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Tony Wickenden: A matter of relevance

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This week I shall consider how the proposed new rules for applying inheritance tax to relevant property trusts (basically non-bare trusts) would operate if enacted.

First, let us consider trusts put into effect on or after 7 June 2014.

(a) Protection policies held subject to trusts other than a bare trust, such as discretionary and flexible power of appointment trusts

With some exceptions, the value of a trust that holds a protection policy will usually be nil or negligible up until the point the life assured (or last life assured) dies and the sum assured becomes payable.

Because, under the new rules, the settlor will be able to allocate their settlement nil-rate band as they see fit, it will not be necessary for any part of their SNRB to be set against such trusts until the need arises, say because of a change in circumstances.

Where an absolute appointment of benefits is made shortly after the death of the settlor/life assured, and so the trust is effectively wound up, IHT charges will frequently be avoided altogether. Problems can arise, however, where a 10-year anniversary coincides with serious ill health or the untimely death of the life assured. Then suddenly the trust can have a significant value.

However, under the revised model for simplification, this situation can be dealt with by a settlor (or perhaps an attorney acting under a registered LPA) who recognises that the life assured is in serious ill health. 

If a 10-year IHT anniversary is imminent, such a settlor could allocate any available SNRB to the trust to avoid, or at least mitigate, the charge.

Equally, trustees facing the prospect of a charge following the settlor’s death and before they have time to effect a distribution would be able to ask the settlor’s personal representatives to consider allocating the settlor’s unused SNRB to the trust.

(b) Spousal by-pass trust

Like trusts of protection policies, spousal by-pass trusts (commonly set up with a nominal £10 gift) that are used with lump-sum death benefits under pension schemes will have little value until after the settlor’s death, when any pension death benefits become payable. 

The established position here is that the by-pass trust itself is separate from the trust of the pension death benefit, which is deemed to have commenced when the member joined the pension scheme (assuming the scheme is a trust-based scheme).

Under Section 81 IHT Act 1984, this separate deemed trust will be treated as continuing, even on later transfer to another trust. When death benefits become payable under the scheme, HMRC accepts the value of the trust property has simply increased and therefore becomes vulnerable to future charges under the relevant property regime as a result of having left the protected environment of the pension scheme.

Therefore, under the proposed new rules and assuming there is no other counteracting legislation introduced, a by-pass trust of a nominal amount created after 6 June 2014 need not be allocated any part of the settlor’s SNRB. Once payments from the death benefits under the pension scheme are made into the trust, IHT is likely to have to be considered if the funds remain in the by-pass trust at the time of the next periodic charge.  

In this case, under a trust-based pension scheme, the position will depend on when the member joined the scheme. Where the member joined after 6 June 2014, the trust will be subject to the new rules. Where the member joined before 7 June 2014, subject to any counteracting legislation, the trust of the death benefits will be treated under the new rules as an existing trust (see below).

(c) Loan trusts

With loan trusts, the value of the trust property for IHT purposes immediately after it had been created would be nil because the trust property value would be neutralised by the outstanding loan so there would be no risk of an exit charge in the first 10 years of the trust’s life. 

At the time of a periodic charge (10-year anniversaries), the charge to IHT would depend on whether the value of the trust property (the investments less the amount of the outstanding loan) exceeded that part of the SNRB allocated to the trust.

As a settlor is able to reallocate their SNRB at any time (provided that no point of charge has previously occurred), the new rules would appear to allow a settlor to avoid or reduce an imminent 10-year charge by increasing the percentage of the SNRB allocated to the trust prior to the crystallisation of the charge.  

It should be noted, however, that once an occasion of charge has arisen on a particular trust, it is not possible to reduce the percentage of the SNRB allocated to it. So it will be important not to allocate more than is necessary in case some of the SNRB is needed in the future.

Next week I will continue this look at how commonly used trust structures will be affected by the proposed new provisions for applying IHT to non-bare trusts.

Tony Wickenden is joint managing director of Technical Connection

Techlink Professional Access full CPD, technical updates and business generation ideas through Techlink Professional. Go to www.techlink.co.uk and click the Contact Us link at the top of the screen and then request your free trial from the drop down menu.

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