New rules make further multiple trust or ‘Rysaffe’ planning as well as ‘order of gifting’ redundant. This change is likely to increase the likelihood of periodic and exit charges and will affect most trust-based estate planning.
Provisions
The Treasury has issued a third consultation paper on simplifying inheritance tax on discretionary trusts – which specifically affects periodic and exit charges but not entry charges.
This consultation paper, which is likely to be final, backdates legislation to affect trusts set up on or after 6 June 2014. It does not affect trusts settled prior to this date. The new rules introduce the concept of a ‘settlement nil-rate band’ whereby all trusts settled by an individual from 6 June will now share one nil-rate band for periodic and exit charges. Where an individual settles more than one trust, they will need to decide how the settlement nil-rate band is apportioned.
Periodic charges will be taxed at 6 per cent of the excess over the available settlement nil-rate band from 6 April 2015 with exit charge calculations being based on the periodic charge in the same way as before.
This means where the aggregate gift across trusts is close to the nil-rate band, a decision will need to be made as the growth in real assets is likely to exceed that of the nil-rate band, especially as the latter is frozen until at least April 2019. The client will have to either relinquish some flexibility (for example through use of an absolute trust instead) or pay additional tax through periodic and exit charges.
Background and effect
Previously individuals were already constrained to gifting within the nil-rate band by the entry charge of 20 per cent for chargeable lifetime transfers. However, they could largely avoid further internal IHT by settling more than one trust on different days, whereby each trust broadly had its own nil-rate band for periodic and exit charges.
The change in rules means it is far harder to mitigate periodic charges and they will now come into play. The basic choice is between the higher tax but complete flexibility of discretionary trusts and the tax-efficient but inflexible absolute trusts.
For absolute clarity, with periodic charges for new trusts we now look at the total value transferred to non-bare trusts from 6 June 2014. The settlor can decide how to divide the settlement nil-rate band between these trusts.
However, we still use the seven-year cumulation– reducing the available nil-rate band by chargeable transfers made in the previous seven years – to assess whether an entry charge will apply.
Planning issues and impact
It is unlikely gifts to trust will be recommended which incur entry charges at the lifetime rate of 20 per cent. Therefore the amount of expected tax is not likely to be significant relative to the trust fund. However, where total funds gifted since 6 June 2014 are near the nil-rate band, there is likely to be some tax payable at each 10-year anniversary and the client will have decisions to make for new gifts into trust.
Where the client is settling one trust with no previous gifts to trust since 6 June 2014, there is a decision to be made as to whether to take the probable tax hit at each 10-year anniversary or to relinquish some control.
Where the client has settled two or more trusts since 6 June 2014, in addition to the above, the client will have to decide how to apportion the settlement nil-rate band between the trusts.
Clearly the bigger the total transfers of value and the longer the expected lifetime of the trust or trusts, the higher the potential tax bill.
The decision will depend on client circumstances but some clients may consider that it is worth paying a small amount of tax for the flexibility, especially as the potential IHT saving is 40 per cent of the gift. This change should not necessarily prevent clients from using trusts to estate plan although some clients might decide to defer such gifting.
Using discretionary trusts
Where the recommendation is to transfer an amount equal or close to the nil-rate band into trust, there is likely to be a periodic charge at the 10-year point. This is because the growth in assets is likely to rise faster than the nil-rate band. The choices are:
•Accept the likelihood of a periodic charge
•Gift less to discretionary trust
•Gift some or all to a bare trust.
The general rules that apply are that the younger the client, the higher the likelihood of a periodic charge, and, the higher the imposition of inflexibility on client circumstances, the less attractive a bare trust is.
How apportionment works
The settlor will have a decision of how to apportion the settlement nil-rate band where they have settled more than one non-bare trust since 6 June 2014.
Apportionment can be changed as related trusts are settled and wound up. However, further apportionment is restricted for an existing trust which has reached a charge.
Examples of how this can be achieved are outlined in Box 1.
Danny Cox is head of financial planning at Hargreaves Lansdown
