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Use of Trusts to Minimise Inheritance Tax (Part 1)

As readers of this series of articles on Trusts will know, there are two main types of trusts namely ‘Qualifying Interest in Possession’ (‘IIP’) Trusts and ‘Discretionary (or ‘Mainstream’) Trusts.  But what of the Inheritance Tax (IHT) implications where Trusts are concerned?

Prior to the Finance Act 2006, the Inheritance Tax (IHT) treatment of trusts was relatively straightforward, such that if a beneficiary was named in a trust (ie the trust was an ‘IIP’ trust) then that beneficiary was treated as the owner of the capital held within that trust. On the death of that beneficiary the trust was subject to IHT at the full tax rate as if the capital had actually belonged to the beneficiary. If there was no defined beneficiary then the trust (a ‘discretionary’ trust) was subject to a special tax regime which included a charge levied every ten years. Post 2006 this distinction does not normally apply - instead trusts that are ‘relevant property trusts’ are taxed using the same special regime previously only reserved for discretionary trusts. This change in rules has reduced the value of trusts for IHT planning but there are still some opportunities available if undertaken carefully.

This article is the first of two that deal with Trusts and IHT - this one details the IHT charges that apply to trusts and the second will cover what IHT planning remains post Finance Act 2006.

‘Relevant property trusts’

Most types of trust are now termed ‘relevant property trusts’, the following being ‘excluded’:

• IIP trusts created prior to 22 March 2006 where the pre-2006 beneficiaries remain in place  (or were changed before 6 October 2008);

• trusts created on or after 22 March 2006 under the terms of a will that gives an immediate  interest in the income to a beneficiary;

• Disabled Person’s Trusts;

• Trusts for ‘bereaved minors’ - a ‘bereaved minor’ is a person aged under 18 who has lost at  least one parent; and

• Trusts for persons aged age 18 to 25 years.

When is IHT charged?

IHT is payable on the value of the assets held within a ‘relevant property’ trust:

• On the transfer of assets into the trust and

• On the 10 year ‘anniversary’ of the trust being set up and

• On the transfer of assets out of the trust (or cessation of the trust)

With the ‘excluded’ trusts mentioned above the assets are not regarded as ‘relevant property’ and as such there are no tax charges at the ten year ‘anniversary’ or on  transfer of assets out of the trust.

Tax charge in detail

• On transfer of assets into the trust

If the trust is created during the settlors’ lifetime the transfer is a lifetime transfer/gift and IHT will be due at 20% of the transfer value in excess of the Nil Rate Band (NRB) amount - currently £325,000. Therefore the placing of an asset with value of less than £325,000 (which could easily include a property) will not produce a tax charge if the full NRB is available. Gifts made within the previous seven years are aggregated with the transfer to determine the amount remaining of the NRB and if this total figure is higher than the NRB amount then the tax charge is on the excess amount only. If the trust is created via a will, the estate will be subject to IHT - the creation of such a trust being a disposition of part of the estate’s assets on death.

• On the 10 year anniversary

IHT is charged on a ‘Mainstream’ Will trust every 10 years. The actual tax rate is 30% of the ‘effective rate’ applying to an imaginary cumulated total which comprises the value of trust assets plus the value of any assets that have exited from the trust within the previous 10 years (otherwise those assets would avoid the charge). The resulting amount is charged as if it was a chargeable lifetime transfer made by a transferor who had made the same chargeable transfers within the seven years preceding the ‘anniversary’ date as the settlor of the trust has actually made.  This is best explained by a basic example:


On 1 September 2005 Jane placed a property valued at £180,000 and cash of £50,000 into a ‘Mainstream’ trust. She had previously made chargeable lifetime transfers of £40,000. No IHT is due on the transfer of assets into the trust as the value of £230,000 plus the £40,000 brought forward (total = £270,000) is less than the Nil Rate Band (£275,000 for 2005/06).

£30,000 was transferred out of the trust on 1 September 2010 but any transfer out of the trust prior to the ‘anniversary’ date is not be subject to tax as no ‘anniversary rate’ charge yet applies.

• ‘Anniversary’ rate charge

 The ‘anniversary’ rate charge is levied on the value of assets in the trust as at
1 September 2015. For the purposes of this example assume that the value of the property has increased to £305,000 and cash to £55,000. The calculation will be:

Cumulative chargeable lifetime transfers             40,000
Transfers out of trust within prior 10 years        30,000
Value of fund as at 1 September 2015              360,000
Less Nil rate Band (2015/2016 - assume)         (325,000)
IHT   £105,000 x 20%                                       £21,000

Effective rate:

21,000 / 360,000 = 5.833%

Tax rate:

 30% x 5.833% = 1.750 %

IHT ‘Anniversary’ charge:

 £360,000 x 1.750% = £ 6,300



£105,000 x 6% = £6,300


• Transfer of assets (‘exit’) out of the trust

This ‘exit’ charge is similar in calculation to the ‘anniversary’ charge requiring use of the NRB at date of transfer. No ‘exit’ charge is payable if the distribution takes place within three months of the anniversary charge.

IHT is due at the ‘anniversary rate’ (1.750% in the example above) reduced by the number of quarters since the previous 10 year anniversary.

1 June 2016 - assume transfer of £30,000 cash when the NRB has increased to £375,000

Recalculate ‘effective rate’:

Chargeable transfer amount brought forward:       £430,000
Less: NRB 2016/2017 (assume)                            (375,000)
IHT on £55,000 at 20%                                         £11,000
Effective rate:

11,000 / 360,000 = 3.055%

Tax rate:

 30% x 3.055% = 0.916 %

Tax on distribution:

 £30,000 x 0.916% x 3/40 quarters = £20.62

Practical Tip

At first glance the application of the ‘30% rule’ appears to be extremely generous - allowing a tax rate of only 0.916% in the example above on the distribution made rather than 40% if the cash had remained to be taxed as part of the estate - but there is the 10 year ‘anniversary’ charge to consider. The reason for the apparent generosity is that it corresponds with the charge that arises on the death of the life tenant of an IIP trust and its effect is that a full charge to IHT arises, theoretically, once in a lifetime. Even so a 6% charge every 10 years is possibly preferable to a full 40% charge every generation and if you remember that trusts are usually not used solely for the tax savings, a settlor may prefer that the trust be subject to a small tax charge every ten years rather than a valued asset go to beneficiaries who may not be as appreciative as the settlor. Such a reason for trust planning was mentioned in the article ‘Use of trusts to protect property assets’ - June edition.

Even though ‘anniversary’ charges now apply to most trusts, IHT planning (particularly in relation to the timing of withdrawals) is still possible. Remember: a lifetime transfer into a trust of an asset valued at less than the NRB is not subject to IHT (assuming no previous chargeable lifetime transfers) meaning that any subsequent withdrawals made before the ten year ‘anniversary’ date is also not taxed. Further, if the total value (not forgetting to account for previous withdrawals) of the trusts‘ assets at the ten year ‘anniversary’ date remains under the NRB then there will still be no IHT charge on any subsequent withdrawals.

Further tax planning possibilities will be covered in next month’s article.

This is a sample article from the monthly Property Tax Insider magazine. Go here to get your first free issue of Property Tax Insider.