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Discretionary Trust 10 yearly charge – 10 pointers

Author Image The Technical Team
7 minutes read
Last updated on 24th Dec 2019

Trusts and IHT….Help

The UK tax system is complicated, so no wonder the Office of Tax Simplification (OTS) was established to give independent advice to the government on making things easier for taxpayers. Consider Inheritance Tax (IHT), the OTS has issued two reports on the complexities of the regime and makes a comment we can all sympathise with.

“The Inheritance Tax rules applicable to trusts are not straightforward. Most individuals do not understand how trusts are used and have no knowledge of how they are taxed. It is not uncommon for experienced advisors to make errors as the Inheritance Tax charged on trusts is difficult to calculate.”

A case in point is the 10 yearly charge which potentially applies to most flexible trusts. It arises under what’s called the ‘relevant property regime’. The OTS observe that the 10 yearly charge calculation is too complex. Its suggestion is that the IHT treatment of trusts should be addressed by the separate HMRC trust consultation, running in parallel, which has a wider remit and so can consider IHT in the round alongside income tax and capital gains tax paid by trusts. The trust consultation closed on 28 February 2019. We will need to wait and see if the government is minded to propose any specific changes based on the suggestions received.

In the meantime, here are 10 pointers to help you with the IHT regime applying to discretionary trusts.

What is a discretionary trust?

It’s a trust where the trustees can accumulate income or pay it at their discretion. The beneficiaries do not have any entitlement to the trust fund and therefore it does not form part of their estate for IHT purposes. Due to this flexibility, these trusts are potentially subject to an entry charge, a 10 yearly charge and an exit charge. Sometimes discretionary trusts are referred to as “relevant property trusts”.

Is all property in a discretionary trust ‘relevant property’?

Broadly yes, albeit that there are exceptions. Trusts for disabled persons for example.

What is the IHT situation when a discretionary trust is set up?

Placing assets into the trust gives rise to a chargeable lifetime transfer (CLT), unless it’s an exempt transfer (e.g. covered by £3,000 annual exemption). If the CLT exceeds the settlor’s available NRB there is an immediate charge at 20% based on half the death rate of 40%. Any previous CLTs made within the last 7 years will reduce the available NRB. Potentially Exempt Transfers (PETs) however are not included in this cumulation at time of set up. If the settlor dies within 7 years of making the CLT, a further liability to IHT may arise. A trust incidentally can have only one settlor for IHT purposes, so if 2 people add assets to a trust they have each made a separate trust.

How does the 10 yearly charge apply?

The 10 yearly charge applies from the date the trust was set up and for a will trust, this is normally the date of death. At each 10-year anniversary, there is a ‘principal’ charge of 6% maximum on the value of the relevant property in the trust. If funds were placed into trust later than the date of set-up or last 10 year anniversary, then an allowance is made to tax those assets roughly in proportion to how long they have been in the trust (done by dividing the 10 year period into 40ths and using the number of 40ths to calculate the percentage rate of tax chargeable).

How does the 6% rate arise?

The rate for the 10 yearly charge is 3/10ths of the rate which would be charged on a CLT which is 20%. Therefore, 3/10 x 20% = 6% maximum. The amount of IHT threshold available against the assumed chargeable transfer is reduced to account for previous cumulative transfers. Consider Tom – having made no previous gifts, he sets up a discretionary trust for £100,000 and one year later sets up a second discretionary trust for £150,000. When these trusts achieve their respective 10 year anniversaries, the trustees of the first trust will have a full NRB to set against the value of trust fund, but for the trustees of the second trust, the NRB will be reduced by £100,000.

What is the position if the trust fund comprises Business or Agricultural property?

For the 10 year charge, tax is charged on the value of the relevant property immediately before the anniversary. The charge is on the value after business relief or agricultural relief, if appropriate.

How do exit charges arise?

Exit charges may apply when capital sums are paid out from the trust. These are also known as ‘proportionate’ charges. There are different rules for charges before and after the first 10 year anniversary. Again, the number of 40ths that the assets have been in the trust since the last 10 year anniversary or the set up of the trust are used to calculate the precise rate. The measure of the exit charge is the loss to the trust. If the tax due is paid out of any relevant property remaining in the trust, the loss will be grossed up so that the amount chargeable includes the tax.

