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Tony Wickenden: Applying IHT to DGTs and pilot trusts

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Last week I looked at how the proposed new rules for applying IHT to relevant property trusts would work in relation to protection policy trusts, spousal bypass trusts and loan trusts created on or after 7 June.

This week I will continue my six-part review with a look at discounted gift trusts and pilot trusts for testamentary gifts.

(a) Discounted gift trusts

Other than the fact that the value of the trust fund will be discounted to reflect the settlor’s continuing retained rights for the purposes of calculating IHT trust charges, DGTs set up on a discretionary trust basis will be treated in the same way as any other trust for the purposes of the proposed new regime.

(b) Pilot trusts for testamentary gifts

Pilot trusts are often used in conjunction with will planning on death to mitigate the possibility of exit and 10-yearly charges on wealth the testator wishes to pass to future generations. By setting up a series of pilot trusts (each established with a nominal amount) on successive days during lifetime, and providing for a sum (usually in excess of the nil-rate band) to be settled across all the pilot trusts on the testator’s death, this objective can be achieved under the current rules.

The reason this planning works is the settlor will only be using a tiny amount of the nil-rate band when each pilot trust is established because chargeable lifetime transfers in the previous seven years are nominal.

Where the only non-exempt transfers made are the nominal transfers into the pilot trusts, this condition is likely to be satisfied. Although this seven-year cumulation period can be displaced when added property is given to the trust, when calculating the settlor’s cumulative total for the purposes of determining the amount of nil-rate band available to the trustees, transfers made on the same day are ignored. This means that, as the rules stand, although the sums are all added to the pilot trusts on the same day (the date of the settlor’s death), each trust benefits from its own nil-rate band so the possibility of IHT charges is substantially reduced.

Under the new regime, the related settlement rules become redundant and pilot trusts created after 6 June would each have to share a percentage of the settlor’s SNRB.

I shall now consider the position of trusts created on or before 6 June.

Under the revised proposals, existing trusts (those created on or before 6 June) will continue to be taxed under the current system but would also benefit from a simplified calculation method using the new standard rate of 6 per cent. This means such trusts would retain the nil-rate band available to them under the current rules.

Under the existing rules, the nil-rate band available to a trust on creation is adjusted to take into account any previous chargeable lifetime transfers made by the settlor. If there were no such transfers in the preceding seven years, the trust would have the benefit of a full nil-rate band on its creation. Any transfers out of the trust between 10-year anniversaries will also effectively reduce the nil-rate band accordingly. 

Relief will be given for any period throughout the 10-year period when the trust did not consist wholly of relevant property. 

All these rules will continue to apply so how will they affect the main types of trust used in financial planning?

First I will consider protection policies held subject to trusts other than bare trusts such as discretionary and flexible interest in possession trusts. Existing trusts (those created prior to 7 June) retain the benefit of their own nil-rate band as calculated under the current rules but adjusted to take account of the settlor’s cumulative total of chargeable transfers in the seven-year period prior to the commencement of the trust. 

The exception is where additions are made to a pre-7 June trust after 6 June. In such cases, the additions will be treated as a separate fund within the trust which will be taxed in accordance with the new rules. For the purpose of calculating 10-yearly and exit charges, HMRC would work from the original trust commencement date and apply the 40ths rule for the length of time the new funds had been relevant property.

Most protection policies are regular-premium policies and so, theoretically, the regular premiums could fall to be treated as additions to the trust. However, one would hope an exception will be made for regular premiums in the same way that relief was given for the payment of regular premiums to pre-22 March 2006 trust policies when flexible interest in possession trusts were brought into the relevant property regime in 2006.

Next week I will continue looking at other trust arrangements used in IHT planning. 

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.

Tony Wickenden is joint managing director of Technical Connection

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