Discretionary Trusts and Inheritance Tax - what your clients need to know

The most contentious proposal is that the settlor’s nil-rate band should be split by the number of relevant property settlements the settlor has made.  This will “alleviate the risk” (according to HMRC!) that settlors might seek to fragment ownership of property across a number of trusts to maximise the availability of reliefs or exempt amounts. Under these proposals a pilot settlement with only £10 in could use up more than just £10 of the nil rate band.

HMRC proposes that a simple rate of 6% of the chargeable transfer is used in the calculation of periodic and exit charges rather than the lengthy calculations of the effective rate and settlement rate as at present.

HMRC argues that the new rule which would split the nil rate band between settlements made between the same settlor would mean that the “related settlements” rule would no longer be necessary.  HMRC propose that, for the first 10 year charge, the nil rate band is split between all relevant property settlements made by the settlor and in existence at any time between the date the trust concerned was set up and the time of the charge.  This would include any settlements which had been wound up before the date of charge.

For subsequent 10 year charges it is proposed that the nil rate band is split between all relevant property settlements made by the settlor and in existence at any time between the date of the previous 10 year anniversary and the date of the current charge.

For distributions before the first 10 year anniversary it is proposed that the nil-rate band is split between all relevant property settlements in existence at any time during the period the trust concerned commenced to the date of the distribution.  For payments after the 10 year anniversary it is proposed that the nil-rate band is split between all relevant property settlements taken into account for the purposes of calculating the Inheritance Tax charge at the last 10 year anniversary plus any in existence since the 10 year anniversary to the date of the payment.

For these purposes relevant property trusts that have been created using insurance company paperwork will be included.  A number of discounted gift trust and life insurance policies written in trust could well therefore be caught by these proposals. Trusts created by a Will will also be included.

A few points to bear in mind: 

• Trusts/settlements that qualify as “disabled trusts” will not be caught by these proposals.  However, it will not be possible for existing relevant property trusts to be converted to disabled trusts.  In the past, discretionary settlements have often been used for the benefit of a disabled beneficiary because of the greater flexibility they offer.  This solution will need to be kept under review. 
• The use of pilot settlements could seriously affect the Inheritance Tax charge. 
• Trusts created under Wills that confer an immediate post-death interest (previously known as a life interest) will be outside the new proposal. 
• Trusts that qualify as “bereaved minor trusts/settlements” will be outside the new regime. 
• Settlements/trusts that are terminated before the date of commencement for the proposals will be excluded. 
• Where discretionary trusts arise under a will, distributions that are made within two years (but after three months) of the death will be written back and treated as if included in the will itself.

As a first step it is suggested that clients should review their affairs and make a list as best they can of: 

• Any trusts/settlements they have created or benefit from (for example, a will trust).
• The value of those trusts.
• Their understanding of the nature of the trust – is it a bare trust, Discretionary Trust or some other type.
• Obtain a copy of the Trust Deed and any supplemental deeds.

For more information

If you'd like to know more about discretionary trusts or inheritance tax, and how they might impact your clients, please contact Alex Elphinston on 0121 212 7404 or alex.elphinston@anthonycollins.com.