Earlier this year, I looked at the methodology used to calculate the initial ‘discount’ when a discounted gift trust is effected in light of the EU Gender Directive and the judgment of the European Court of Justice in the Test-Achats case.
In essence, EU law now prohibits gender being used in setting life insurance premiums and in turn, as the market moved to unisex life insurance rates it seemed this should lead to unisex initial discounts. This is not because a DGT is an insurance product but is because the cost of life insurance forms a fundamental part of calculating the initial discount.
The accepted actuarial principles for valuing the discount do not take explicit account of mortality but assume a hypothetical purchaser of the settlor’s retained rights will affect life insurance on the settlor to protect their capital outlay.
While the purchaser of the settlor’s rights will be hugely concerned by how long the settlor will live in determining what to pay (as the income from their purchase will stop on the settlor’s death) they do not actually account for this directly in their calculation because it is implicitly included within the life insurance premiums. Therefore, the way in which the settlor’s expected longevity is dealt with in the initial discount calculation is not by looking at their age, gender and health, but by looking at insurance premiums, which factor in these elements.
Thus, if life premiums are the same for male and female lives then initial discounts should be the same. This has now been confirmed by HMRC and from 1 December 2013, discounts are suggested to be based for both males & females on the same female mortality table, (AFC00 select mortality).
But the wonderful intellectual world of the DGT does not stop there. Where the trust is a relevant property settlement, it is also necessary to conduct 10-year anniversary inheritance tax calculations.
Again, we use open market valuation principles and the hypothetical purchaser. But the purchaser is not this time buying the settlor’s retained rights – they are buying the trust fund and it is that value we need to determine the 10-year charge.
In deciding what to pay the purchaser, you take account of the fund value at valuation date then allow for what the settlor is expected to take back before their death. Here, the purchaser of the trust fund would not be in the slightest bit interested to insure the life of the settlor. They will benefit from an early demise of the settlor, in fact, the sooner the better for them. They have no capital outlay that needs to be protected from the death of the settlor and life insurance premiums are therefore irrelevant to the purchase price.
They would of course look at the settlor’s age and health at the time of purchase but would also surely take account of gender. As this valuation does not need to take account of life insurance premiums, unisex life rates have no application so in theory, the 10-year valuation can account for gender. This finer point will not be taken in practice and HMRC has outlined suggested regimes to try to minimise the administrative burden.
The DGT truly parades a blend of English trust law, tax law, a dollop of EU law, all wrapped around an hypothetical purchaser, who it seems is an actuarial genius.
Paul Kennedy is head of tax and trust planning at FundsNetwork