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Periodic tables

How is the 10-year anniversary charge calculated on a settlement?

Having last week considered the meaning of relevant property, the entry charge and reporting requirements, it is time to look at the periodic or 10-year anniversary charge.

The periodic charge is made 10 years after the creation of a settlement and at the end of each subsequent 10-year period during the life of the settlement while it remains in discretionary format. The anniversary date for the charge is normally reckoned from the date when the settlement was made and this is true even for settlements that were not originally discretionary trusts but have been recategorised as such.

The amount charged to tax at each 10-year anniversary is the value – after business property or agricultural property relief – of any relevant property comprised in the settlement immediately before that anniversary. The inheritance tax arising as a result of a periodic charge is calculated using the lifetime table – 20 per cent on amounts over the nil-rate band – but reduced to 30 per cent of the effective rate (see below for definition).

If the settled property being charged has not been comprised in the settlement throughout the 10 years ending in the 10th anniversary in question, the rate charged on that part of the relevant property will be 30 per cent of the effective rate reduced by one-fortieth for each quarter in the 10-year period which expired before the property became so comprised. This could be important in respect of additions to life policies (premiums) that become settled property. There may also be an argument that when paid direct to the life company, the premiums do not become settled property and so do not become comprised in the settlement.

The effective rate referred to above is the rate that results from expressing the tax chargeable (using the lifetime rate table, that is 20 per cent on amounts over the nil-rate band) as a percentage of the amount on which tax is charged on an assumed chargeable transfer by an assumed transferor.

To establish how much tax is to be charged on a 10-year anniversary, it is necessary to establish what tax would be payable on an assumed transfer by an assumed transferor and then express this amount as a percentage of the amount actually chargeable to tax. This will give the effective rate and the rate actually payable will be reduced to 30 per cent of this.

To determine the effective rate, it is essential to ascertain the assumed chargeable transfer and IHT background of the assumed transferor.

The assumed chargeable transfer is:

  • The value of the relevant property in the settlement immediately before the 10-year anniversary (Section 66(4)(a) IHTA 1984) plus

  • The value, at the time they were set up, of any other trusts set up by the settlor on the same day (related settlements) (Section 66(4)(c) IHTA 1984) plus

  • The value, at the time it was put into the trust, of any other property in the trust which was not then, and has not at any time been, relevant property, for example, because there is an interest in possession in it (Section 66(4)(b) IHTA 1984).

In most cases, only the last point will be relevant as the assumed transfer will be the value of the settled property.

The assumed transferor is one who has made chargeable transfers in the seven years prior to the date on which the assumed transfer was made, equal to:

  • The settlor’s cumulative total of chargeable transfers in the seven years ending with the day on which the settlement commenced (but ignoring transfers made on that day) plus

  • The amounts in respect of which any proportionate charges have arisen under the settlement in the 10 years before the present charge (Section 66(5) IHTA 1984).

These rules are modified in the case of trusts set up before March 27, 1974 and also if there have been distributions from the trust before March 9, 1982 (Section 66(6) IHTA 1984).

In the 10 years leading up to the anniversary, where the settlor makes a chargeable transfer that increases the value of the settled property, regardless of whether the amount of the settled property is increased, it is the cumulative total of transfers made by the settlor in the seven years preceding the chargeable transfer that is taken into account in determining the effective rate, if this is greater than the cumulative total for the seven years leading up to establishment of the settlement. Where the settlor has made two or more transfers within the said period, it will be the transfer in relation to which the greater cumulative total results that will be taken into account.

This added property proviso could be relevant in the case of a life policy trust where the payment of a premium is a chargeable (non-exempt) transfer and it increases the value of the settled property, even if it is paid direct to the company. In most cases, though, the premium will be exempt and, even if it is not, may not increase the value of the settled property.

In ascertaining the cumulative total of transfers of the assumed transferor, the need to take account of amounts on which a proportionate (exit) charge has been imposed could be relevant in respect of discounted gift trusts if amounts payable to the settlor in respect of his retained rights are treated as such payments. These payments would effectively eat up the nil-rate band.

There may be an argument that the settlor’s rights are held on bare trust for his benefit and so payments to him (not coming from settled property) do not constitute property ceasing to be relevant property. However, in the light of the risk, it may be worth taking this into account in determining a safe amount to invest into a discounted gift trust, to give a reasonable chance that no 10-year charge will arise.

Some further clarification on this may emerge as the Finance (No 2) Bill moves through Parliament.

I will look at an example of how the charge works next week.


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