Ron establishing the
discounted gift trust (DGT). You should assume a discretionary trust is used.

Answer 64

Advantages
* Ability to make an immediate gift for IHT purposes/the discount is immediately outside of the estate.
* but Ron would retain a regular payment stream/could take withdrawals of up to 5% of the initial sum invested (tax-deferred)
* without the GWR/POAT provisions applying (to the withdrawals).
* Investment growth would have been immediately outside Ron’s estate.
* The investment amount could exceed Ron’s NRB (because the potential discount brought it below the NRB),
* so the 20% lifetime IHT entry charge did not apply.
* The entire gifted amount dropped out of the estate after 7 years.
* By using a discretionary trust, Ron retained an element of control over who could benefit.

Disadvantages
* Loss of access to capital.
* Inflexibility/payments cannot usually be adjusted.
* The fund could be exhausted before Ron died or
* withdrawals could become chargeable events after 20 years/once the original capital has been repaid.
* Withdrawals from investment bonds would not be regarded as surplus income for gifting purposes.
* Periodic/10-year charges and exit charges could apply.

Question 65

Explain how any potential discount is calculated.

Answer 65

• The application is medically underwritten based on a person’s age and health.
• An actuarial calculation determines the payments one should expect to receive during the rest of their lifetime.
• The discounted amount provides a saving to their estate should they die within seven years of making the gift.

Question 66

Identify the factors which should have been considered prior to Ron investing
in the DGT.

Answer 66

• Ron’s age and health./Was Ron likely to survive 7 years?
• Was Ron happy to be medically underwritten?
• Potential IHT liability on the estate.
• Could Ron afford to give capital away?/Did Ron need access to capital being gifted?
• Did Ron need/want additional income?/Could Ron spend the extra income?
• Ron’s attitude to risk/capacity for loss.
• Was Ron happy with a fixed amount of income/income which would be eroded by inflation over time?
• Did Ron make any other gifts in the previous 7 years?
• Should the bond have been in single or joint names?/Should his wife’s circumstances have been taken into account at the time?

Question 67

Explain how the Loan Trust will be dealt with following Ron’s death.
You should assume that Ron’s Will did not contain any provision in this respect.

Answer 67

• The outstanding loan/£150,000
• will form part of Ron’s estate,
• and must be called in by Arthur as the executor.
• The trustees must pay back the outstanding loan (unless a specific clause in the loan arrangement precludes this).
• The bond will have to be accessed
• and any chargeable event would result in Income Tax liability.
• The growth (which is outside the estate) can be distributed to beneficiaries under the terms of the trust/trust can continue.

Question 68

Describe the planning aspects Larry should consider before creating a Loan Trust.

Answer 68

• There is no immediate gift for IHT purposes.
• He can take regular, or ad-hoc payments and the loan is repayable on demand.
• He will not have access to capital after the loan has been repaid/any regular withdrawals must stop once the loan has been repaid.
• Any outstanding loan will remain in his estate for IHT purposes.
• Any outstanding loan will be distributed in accordance with his Will/rules of intestacy.
• Unless he makes provisions to gift this to the beneficiaries of the trust (on death).
• He must spend any loan repayments, or these will accumulate in his estate.
• He could waive/gift any outstanding loan if it is no longer required.
• Any growth is outside the estate for IHT.

Question 69

State the benefits to Brian and Clare of using a joint life discounted gift trust

Answer 69

• Withdrawals of capital for the rest of their lives or until the investment runs out.
• No further income tax on the withdrawals/5% tax deferred.
• Possible immediate discount on the size of the gift/immediate Inheritance Tax (IHT) benefit.
• Discount is determined by underwriting criteria/life expectancy.
• Remainder of gift is outside of their estate after 7 years.
• Growth outside of their estate/IHT free.
• On first death income is paid to the survivor.
• Both can be trustees to maintain a level of control.
• Any future grandchildren can be included (range of potential beneficiaries).

Question 70

State the factors specific to Brian and Clare that an adviser would need to take into account before considering an investment in a joint life discounted gift trust.

Answer 70

• Their health and their age will affect the size of the discount they receive.
• Whether they will survive 7 years for it to be outside of their joint estate.
• The fact they have an IHT liability.
• Whether they need access to the capital.
• The amount of income needed to help with university costs/their income needs.
• Their attitude to risk/capacity for loss.
• Their tax positions.
• Whether it leaves sufficient emergency funds.
• The impact of it being her money/impact on any discount.

Question 71

Explain briefly the main features of an excluded property trust.

Answer 71

• Typically, an excluded property trust (EPT) is a discretionary trust used with offshore bonds.
• It protects investments held outside the UK from UK IHT
• for those that are non-UK domiciled.
• This means that even if one becomes UK domiciled in the future, the assets (held in the EPT) will not be liable to UK IHT on one’s death.

