Rules introduced 10 years ago means grappling with periodic charges for the first time this year. Danny Cox explains
It has been just over a decade since changes to trust taxation were introduced on 22 March 2006. As a result, many more new trusts are within the relevant property regime, and are therefore potentially subject to an inheritance tax periodic charge on each 10th anniversary of the trust’s establishment. The first of the trusts set up under the new rules are now reaching this anniversary.
Before looking at the detail, it is worth mentioning that any jointly settled trust is effectively treated as two settlements, with separate calculations for each half (usually) of the trust. For a loan trust, the amount of any outstanding loan is deducted from the gross value of assets in determining the value of the trust.
The calculation of the periodic charge depends upon:
• The value of the trust assets immediately before the 10th anniversary,
• Whether there are any related settlements (other trusts set up on the same day as the one for which the calculation is being carried out),
• Whether any other chargeable transfers were made in the seven years before the trust was established,
• How much capital* has been distributed from the trust in the previous 10 years.
Investment bonds are, of course, treated as non-income producing assets so any distributions from bonds will be treated as capital rather than income payments.
*Note that where income rather than capital has been distributed from a trust it does not have to be taken into account for the purposes of the periodic charge. Income that is not distributed may be treated as capital by HM Revenue & Customs after a certain period has elapsed. Specialist tax advice will be required if trustees are unsure about the status of any accumulated trust.
The purpose of the periodic charge calculation is to establish the tax rate on the assets in the trust. Whatever rate is established will be applied to the value of the trust assets.
The basic calculation takes the value of the trust assets at the 10-year anniversary and calculates the lifetime tax that would be due if that amount were transferred into a relevant property trust at that time.
The actual tax rate is then 30 per cent of the lifetime rate that would apply. As the lifetime rate of tax on chargeable transfers is 20 per cent, the maximum possible tax rate at a 10-year anniversary is 6 per cent (30 per cent of 20 per cent).
In working out what the lifetime rate would be:
• Any chargeable transfers in the seven years before the trust was established have to be taken into account,
• Any capital distributions out of the trust in the previous 10 years are also included,
• So it is not possible to avoid a periodic charge by making distributions from the trust just before the anniversary,