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Trust reality

The result of a recent High Court judgment in the case of Rysaffe Trustee Co (CI) Ltd •CIR [2002] EWHC 1114 (Ch) seems to be that settlors can easily avoid the 10-yearly periodic charge to inheritance tax on discretionary trusts.

This can be done by employing segmentation, a technique which is well known and indeed well used for life policies but less so for trusts.

The workings of the periodic charge would take more than this article to explain. However, the benefit of segmentation, which Rysaffe confirms, is that it creates extra nil-rate bands for periodic charge purposes.

In the case before the court, the settlor created five identical trusts of £10 each on separate days over a five-week period in 1984. Shortly after that, he transferred 6,900 shares in a private limited company to the trustee of each of the five settlements.

The 10-yearly charge arose in 1994 and the Revenue contended that the five separate trusts should be treated as one for inheritance tax purposes.

The Special Commissioner held that the establishment of the five settlements and the later transfer of shares were “associated operations” under S268 Inheritance Tax Act 1984. The Special Commissioner thus held that since a disposition included a “disposition by associated operations” under S272, there was one settlement within S43 and one settlement for the purpose of the periodic charge in S64.

The High Court judge, however, considered the general understanding of trust practitioners was that it was for the settlor to decide whether he intended to create one settlement or more than one. The judge stated that the structure created by a particular settlor would depend on how he chose to do it.

The question was, therefore, whether the legislation changed this approach for tax purposes.

S43 IHTA 1984 defines “settlement” as “any disposition or dispositions of property”. The judge stated that the use of the plural in the section meant no more than that it was possible to have more than one disposition to the trustee of a single settlement.

In addition, the use of the plural was not a positive enactment that, where there were two or more dispositions to different settlements, they formed one settlement for inheritance tax purposes.

This was true even if they formed two or more settlements under the general law. Further, the judge&#39s view that there were five settlements, not one, was not changed by the fact that the original terms of the trusts were identical in all except formal respects.

Turning to the associated operations provision, the judge said that the terms set out in S268 IHTA 1984 did not apply to the case.

The Special Commissioner&#39s starting point should have been to consider whether the property was “property comprised in a settlement” within SS43 and 64.

If it was such property, without the need to rely on the extension of “disposition” to cover also a disposition by associated operations, the associated operations provision was not relevant.

Applying those general principles to the shares contained in the first of the five settlements, the judge said the trustees held the shares on trust by a “disposition of property”.

As such, these shares on their own satisfied the requirements of S43(2)(b).

Therefore, they formed property comprised in a settlement so as to invoke the charging provision in S64. Such an interpretation depended only on the ordinary meaning of disposition, without recourse to the extended definition of a disposition by associated operations.

It was neither necessary nor proper to invoke the extended statutory definition to infer that the shares were property comprised in a settlement. That analysis ext-ended equally to the other four parcels of shares.

It seems unlikely that the Revenue will meekly accept this result. However, if they successfully appeal, then this is unlikely to plug the gap. Settlors would simply create segmented trusts, where some minor differences existed, and thus distinguish their actions. This would drag the Revenue into further litigation.

The more likely outcome is legislative change to correct this situation.

In summary, segmentation may succeed for trusts created now but for how much longer will new trusts have this opportunity?

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