Discounted gift trusts portray a blend of English trust law, tax law, actuarial science, a tad of make-believe and now a dollop of European law looks set to be added.
In the ‘Test-Achats’ judgment, the European court ruled that from 21 December 2012, the ‘unisex rule’ contained in Article 5(1) of Council Directive 2004/113/EC must be applied to the calculation of individuals’ premiums and benefits in new life insurance contracts. The overarching aim of this Directive is implementing the principle of equal treatment between men and women in the access to and supply of goods and services.
Fundamentally, a DGT is not an insurance or an annuity nor even a good or service in the wider sense. It is certainly not a gender priced product so how can this EC directive apply to what is a personal trust arrangement. The answer lies in the way the so-called ‘discount’ is calculated.
A DGT entails the donor conveying property (usually an insurance bond) to trustees to hold upon trust some interests therein for the beneficiaries and the remainder for the donor himself. In essence, the donor gives to the beneficiaries the bond shorn of the right held in trust for him, being the annual ‘income’ stream. For inheritance tax purposes, the gift to the beneficiaries is a transfer of value and it is necessary to value that gift. This is determined under the normal loss to the estate principles and to value the gift we must determine the value retained by the donor.
The retained rights must be valued on an open market basis in accordance with s160 IHTA 1984. That is, the price that the right to the ‘income’ for life might reasonably be expected to fetch if sold in the open market. This means we assume a hypothetical sale though in the real market. As there is no market in the sale of DGT rights, such valuation is largely guided by long-held actuarial principles. One might think the purchaser would be acutely concerned with how long the donor will live but actually, this is not the case.
The actuarial principles for valuing a life interest assume the purchaser will effect life insurance on the life-tenant; insuring an amount sufficient to repay his capital investment when the income ends on the death of the lie-tenant.
The income from the life interest must be adequate to meet the insurance premium as well as providing a reasonable interest return on the investment during the life of the life-tenant. Under these principles, mortality as a factor in valuation is eliminated as far as the purchaser is concerned. The premium for the life policy will automatically take into account the age and health of the life-tenant and the number of years for which he is expected to live. It is not necessary to make a separate provision for the expectancy of life of the life-tenant.
The ‘capital value’ of the income stream receivable is computed by applying a valuation formula based on the above principles. Expected longevity plays a part but only in so much as factored into the insurance premiums.
In the real market, life insurance premium rates will become common between males and females, so our hypothetical purchaser will pay the same price irrespective of gender. Accordingly, DGT discounts should equalise somewhere in the middle of current male and female discount levels. Other things being equal male donors will see an increase in discount and female donors a reduction. HMRC are expected to issue updated guidance in 2013.
Paul Kennedy is head of tax planning at FundsNetwork