What is the position for a discretionary Discounted Gift trust (DGT)

We need to consider how to calculate the value when calculating the 10 year anniversary charge. The asset to be valued is the total fund, less the value of the rights retained by the settlor, payable on the death of the settlor. HMRC considers that the most practical approach is to compute a valuation on the basis of the settlor’s rated age next birthday when the DGT was effected, plus an addition of 10 years for each 10 year anniversary. This has the advantage of simplicity and places the minimum administrative burden on trustees and product providers who can quote from outset the likely discount not only at inception but also at the 10th anniversary.

What is the position for a discretionary loan trust?

The trust fund is potentially subject to 10 yearly charges and exit charges although in practice the impact of this is limited as the value of trust property at the 10th anniversary is net of the outstanding loan. Note however that a quirk arises with the reporting rules. Form IHT100d is used to report to HMRC regarding the 10 year anniversary charge unless the ‘excepted settlement’ rules apply. These state that reporting is not required where the ‘value’ does not exceed 80% of the NRB. At first sight, the value would seem to be the bond value less the outstanding loan. The ABI previously confirmed however that when determining whether 10th anniversary reporting of a loan trust is required, no account can be taken of the outstanding balance of the loan. The reason being is the appropriate regulations state that any liabilities that may be deductible should be ignored. Therefore, reporting is required even if the net value of the bond less the outstanding loan, is less than 80% of the NRB (80% x £325,000 = £260,000) and therefore there is no liability to IHT.

How does the 80% rule apply to a discretionary DGT?

Again the 80% rule applies for reporting purposes. This will be 80% of the ‘relevant property’ which will be the value of the bond less the value of the settlor’s retained rights (if still alive).

Labelled Under:
Estate planning Trust

Next steps

Discretionary Trust 10 yearly charge – 10 pointers
For UK financial advisers only, not approved for use by retail customers. Click here for the consumer website For UK financial advisers only, not approved for use by retail customers. Click here for the consumer website
PruAdviser on-line services will be unavailable from 20:00 PM on Saturday 19th September until 17:55 PM on Sunday 20th September for website essential maintenance. We apologise for any inconvenience caused.

Discretionary Trust 10 yearly charge – 10 pointers

Author Image The Technical Team
5 minutes read
Last updated on 18th Feb 2020

Trusts and IHT….Help

The UK tax system is complicated, so no wonder the Office of Tax Simplification (OTS) was established to give independent advice to the government on making things easier for taxpayers. Consider Inheritance Tax (IHT), the OTS has issued two reports on the complexities of the regime and makes a comment we can all sympathise with.

“The Inheritance Tax rules applicable to trusts are not straightforward. Most individuals do not understand how trusts are used and have no knowledge of how they are taxed. It is not uncommon for experienced advisors to make errors as the Inheritance Tax charged on trusts is difficult to calculate.”

A case in point is the 10 yearly charge which potentially applies to most flexible trusts. It arises under what’s called the ‘relevant property regime’. The OTS observe that the 10 yearly charge calculation is too complex. Its suggestion is that the IHT treatment of trusts should be addressed by the separate HMRC trust consultation, running in parallel, which has a wider remit and so can consider IHT in the round alongside income tax and capital gains tax paid by trusts. The trust consultation closed on 28 February 2019. We will need to wait and see if the government is minded to propose any specific changes based on the suggestions received.

In the meantime, here are 10 pointers to help you with the IHT regime applying to discretionary trusts.

What is a discretionary trust?

It’s a trust where the trustees can accumulate income or pay it at their discretion. The beneficiaries do not have any entitlement to the trust fund and therefore it does not form part of their estate for IHT purposes. Due to this flexibility, these trusts are potentially subject to an entry charge, a 10 yearly charge and an exit charge. Sometimes discretionary trusts are referred to as “relevant property trusts”.

Is all property in a discretionary trust ‘relevant property’?

Broadly yes, albeit that there are exceptions. Trusts for disabled persons for example.

What is the IHT situation when a discretionary trust is set up?

