IHT and Trusts

Inheritance tax (IHT) is a tax on your estate – the things that belong to you – when you die and is also sometimes payable on trusts or gifts made during your lifetime. This includes the total of everything you own and a share of anything you own jointly.
With a little planning you may be able to reduce the bill or avoid IHT altogether.
Things that might count towards your estate include:
Property.
Investments.
Insurance.
Payment from a pension plan or employee death benefit (unless in a trust).
Other assets, for example, cars, art, jewellery, furniture.
Gifts you have made but still benefit from, for example, a house you have given away but still live in.
Certain gifts that you have made in the last seven years.
Assets held in trust from which you receive personal benefit.

How much can I leave before inheritance tax affects my family?
For the 2011/12 tax year, no tax is charged on the value of your estate up to £325,000.
This is also known as the ‘nil rate band’ and everything above that is taxed at 40%.

What is a Trust and why would you use one?
A trust is a legal relationship whereby one individual (the “settlor”) transfers his or her assets (the “trust fund”) to another individual or company (the “trustee”) who holds and manages these assets for the benefit of others (the “beneficiaries”) named by the settlor. The trustees are bound by the terms of the trust deed.
A trust can be established during your lifetime (“inter vivos trust”) or upon your death under the terms of your will (“testamentary trust”).
Trusts have different characteristics depending on the provisions included in a trust deed. For example, a trust may be revocable or irrevocable; discretionary or specific. To allow for maximum flexibility, most people establish a discretionary trust, which gives the trustee discretionary power to react swiftly to changed circumstances.

Privacy
Assets are held in the trustee’s name, therefore the identity and interests of the beneficiaries may be kept confidential continuously until the trust terminates.

Tax planning
A trust may be used to reduce tax liabilities. Assets owned by a trust will not be dealt with in the estate of a deceased person. Hence,
estate or inheritance tax may be minimised or eliminated

Succession planning
Trusts are effective tools for succession planning. They enable you to make provisions for your family members, relatives and friends, charities and other organisations in the way you desire.  They also enable efficient distribution of trust assets to beneficiaries, without consuming the time and money associated with lengthy and complicated procedures and formalities required for probate.

Absolute & Discretionary Trusts
The main characteristics are as follows.

Absolute trust
Neither the beneficiaries nor their share of the trust can be changed after the trust has been set up.
Any gift element into a trust, if not covered by an exemption, is a potentially exempt transfer (PET).
There is no IHT if the settler survives for seven years.
There may be taper relief after three years.
Each beneficiary’s share of the trust fund is part of their estate.
Beneficiaries with legal capacity (generally, at age 18 in England and Wales and 16 in Scotland) have the right to demand their vested share of the trust fund at any time.

Discretionary trusts
Beneficiaries can be changed and do not have a fixed share of the trust fund.
The trust must be reported to the local tax office and gifts into it must be notified to HMRC if they are over the relevant limit.
IHT returns are currently required every 10 years, subject to reporting limits.
Any gift element into a trust, if not covered by an exemption, is a chargeable lifetime transfer,
The trust fund may be subject to 10 yearly periodic charges and proportionate exit charges.
While in the trust, none of the trust fund will be part of a beneficiary’s estate.

The Nil Rate Band
The nil rate band for the 2011/2012 tax year is £325,000.
The nil rate band allowance is transferable on death between married couples and registered civil partners. This means that, for the current tax year, the nil rate band could be up to £650,000 on the second death.
If any of the allowance is used on the first death, it is the unused proportion that is transferred. For example, for a person who died in the 2008/2009 tax year (when nil rate band was £312,000), who had used £156,000 of their nil rate band allowance, a proportion of 50% would be transferable. So if their spouse died in the current (2011/2012) tax year the transferred proportion would be worth £162,500, on top of their own allowance of £325,000. The balance above this is taxable on death at 40%. The value of the estate, for IHT purposes will include everything the person owns, individually or jointly This will include, for example, furniture and other house contents, car, jewellery, savings, investments and life assurance benefits (uniess written in trust).
For clients who are UK domiciled it will also include any assets held overseas.

