March 2016 will represent the ten year anniversary since inheritance tax changes were introduced to trust rules. From March 2006 settlements into trusts with an interest in possession were no longer treated as Potentially Exempt Transfers (PETs) but rather as Chargeable Lifetime Transfers (CLT), which was already the case with discretionary trusts. A PET will fall outside of your estate for inheritance tax purposes assuming that the donor (the person who makes the gift) lives for seven years. Gifts into Absolute / Bare trust continue to be treated as PETs.
Since 2006, settlors requiring an element of choice as to how and when the trust property can be distributed or apportioned have largely been directed to Discretionary Trusts; sometimes known as Non-Vested Interest Trusts. This means that a CLT will have occurred and, although the gift will also fall outside of the estate after 7 years, there is the potential for periodic and exit charges to apply.
Periodic charges are assessed to the trust every ten years; the maximum rate of tax that can be applied is 6%. Exit charges can also apply, most commonly when the trustees distribute capital to a beneficiary. The best way to illustrate the possible impact is to look at an example:
How periodic charges are calculated (assuming no previous chargeable lifetime transfers in the 7 years preceding the creation of the trust)
An example of a periodic charge calculation assuming trust property is valued at £525,000 at the 10th anniversary and there have been no distributions of capital in the first 10 years
Assumed Nil Rate Band at the first 10th anniversary is £325,000
|Value of trust – the Nil Rate Band (NRB)||£525,000 – £325,000|
|= value of trust property in excess of NRB (VT)||= £200,000|
|Tax on trust property = VT x 20% (lifetime rate)||£40,000 (£200,000 x 20%)|
|Effective rate = tax on trust property x 100%Value of trust property||7.619% (£40,000 x 100%)£525,000|
|Periodic charge (maximum of 6%) = 30% of the effective rate||2.2857% (30% of 7.619%)|
|IHT payable = value of trust property x periodic charge||£12,000 (£525,000 x 2.2857%)|
How exit charges are calculated
Assumes that the trust property grows in value to £600,000 when it is distributed on the 12th anniversary
|Rate at which tax charged on the previous 10 year anniversary (periodic charge) but calculated using current NRB*||2.2857%|
|Number of quarters since last 10 year anniversary (NQ)||= 8|
|Rate at which tax chargeable on trust assets distributed from trust (R) = periodic charge x NQ40||0.4571% (8 x 2.2857%)40|
|Tax payable = trust assets distributed x R||£2,742 (£600,000 x 0.4571%)|
*Assumes that the NRB remains unchanged
What does this tell us?
- Has the significance of 2016 with regard to trust planning been considered?
- Retaining the knowledge, understanding and significance of such issues can fade over time
- If you have a trust that has not been looked at for sometime then the next six months may be an ideal time for a review
- Do you need to consider liquidity, to pay any tax that may be due?