Placing assets into the trust gives rise to a chargeable lifetime transfer (CLT), unless it’s an exempt transfer (e.g. covered by £3,000 annual exemption). If the CLT exceeds the settlor’s available NRB there is an immediate charge at 20% based on half the death rate of 40%. Any previous CLTs made within the last 7 years will reduce the available NRB. Potentially Exempt Transfers (PETs) however are not included in this cumulation at time of set up. If the settlor dies within 7 years of making the CLT, a further liability to IHT may arise. A trust incidentally can have only one settlor for IHT purposes, so if 2 people add assets to a trust they have each made a separate trust.

How does the 10 yearly charge apply?

The 10 yearly charge applies from the date the trust was set up and for a will trust, this is normally the date of death. At each 10-year anniversary, there is a ‘principal’ charge of 6% maximum on the value of the relevant property in the trust. If funds were placed into trust later than the date of set-up or last 10 year anniversary, then an allowance is made to tax those assets roughly in proportion to how long they have been in the trust (done by dividing the 10 year period into 40ths and using the number of 40ths to calculate the percentage rate of tax chargeable).

How does the 6% rate arise?

The rate for the 10 yearly charge is 3/10ths of the rate which would be charged on a CLT which is 20%. Therefore, 3/10 x 20% = 6% maximum. The amount of IHT threshold available against the assumed chargeable transfer is reduced to account for previous cumulative transfers. Consider Tom – having made no previous gifts, he sets up a discretionary trust for £100,000 and one year later sets up a second discretionary trust for £150,000. When these trusts achieve their respective 10 year anniversaries, the trustees of the first trust will have a full NRB to set against the value of trust fund, but for the trustees of the second trust, the NRB will be reduced by £100,000.

What is the position if the trust fund comprises Business or Agricultural property?

For the 10 year charge, tax is charged on the value of the relevant property immediately before the anniversary. The charge is on the value after business relief or agricultural relief, if appropriate.

How do exit charges arise?

Exit charges may apply when capital sums are paid out from the trust. These are also known as ‘proportionate’ charges. There are different rules for charges before and after the first 10 year anniversary. Again, the number of 40ths that the assets have been in the trust since the last 10 year anniversary or the set up of the trust are used to calculate the precise rate. The measure of the exit charge is the loss to the trust. If the tax due is paid out of any relevant property remaining in the trust, the loss will be grossed up so that the amount chargeable includes the tax.

What is the position for a discretionary Discounted Gift trust (DGT)

We need to consider how to calculate the value when calculating the 10 year anniversary charge. The asset to be valued is the total fund, less the value of the rights retained by the settlor, payable on the death of the settlor. HMRC considers that the most practical approach is to compute a valuation on the basis of the settlor’s rated age next birthday when the DGT was effected, plus an addition of 10 years for each 10 year anniversary. This has the advantage of simplicity and places the minimum administrative burden on trustees and product providers who can quote from outset the likely discount not only at inception but also at the 10th anniversary.

What is the position for a discretionary loan trust?

The trust fund is potentially subject to 10 yearly charges and exit charges although in practice the impact of this is limited as the value of trust property at the 10th anniversary is net of the outstanding loan. Note however that a quirk arises with the reporting rules. Form IHT100d is used to report to HMRC regarding the 10 year anniversary charge unless the ‘excepted settlement’ rules apply. These state that reporting is not required where the ‘value’ does not exceed 80% of the NRB. At first sight, the value would seem to be the bond value less the outstanding loan. The ABI previously confirmed however that when determining whether 10th anniversary reporting of a loan trust is required, no account can be taken of the outstanding balance of the loan. The reason being is the appropriate regulations state that any liabilities that may be deductible should be ignored. Therefore, reporting is required even if the net value of the bond less the outstanding loan, is less than 80% of the NRB (80% x £325,000 = £260,000) and therefore there is no liability to IHT.

How does the 80% rule apply to a discretionary DGT?

Again the 80% rule applies for reporting purposes. This will be 80% of the ‘relevant property’ which will be the value of the bond less the value of the settlor’s retained rights (if still alive).

Labelled Under:
Estate planning Trust

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