Main Exemptions
A number of gifts are exempt from IHT including:
all gifts transfers between UK domiciled married couples or registered civil partners
gifts to a non UK domiciled spouse or registered civil partner are exempt subject to £55,000 lifetime limit
gifts up to £3,000 in total per donor each tax year; any unused part of this allowance can be carried forward for one year
gifts of up to £250 per recipient
gifts that are part of normal expenditure our of income
gifts on marriage or civil partnership: £5,000 from each parent, £2,500 from each grandparent and £1 000 from anyone else
gifts to charities
family maintenance
There are also special reliefs on business property and agricultural property, under which 50% or 100% of the value may he exempt

Potentially Exempt Transfers
Most lifetime gifts, including those between one person and another, are potentially exempt transfers (PETs). If the donor survives for seven years after making the gift, it becomes exempt from IHT. If the donor dies within the seven years, the value of all such gifts will be included in the estate when calculating any IHT liability and will be applied first against the nil rate band.
Where PETs use up part or all of the nil rate band, there will be less or none to apply to the remaining estate on death. For example, if PETs amount to £150,000, there will be only £175,000 left of the nil rate band to offset against the value of the retained estate. So, if the retained estate is worth, say, £200,000, there will be an IHT liability, even though the value of the retained estate by itself is below the nil rate band.

Taper relief
Where a PET becomes liable to IHT on death, taper relief may apply if the donor died more than three years after making the gift, Taper relief applies to the amount of tax payable, not the value of the gift, and rates are as follows.

Years between gift & death Taper Relief
< 3 years            -      None
3 – 4                    -      20%
4 – 5                    -      40%
5 – 6                    -      60%
6 – 7                    -      80%
> 7 years           -     100%

Remember that lifetime transfers are applied against the nil rate band, in chronological order. So if the total of PETs is below, the nil rate band, no IHT is payable and  taper relief is irrelevant.
In the previous example, where the PETs totalled £150,000 this was all covered by the nil rate band. No IHT would have been payable, so no taper relief would have applied.
Even where the PET exceeds the nil rate band the same principle applies.

Lets assume a single PET of £400,000 and that the donor dies between five and six years after making the gift. Again, the nil rate hand is applied first against the PET so, of the £400,000, only £75,000 (ie. £400,000 minus £325,000) is chargeable to IHT. The charge is 40% which comes to £30,000. Taper relief now applies to that figure. whch reduces the tax payable by 60%. The relief is £18,000, leaving an IHT charge of £12,000.

Suppose a further PET of £100,000 had been made 3.5 years before death. In this case the first PET would absorb the entire nil rate band, so the second PET will he chargeable as 40%. The tax charge is £40,000, to which taper relief of 20% would apply, reducing the charge on this PET to £32,000. (These examples do not take account of any annual exemptions that may he available).

Chargeable Lifetime Transfers
Gifts into a discretionary trust are chargeable lifetime transfers (CLTs), which may attract an immediate tax charge. The value of the gift is added to any other CLTs made in the previous seven years and tax will be charged on any excess over the nil rate band. Lifetime IHT is charged at 20% (half the death rate), but if the settlor pays the tax, or it is paid from their estate after death, the value will be grossed up.
If the settlor dies within seven years of making the CLT, there may be an additional tax charge. The tax due is recalculated using the IHT death rate of 40% and the nil rate hand at that time. The calculation will include CLts in the previous seven years, as before, and also any PETs made within seven years of death or seven years of CLT.
Taper relief will apply if the death occurs more than three years after the gift. Any tax already paid is taken into account, but no refund can be made.

Payment of tax
Where an estate is liable to IHT, the tax s usually payable within six months of the end of the month in which the death occurred, if it becomes overdue the amount owing may incur interest, currently at 3% pa (as at April 2011).
The estate cannot normally he distributed until the IHT bill has been settled.

Deeds of Variation
A person who inherits under a will or through intestacy can use a deed of variation to redirect assets within two years of the death. IHT will then apply as if the variation had been made by the deceased (included in the deceased’s will).
This presents a further opportunity for a spouse or civil partner and other heirs to effectively take retrospective action to improve their tax position when they may have believed the opportunity had already been lost.

Intestacy
The rules on intestacy are quite complex and depend on who survives the deceased. There are also different rules in England and Wales, in Scotland and in Northern Ireland, However, in all cases, intestacy rules are not designed to save IHT and can make the bill higher.
The points to remember are that, generally speaking:
the spouse or civil partner will not inherit everything — so there could be an immediate IHT bill on the balance, which will go to children or other near relatives:
where the spouse or civil partner gets the majority of the estate, this may lead to an IHT problem on the second death.
Some transfers on death may also be exempt from IHT such as transfers of assets between a husband and Wife or civil partners and business property. However it is important, not to ignore IHT by plannng to give or leave everything to a spouse or civil partner as your assets may increase by more than the increases in the IHT tax band
Statement of wishes
With a discretionary trust, the trustees have discretion (within the rules of the trust) over when and to whom they pay benefits. This could mean that the assets are not distributed in the way the settlor would have liked, or it could lead to difficulties if the trustees are not in agreement on who should benefit.
A Statement of wishes form allows the settlor to record how they would like the trustees to distribute assets, and why, or factors they would like the trustees to take into account. This cannot he binding on the trustees in any way, but may provide valuable guidance.
As a rule the type of trust to use and even whether a trust is appropriate will be the primary consideration.
Questions to consider include:
Where is the clients domicile: UK or elsewhere?
if the client is non-UK domiciled, there are particular planning options available, such as an excluded property trust.

