Last week, I completed my summary of the way in which the 10-year anniversary charge works. I then cruelly left you hanging on, in a state of high tension, for the example that would bring it all together. Well, wait no longer, here it is.
In October 1996, A, who has already made chargeable transfers totalling 120,000 in the previous seven years, transfers a single-premium life insurance bond valued at 150,000 into a discretionary trust. By October 2006, when the first 10-yearly charge is due, the value of the trust property has grown to 300,000. The sum of 80,000 was paid out to beneficiaries in 1998.
Tax is charged on the 300,000 relevant property then in the settlement as shown in the table (right).
In this example, if the settled property had been a regular-premium term insurance with no surrender value and at the 10-year anniversary the settlor had been in good health, the value of the relevant property would be nil. As the assumed cumulative total did not exceed the nil-rate band, there would be no tax payable.
Having looked at the fundamentals of discretionary trusts, including what is relevant property, the entry charge and the 10-year or periodic charge, I would now like to look at the proportionate charge, which is also known as the exit charge.
A proportionate charge can arise, generally speaking, where property or part of the property comprised in a settlement ceases to be relevant property (section 65(1)(a) IHTA 1984).
Under a loan trust, it is thought that the making of loan repayments will not give rise to the need to consider an exit charge.
Clarification is required in respect of payments to the settlor under a discounted gift trust. If they are payments from property that is not relevant property, that is, property held on bare trust for the settlor, then exit charges will not be relevant.
Aside from this, there are some exceptions to the proportionate charge which are set out in section 65 IHTA 1984. Tax will not be charged:
- On payments by the trustees of costs or expenses which are attributable to relevant property.
- On payments which are subject to income tax in the hands of any person.
- When the event giving rise to the charge occurs within three months of the setting up of a settlement or following a 10-yearly anniversaryl Where property settled by a person domiciled outside the UK becomes excluded property and so is no longer relevant property.
- On a decrease of value which results only from a bad bargain made by the trustees, provided that there was no intention to confer any gratuitous benefit by the disposition.
- If the decrease results from the grant for full consideration of an agricultural tenancy.
In addition to these exceptions, there is no proportionate charge when property ceases to be relevant property on becoming:
- The property of a charity or other exempt body (section 76 IHTA 1984).
- Held on certain specified trusts for employees (section 75 IHTA 1984).
- Held on trusts of an approved fund for the maintenance of heritage property (schedule 4, Part III IHTA 1984).
I will look at the measure of the proportionate charge next week.