*Settlements into an EPT would not count as transfers at the time of the trust creation for IHT purposes and, even though it is a discretionary trust, it is not subject to the relevant property regime. So, there are no periodic or exit charges.

Equally, the trust can include the settlor, their spouse / civil partner, and children without any gift with reservation implications. On death, all assets within the trust are not within the settlor’s UK estate.

Question 72

Explain the benefits to Ricardo of him placing the offshore bond into an excluded property trust.

Answer 72

• Ricardo can place his existing offshore bond into the EPT and have full access to it.
• It will not be treated as a chargeable lifetime transfer as the transfer is exempt under excluded property rules.
• There will be no periodic or exit charges.
• Ricardo can be a trustee, which means he will keep an element of control.
• Beneficiaries can be chosen from the discretionary class of beneficiary.
• The asset is free from IHT on his death.

Question 73

What does periodic and exit charging apply to?

Answer 73

Periodic and exit charging applies to Chargeable Lifetime Transfers, so there is none on bare or vulnerable beneficiary trusts. It would however apply to trusts created within a Will such as a discretionary Will trust.

Question 74

why does periodic charging exist?

Answer 74

Chargeable lifetime transfers that are cumulatively in excess of the nil rate band pay lifetime IHT at 20%. Compare this to the 40% death rate, and HMRC are missing out on some potential taxation!

As a result, when a CLT has been made, HMRC will look to see if there is an opportunity to collect the additional tax due. They are highly unlikely to let funds sit in a discretionary trust forever, and never attempt to claim any of the missing IHT!

Periodic charging is an IHT charge on a CLT.

Question 75

What is a periodic charge?

Answer 75

Broadly, on each 10 year anniversary the trust is taxed on the value of the trust less the nil rate band available to the trust. The rate they pay on this excess is 6% (calculated as 30% of the lifetime rate, currently 20%). If the value of the trust is less than the nil rate band, there will be no charge.

The effective rate calculated via the periodic charge is known as the effective rate of IHT on the trust

Question 76

Tony makes a CLT of £300,000 into a discretionary trust. He has made no other CLTs or gifts.

He has the full NRB available at the first 10-year periodic charge. The value of the fund is 530,000

Calculate the 10 year periodic charge

Answer 76

530,000 - 325,000 = 205,000

205,000 x 0.06 = 12,300

12,300 / 530,0000 = 2.321 effective rate

530,000 x 0.02321 = 12,301.30 periodic charge.

Question 77

What is an exit charge?

Answer 77

An exit charge is calculated whenever a capital distribution or appointment or capital is made to a beneficiary. In other words, part of the trust assets are being passed out to beneficiaries.

When calculating an exit charge, we consider the effective rate calculated on the previous periodic charge, and then the amount of complete quarter years that have passed since then.

Question 78

what are the two situations where an exit charge needs to be calculated?

Answer 78

where part or all the fund is distributed after the 10-year point, so a period charge and effective rate have already been calculated.

where a periodic charge hasn’t yet been calculated as the fund distribution is happening within the first 10 years.

Question 79

Where an exit charge occur after a 10 year periodic charge, what needs to be calculated?

Answer 79

The effective rate.

The number of COMPLETE quarters since the periodic charge.

The amount of the fund being distributed, whether partial or full.

Question 80

Where an exit is occurring after a 10-year periodic charge, how do you calculate the exit charge?

Answer 80

Exit charge rate =

effective rate x number of complete quarters since periodic charge / 40

(40 representing the total quarters in 10 years)

Question 81

How do you calculate the exit charge of a distribution where there has not yet been a 10 year period.

Answer 81

1. Calculate lifetime IHT paid as a % of original trust value, to get pseudo effective rate
2. Exit charge would be based on 30% of this pseudo effective rate.
3. apply pseudo effective rate to the number of full quarters it relates to within the 40 quarter period (total quarters in 10 years)

i.e. distribution amount x pseudo effective rate x 12 / 40

Question 82

Describe how any exit charge would be calculated if capital distributions are made within the first ten years of the Trust being created.

Answer 82

• Any distributions within 2 years
• of the date of death
• will not be subject to an exit charge.
• An exit charge will be payable on any distributions after 2 years of the date of death.
• The effective rate of tax is calculated first
• on the basis of 30%
• of the lifetime rate/20%
• charged on a hypothetical transfer on the date of death
• taking into account failed gifts in 7 years.
• The exit charge is the amount of the distribution multiplied by the effective rate of tax
• reduced by the number of quarters since the trust was created.

Question 83

What is the key thing to remember with periodic and exit charges?

Answer 83

they reflect a proportion of the lifetime tax paid on the initial set up of the trust. So, if there had been no IHT due on the initial transfer into trust, then there is likely to be no periodic or exit charges.