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Don&#39t look discounted gift trust in mouth

Following the Inland Revenue&#39s announcement on so-called spouse interest trusts in June, advisers will look for more detailed comment on the inheritance tax treatment of discounted gift trusts. These arrangements enable investors to give away assets but keep the right to an income without creating a gift with reservation.

Under the capital transfer tax regime, which existed until March 1986, an individual who disposed of an asset but kept the ability to benefit from it nevertheless successfully lessened the value of his estate for tax purposes. However, the Finance Act 1986 reintroduced the idea of gifts with reservation that broadly existed under estate duty.

It made certain exceptions to the general rule, which was contained in S102 FA 86. Of particular recent relevance was the exception contained in S102(5)(a) where a gift to the donor&#39s spouse was not to be treated as a gift with reservation. This was subsequently identified as an opportunity where the donor could route a gift to his heirs through a spouse interest trust. The donor could keep the right to benefit in the future and still avoid the gift being a gift with reservation. S185 FA 2003 has now reduced this opportunity for gifts made from June 20. It will, however, not affect any other inheritance tax mitigation arrangements.

This will lead to increased focus on other inheritance tax planning arrangements. Some advisers may wish to consider the opportunities offered by discounted gift trusts. These trusts enable the investor to transfer assets to his or her heirs but keep the right to an “income” from them.

These arrangements might best be classified as carve-out trusts to distinguish them from other constructions available in the marketplace. This classification flows from the fact that the donor carves out a predetermined property right and gives away all other property, subject to having kept this right. In discounted gift trusts, the right carved out is the right to regular capital payments. In some arrangements, it may also be possible to lessen and vary these payments from time to time.

The effectiveness of so-called carve-out trusts has been confirmed by a long history of estate duty court cases. These include Munro



Commissioner of Stamp Duties of New South Wales [1934] AC 61 and Privy Council and Nichols



IRC [1975] 2 All ER 120, Court of Appeal, to name but a couple. As a result, so-called carve-out trusts do not of themselves result in a gift with reservation, as described in S102 FA 1986.

However, some advisers may ask whether they fall into the specific anti-avoidance legislation aimed at insurance-based arrangements and contained in Para 7 Sch 20 FA 1986.

Para 7(1) states: “Where arrangements are entered into under which (a) there is a disposal by way of gift which consists of or includes, or is made in connection with, a policy of insurance on the life of the donor or his spouse or on their joint lives and (b) the benefits which will or may accrue to the donee as a result of the gift vary by reference to benefits accruing to the donor or his spouse (or both of them) under that policy or under another policy (whether issued before, at the same time as or after that referred to in paragraph (a) above), the property comprised in the gift shall be treated for the purposes of the principal section as not enjoyed to the entire exclusion, or virtually to the entire exclusion, of the donor.”

Discounted gift trusts are beyond the reach of this legislation because they are a carve-out trust based generally on a capital redemption policy and not on “a policy of insurance on the life of the donor or his spouse or on their joint lives”. If Para 7 is to apply, then it needs there to be such a life policy. As capital redemption bonds do not have any lives assured, they are not policies of life insurance.

Advisers will now more often consider recommending discounted gift trusts as arrangements that enable investors to make an inheritance tax-efficient gift which is not a gift with reservation.

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