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The true cost of flexibility

Moves to overcome the complexities of IHT charges on discretionary trusts is good news for advisers

By Julie Hutchison | Published Jun 27, 2012 | comments

As announced in this year’s Budget, a simplification of the inheritance tax charges on discretionary trusts can only be good news for advisers and their clients. Especially when accompanied by the news that the income tax trust rate is to be reduced to 45 per cent from next April.

But the complexities of the 10 yearly and exit charges are often seen as a potential barrier to their use for some clients.

A clearer more transparent tax system, perhaps incorporating a flat rate charge for trusts over a certain value, would help clients understand the true cost of the flexibility and control that a discretionary trust offers. The consultation on the changes is expected to be published later in June, and advisers will need to keep a careful eye on its contents.

While a new simplified regime would be welcomed by many, it could also spell the end for certain established tax planning solutions. For example, one way of limiting the effect of the ten yearly charges was to create a series of trusts on separate dates. This helped to maximise the nil rate band available to each trust at 10 year anniversaries.

This type of planning is often referred to as ‘Rysaffe Planning’ following the case of Rysaffe Trustee Co v IRC 2003. Here it was successfully argued that five identical trusts created on successive days should not be treated as a single settlement for IHT. Having failed with their challenge to this type of planning in the courts, HMRC could see the forthcoming consultation as an opportunity to close this perceived planning loophole.

Ten yearly and exit charges on discretionary trusts, and other relevant property trusts, raised almost £76m in 2010/2011. This is significantly greater than the £10.6m raised from the 20 per cent charge on creation of these trusts.

The 2006 IHT trust taxation changes brought more trusts within the scope of the charge. However the tax generated from new trusts being created is down by approximately 30 per cent compared to tax receipts immediately before the changes. While market conditions and property prices may have played their part, much of this fall in revenue is likely to be as a result of client behaviour.

Many clients looking to mitigate IHT by making lifetime gifts into trust for their loved ones are being advised to keep the amount gifted within their available nil rate band to avoid the 20 per cent entry charge. Once the client has survived for seven years, the gift is then outside their estate. They will then have a full nil rate band available and a further gift to trust can be considered. Starting gifting early and making gifts into trust on rolling seven-year basis maximises that can be passed to the beneficiaries IHT free.

Those intending to make gifts which exceed their nil rate band could consider using a bare trust. Gifts into bare trusts are potentially exempt transfers and there is no 20 per cent charge on entry and no ongoing periodic and exit charges. These trusts, however, do not offer the same level of flexibility and control as a discretionary trust. The beneficiary of a bare trust has an absolute right to the trust capital and provided they are over the age of majority can demand that the trustees pass over the trust assets to them. This may raise concerns with many settlors, particularly where there have been large gifts, who believe that the beneficiary lacks the financial maturity to have significant amounts of capital at their disposal.

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