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Make the transition

Creating a transitional serial interest by exercising a power of appointment should be carefully reviewed by most trustees

What is a transitional serial interest? Is it important? And, if so, to whom and why?

Transitional serial interests (TSIs) are defined in paragraphs 49B-E schedule 20 Finance Act 2006. They relate to trusts established before March 22 and, in connection with paragraph 49E, exclusively in connection with life policy trusts.

The TSI provisions exist to preserve the pre-Budget IHT treatment for certain pre-Budget trusts in specified circumstances.

The main TSI provisions relate to pre-Budget interest in possession trusts, and it is the provisions relevant to these trusts that I will be addressing in this article. If they apply, the value of the trust property remains in the taxable estate of the person(s) with the interest in possession for IHT purposes.

First, it has to be said that while the life tenant (the person with the interest in possession) of a pre-Budget trust, (to which nothing other than permitted additions have been added), retains their interest in possession under the trust after March 21, that interest will remain taxable in the same way that it was before March 22. In other words, the discretionary trust IHT regime under chapter III part III IHTA 1984 will not apply. The capital value of the settled property supporting the interest in possession will be treated as being comprised in the taxable estate of the person with the interest in possession. If that person has their interest appointed away from them (terminated) after March 21 and before April 6, 2008, the person who secures the new interest in possession will be deemed to have a favourable interest in possession. This new favourable interest in possession will be a TSI.

Such a TSI can only be created between March 22, 2006 and April 5, 2008. Most involved in IHT planning are aware of the opportunity to review IIP trusts before April 6, 2008 to determine whether a change of beneficiary before that date is worthwhile.

Subject to the appointor’s requirements regarding who should benefit from an IHT standpoint, the appointment of a young beneficiary will give the maximum time for the trust to remain outside of the IHT discretionary trust regime.

In order to qualify as a TSI, the settlement concerned must have been created before March 22, because the day before, the trust must have been one in which a life interest existed and the current beneficiary (the one claiming the TSI) must have become entitled to their interest on the coming to the end of the interest in possession of the person that had it immediately before March 22.

It is the last condition that ensures that only one change of beneficiary is permissible after March 21 and before April 6, if the appointed interest is to qualify as a TSI.

As well as avoiding the discretionary trust provisions, the settled property – where a TSI exists – will remain, for IHT purposes, in the estate of the person with the TSI.

The termination of an IIP and the creation of a TSI will be a potentially exempt transfer, or an exempt transfer if the person who is the new beneficial owner is the spouse or civil partner of the person whose interest has been terminated. Of course, the termination/ appointment must take place before April 6, 2008.

It will be appreciated that a TSI can be created actively or passively: actively where a power of appointment is exercised to change the interest in possession; passively where the life tenant dies and the trust terms provide for a successive life interest.

The ability to create a TSI by exercising a power of appointment will be one that should be carefully reviewed by trustees of most life assurance-based flexible interest in possession trusts.

This represents an excellent opportunity for advisers to review trusts that have the potential to benefit from the TSI provisions.

A change of beneficiary should not be made just to create a TSI – the trust will remain outside the discretionary trust regime if the beneficiary who had the interest in possession before March 22 retains that interest.

If a change of beneficiary is possible, it will be essential to review the trust before April 6, 2008. A pre-April 2008 beneficiary review will be essential, especially for trusts of significant single-premium plans (and thus greater potential for high-valued settled property).

There are two other ways in which TSI protection can be secured. Both stem from the death of a person occurring on or after April 6, 2008. One is of general application, that is, to all trusts, and applies where a spouse or civil partner of a life tenant benefits. The other is applicable to life policy trusts only, and applies on the death of a life tenant, regardless of that person’s relationship to the succeeding beneficiary.

More on these next week.

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