Is the client married or in a civil partnership?
If the client has a spouse or civil partner, consider whether both nil rate bands will he used effectively. It may also have a bearing on what access to funds is required. If the spouse or partner is non- UK domiciled, it will affect the exemption on assets transferred between them.

What access to funds does the client need: none, capital or regular payments only?
This could have important influence or the choice of trust IHT planning often involves a balance between saving tax and providing access to funds.

Could a deed of variation apply?
If a client has recently inherited, assets, more effective IHT planning might be achieved by redirecting assets either outright or to a suitable trusts, subject to the rules governing deeds of variation.

Should the trust arrangement be single or joint?
This depends on who owns what assets and Whether they are split in an appropriate way for IHT planning. It may be that separate single arrangements could be moresuitable than a joint arrangement in some cases. For IHT purposes a joint settlement is treated as two single settlements.

Loan Trust: an arrangement that allows the client to access the original capital, either as lump sums or as regular repayments, while any growth on the capital is outside the estate.

Gift Trust: a trust that is used to hold a gift of an investment bond or of a life assurance policy

Discounted Gift Trust: an arrangement that allows the client to give away capital while keeping a payment stream for life, with a choice of onshore and international investments.

Excluded Property Trust: a trust for clients who are non-UK domiciled.

Loan Trust
An arrangement that allows the client to access the original capital, either as lump sums or as regular payments, while any growth on the capital is outside the estate.
How it works
The settlor makes an interest free loan to the trust, repayable on demand.
The money is invested in one or more sngle premium bonds.
The settlor can waive (by deed) the remaining loan repayment at any time. this will count as a transfer of value at that time, which may have IHT consequences.
At the settlors death:
any part of the loan not previously repaid is repayable and remains part of their estate, and any balance may he distributed to the beneficiaries or the trust may continue.
Who can benefit
The settlor(s):
Can access the original capital but not the growth on demand.
May request access as a single lump sum, occasional lump sums or regular payments.
Can vary the amounts and frequency of withdrawals, but cannot take out more than the original loan.
The beneficaries;
Are entitled to the balance of the trust fund (the total less the outstanding loan) but care must be taken that the outstanding loan can always be repaid.

Gift Trust (Bonds)
A trust that can be used to make an outright gift of an investment
How it works
The settlor’s investment bond is put into trust during his/her lifetime.
Payments can be made, to the beneficiaries at any time. The trust will continue to the end of the trust period or until all benefits have been paid out.
At the settior’s death, either:
— the trust can continue. Or
— the trust can be wound up and the assets distributed.
Who can benefit
The settlor(s)
Cannot receive any benefit from the trust.
The beneficiaries
Will benefit from the entire trust fund. Any payments during the settlor’s lifetime must not be used in a way where the settior could or does benefit

Gift Trust (Life policies)
A trust that can be used to make a gift of a life insurance policy designed to meet or offset an IHT bill
How it works
The settlor pays regular premiums or a single premium into a life policy.
The sum assured is selected in line whh the estimated IHT liability, If the potential IHT liability rises due to a change in legislation, cover can be increased (within limits) without medical evidence, on payment of the appropriate premium(s).
The life policy is set up under the trust.
At the settlor’s death,
the trustees will distribute the proceeds which could then be used towards paying or offsetting the IHT bill.
Who can benefit
The settior(s)
Cannot receive any benefit from the trust.
The beneficiaries
Benefit from the proceeds of the life policy.

Discounted Gift Trust
An arrangement that allows the client to give away capital while still receiving regular fixed payments, with a choice of onshore and offshore investments
How it works
The Settlors investment bond is put into trust during his/her lifetime
The settlor gets regular payments, with the amount and frequency fixed from the outset.
Entitlements for the beneficiaries are at the trustees discretion. Modest one-off payments may be made during the client’s lifetime, as long as the settors income is not put at risk,
At the settors death, either;
the trust can he continued for the benefit of the beneficiaries, or
the trust can be wound up, with the bond assigned to the beneficiaries or cashed in and the proceeds distributed.
Who can benefit
The settlor(s)
Receives regular fixed payments. These continue for the life of the settlor or until the death of the survivor for joint cases (unless the trust fund is exhausted).
Has no access to capital or any other benefits.
The beneficiaries
May benefit from modest amounts of capital during the settlor’s lifetime at the discretion of the trustees.
Receive the capital, dstributed by the trustees, after the settlors death.

