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Conflicts of interest

The relevant property regime for inher-itance tax, incor-porating entry, periodic and exit charges, is now part of everyday tax planning for those considering the use of trusts with financial services products in estate planning strategies.

The extension of these provisions in 2006 to cover all lifetime trusts other than bare trusts and trusts for the disabled caused quite a stir back in its day. However, this extension of provisions that not long ago applied only to discretionary trusts (trusts without an interest in possession) is no longer a source of regularly expressed complaint. It is a fact of life that has been accepted and taken into account when appropriate.

Yes, there was additional learning required of advisers but that learning – at least of the broad principles – has largely taken place. Relatively few may be able to articulate with confidence the fine details of how the entry, periodic and exit charges are calculated but much has been produced, particularly by insurers and other providers with trusts as part of their range, to help advisers where assistance on the provisions is required.

It may not be that long before many forget that the continuing flexibility over the choice of beneficiary that is now delivered by a trust at the potential cost of charges under the relevant property regime was once available “free”.

Before March 22, 2006, few would have disputed that the flexible interest in possession trust, with power to appoint beneficiaries from a wide class of discretionary beneficiaries, was very much the trust of choice for financial planners using insurance products as part of the tools of their trade.

Since March 22, 2006, with the application of the relevant property regime to these trusts, some have moved to use fully discretionary trusts. The view seems to have been taken that as an interest in possession in a trust no longer offers protection from entry, periodic and exit charges, there is no point in not having a fully discretionary trust with no interest in possession.

At least there will be no risk of confusion in the minds of those who remember that there used to be exclusion from the relevant property regime with such a trust. In other words, a new broom approach has been taken.

Where the underlying trust asset is a life insurance policy, which is a non-income and non-capital gains producing asset, there are no further substantial tax consequences to choosing a discretionary trust over an interest in possession trust.

An interest in possession is, broadly speaking, the current right to current income under a trust. Now that would be important with an income-producing trust asset. The common treatment of IIP and fully discretionary non-IIP trusts only extends to IHT. For income tax, if a beneficiary has a right to income under a trust, then that income will be assessed on the person with the right to it, whether or not they actually receive it. This could have positive or negative tax consequences – the former if the beneficiary’s tax rate is less than 40 per cent.

There would be the need for both trust types to consider the anti-avoidance provisions which can result in the trust income being assessed on the settlor, in many cases involving family trusts, where the settlor retains an interest.

Broadly speaking, all trust income is assessed on the settlor unless the trust is one under which the settlor does not retain an interest. A settlor is deemed to have an interest if the trust property, or property derived from it, could be applied for the benefit of the settlor or the settlor’s spouse. Unconditional outright gifts between spouses do not trigger these provisions.

Anti-avoidance provisions will also apply where trust income is used to benefit an unmarried child of the settlor who is under the age of majority and not in a civil partnership. You should note here that there has to be actual use and not the mere potential to benefit. There is much more to consider in respect of the anti-avoidance provisions in relation to trust income and I may do so in a subsequent article but for now, let’s leave it at that.

The fact is that for trusts of insurance products, there is no trust income (chargeable event gains under the chargeable event provisions have their own rules), so there is no problem. However, this does not mean that advisers can just ignore these provisions. With the capital gains tax changes potentially affecting the tax aspects of product choice, it is likely that we will see a continuation of the development of trusts for use with other than insurance products. We have already seen this development with some platforms.

Of course, there are also capital gains. As for income, insurance products are easy. They do not produce capital gains taxable under the Taxation of Chargeable Gains Act 1992 in the hands of the trustees so the anti-avoidance provisions that apply to trusts, other than bare trusts, where the settlor, settlor’s spouse or minor unmarried children not in a civil partnership can benefit are not relevant.

So, with that brief commentary on the income tax and CGT anti-avoidance provisions and their non-application to insurance products, we can see how many will be ambivalent about whether an IIP or discretionary trust is used in estate planning when the settlor requires flexibility.

Next week, I will look in a little more detail at IIP trusts and the special rules applying to those that existed before March 22, 2006 and are still in existence.

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