Excluded property trust
Highly effective UK IHT planning for foreign domiciliaries, allowing the settlor to benefit from the entire trust fund.
How it works
The Excluded Property Trust is a discretionary trust. However as all the trust assets are excluded property, this will not give rise to any immediate, periodic and exit charges.
The trust is suitable only for clients who are currently non-UK domiciled – in particular, those who may in future become UK domiciled or created as UK domiciled for IHT purposes.
It can also be used by non–domiciled clients who have or may have UK domiciled beneficiaries.
The settlors international bond is put into trust during their lifetime.
The trust is set up while the settlor is non-UK domciled, If the settler subsequently becomes UK domiciled for IHT purposes, the trust assets will i excluded property and have no liability to UK IHT.
At the settlor’s death, either:
— the trust can continue, with payments to beneficiaries at the trustees discretion, or
— the trustees can wind up the trust and distribute the assets.
lf the trust continues after the settlors death, assets in it remain excluded property and will not form part of the beneficiaries’ estates, even if they are UK domiciled.
Who can benefit
The settlor(s):
Can benefit from the entire trust fund at any time during their lifetime
The beneficiaries:
Can benefit from the entire trust fund, at the trustees’ discretion and in particular after the settlor’s death

Absolute Trusts
General principles
Once the trust has been set up, the beneficiaries are fixed
Nether they, nor their share of the trust can he changed.
The beneficiaries have the right to demand their share of the trust fund at, any time after reaching the age of 18 (16 in Scotland).
A beneficiary’s share of the trust fund is part of his/her estate.
There are no ongoing reporting requirements after the initial notification. to the local tax office.
The tax rules
Gifts into an absolute trust are potentially exempt transfers. If the donor survives for at least seven years after making the gift it becomes an exempt transfer and will not incur any IHT.
If the donor dies within seven years the gift becomes a chargeable transfer. the tax calculation will then take into account the total of any chargeable transfers made in the seven years before the gift into trust. These include immediately chargeable transfers and also failed PETs              – any other potentially exempt transfers made within seven years of death.
The total of these chargeable transfers is added to the amount of the gift into the trust and tax will then be charged on the excess over the current nil rate band (£325 000 for the current tax year) at a rate of 40%.
If the donor dies more than three years after making the gift into trust, taper relief may be available. The reduction applies to the tax due, not the taxable amount.
If the value of the gift into trust and previous chargeable transfers are together less than the nil rate band, there will be no tax on the trust, but it will reduce the nil rate band allowance available for the rest: of the estate.

Discretionary Trusts
The trustees can distribute the trust fund at their discretion to any potential beneficiary.
Gifts above the relevant limit must be notified to HMRC by the settlor and IHT returns are required every 10 years.
Trust fund assets are not part of any beneficiary’s estate while in the trust.
A change of beneficiary does not create a potentially exempt transfer (PET) or chargeable lifetime transfer.
The tax rules
Gifts into a discretionary trust are chargeable lifetime transfers.
There are three inheritance tax charges that may arise:
an immediate charge,
a 10 yearly periodic charge, and
an exit charge when money from the trust fund is distributed to beneficiaries.
There may also be an additional charge if the settlor dies within seven years of setting up the trust.
When the settior is alive, tax charges on the trust do not take into account any PETS. If the settlor dies and there are PETs which then become chargeable, charges on the trust may, be revised and extra tax may become payable.
Immediate charge
The immediate charge is at the lifetime rate of 20%. This is charged on the excess over the nil rate band of the gift into trust, plus any chargeable transfers made n the previous seven years.
Points to note:
Gifts into trust of an amount, below the nil rate band will not attract any immediate charge if there have been no chargeable transfers in the previous seven years or if the total of the gift and any previous chargeable transfers is less than the nil rate band.
If the immediate charge is paid by the settlor rather than the trust, the amount payable will he grossed up to 25%, as the tax payment represents a further gift being made
This is likely to be the case for gifts of bonds and life policies, as otherwise part of the bond or policy would need to be surrendered immediately to pay the tax if no other trust funds were available.

Additional charge on death within seven years
If the settlor dies within seven years of setting, up the trust, the tax due on the gift into trust is recalculated using the full IHT rate of 40% and the current nil rate band. The calculation includes any chargeable transfers made in the seven years before the trust was set up and also any potentially exempt transfers made before the trust was set up and within seven years of death (failed PETs)
If the settlor dies more than three years after making the gift into, trust, taper relief may be available. The reduction applies to the tax due, not the taxable amount.
If the amount of tax due is more than the tax already paid under the immediate charge, there will be an additional tax charge to make up the difference.
However, if the amount due is less than has already been paid, there will not be any refund.
Points to note:
The additional charge is based on the original gift into the trust, not its current value, but the current nil rate band is used.
If there was no immediate charge when the trust was set up, there will not normally be an additional charge, although any ‘failed’ PETs could trigger a charge if they take the total above the nil rate band.

Periodic charge
Every 10 years, the value of the trust fund is subject to a periodic charge. This applies for as long as the trust contnues, even if the settor has died. The calculation is based on the excess over the nil rate band, taking into account any previous chargeable transfers made in the seven years before the trust was set up. The tax rate that applies is 30% of the effective lifetime rate.
Points to note:
If the, trust fund is growing faster than the nil rate band, there may be a periodic tax charge even if there was no immediate charge when the trust was set up
Further complex rues apply if there are related settlements, if further property has been added to the trust, if the trust contains non relevant property and concerning accumulated and undistributed income.

Exit charge on capital distributions
a) In the first ten years
Where part or all of the trust fund capital is distributed to a beneficiary, either during the settor’s lifetime or after their death, there may be an exit charge.
During the first ten years, this will be based on 30% of the effective lifetime rate. The is then adjusted for the amount of time since the trust was set up, using a factor of X/40, where X is the number of compete quarters that have elapsed.
Points to note:
The calculation for the exit charge is based on the original gift into trust, not its present value, but uses the current nil rate band.If there was no immediate charge, the exit charge will also he nil.

b) After ten years
After ten years, the exit charge will be based on 30% of the effective rate at the last ten-year anniversary, but recalculated using the current nil rate band.
Again, it is adjusted for the time that has elapsed since the last charge, using a factor of X/40 where X is the number of complete quarters that have elapsed.
Points to note:
The calculation for the exit charge is based on the value of the trust fund at the last periodic charge, not its present value, but uses the current nil rate band,If the last periodic charge was nil, the exit charge will also be nil.

Pre Owned Assets Tax
The Finance Act 2004 introduced new rules that provide for an income tax charge on benefits received by a former owner of property. It applies to individuals who continue to receive benefits from certan types of property that they owned after 17 March 1986 but have since disposed of. The tax has applied since the tax year2005/2006.
The property affected can he grouped under three headings; land, chattels and intangible property. Not every instance where an individual may have disposed of property will come within the scope of the charge. There are several types of transactions, relating to land and chattels that are excluded. There are also provisions exempting the relevant property from the charge where it is subject to a charge to IHT or where specific protection from IHT is given by legislation.

UK Income Tax on an Investment Bond in a non charitable trust
Many types of investment in a trust are liable to capital gains tax (CGT).
However, with a bond, any tax charged on any profit made will generally be income tax.
A bond normally consists of a group of identical policies. The chargeable event tax rules look at each policy (or segment) separately. For instance, all the policies may be in the trust at outset, but at some point some may come out of the trust — because the trustees have assigned them to one of the beneficiaries. Where that happens, the assigned policies will be taxed as belonging to an individual, while those still in the trust will be taxed as policies in a trust.
A tax charge only arises when a ‘chargeable event’ occurs. a ‘taxable policy’ means a policy that has become taxable because a chargeable event has occurred for example, the policy has been fully surrendered. Sometimes a chargeable event will occur under all the policies in the bond at the same time, in which case all the policies in the bond will be Taxable Policies. At other times, a chargeable event may occur under just one of the policies, in which case you will be looking at just that one Taxable policy

Bond in Trust – who is the tax payer?
With absolute trusts, the trust is effectively ignored for tax purposes and any charge will fall on the beneficiaries as long as they are adult
If a beneficiary is a minor, the charge will fall on the settlor.
For discretionary trusts, if the settlor is alive and resident in the UK the gain is taxed on the settlor (if not the trustees if they are alive and resident in the UK, if they were not either then HMRC will look at the beneficiaries)

Points to consider
The value, of an investment may fluctuate and is therefore not guaranteed. A client or their beneficiaries may not get back the full amount invested.
Trusts will not always be suitable in all cases, Other forms of planning may be more suitable in individual circumstances.
Creating a trust can have tax as well as legal consequences.
Once a trust has been created it cannot be revoked.
The trustees have special duties to the settler and beneficiaries and the misuse of a trust power by a trustee can make him or her personally liable for resulting losses.
Situations that may involve international or cross-border legal and taxation issues can be extremely complex.
Tax and trust law can be open to differing interpretations.