Likewise, neither will any loan repayments made to a settlor under a gift and loan trust be treated as a distribution.
Whether a 10-yearly anniversary IHT charge is payable or not, the reporting requirements apply where the value of the trust is over 80 per cent of the available NRB (currently £260,000). The trustees may, therefore, have an obligation to report the trust to HMRC even though no tax charge arises.
The trustees then need to consider the NRB available to the trust. The amount available will be the NRB at the 10th anniversary, less any chargeable transfers made by the settlor in the seven years before this trust was created.
From this you can see that the trustees will need to be aware of previous transfers made by the settlor and that these gifts can have an impact for the lifetime of the trust.
Let’s consider an example:
- In January 2013 Lisa made an outright gift of £400,000 to her daughter. As this is a potentially exempt transfer (PET) no tax is payable.
- In January 2017 Lisa sets up a discretionary trust with a gift of £200,000. Lisa regularly used her £3,000 annual gift exemption. This is a chargeable lifetime transfer (CLT).
- As the CLT is below the available nil rate band, no tax is payable.
- Lisa sadly dies in January 2019.
- In January 2027 the trustees must calculate whether a periodic charge is due. The trust value has grown to £250,000 and the NRB has increased to £350,000.
- As Lisa died within seven years of the PET, the PET failed and became chargeable. As the failed PET was £400,000, the available NRB at the 10-yearly anniversary (2027) is zero.
- Therefore a periodic charge will be payable in 2027 on the trust of 6 per cent x £250,000 = £15,000.
As more and more discretionary trusts are approaching their 10th anniversary, questions around how the periodic charge is calculated have increased.
3. 14-year shadow – when does the shadow take effect?
People have heard of the 14-year shadow but are unsure when it becomes relevant. The 14-year shadow is only an issue if, on death, the total of the CLTs and PETs made in the previous seven years exceeds the available nil rate band, meaning that tax is payable.
For those considering making a PET and a CLT at or around the same time, it is logical to make the CLT before the PET as this can impact the periodic charges.
However, when making a PET the donor should also be wary of any CLTs made in the previous seven years, and this is where professional advice is paramount.
Let’s consider two clients, Bert and Eric. Both die on April 6 2022, when the NRB is £370,000, with estates valued at £500,000 each. Both had made gifts in the previous seven years:
- Bert made a £200,000 outright gift to his daughter on April 6 2015 and then a £200,000 gift into a discretionary trust on April 6 2018.
- Eric also made the same gifts but he settled the £200,000 into the discretionary trust on the April 6 2015, with the outright gift to his daughter on the April 6 2018.
Both are divorced, so when calculating the tax payable on the estates they have one NRB.
Bert and Eric’s 2015 gifts can be ignored as they survived seven years, but the 2018 gifts need to be considered.
Both use up the NRB first, meaning that the estate has a NRB of £170,000 (£370,000 - £200,000). This results in £330,000 being taxable at 40 per cent, giving an IHT liability on both estates of £132,000.
But if both estates have the same tax liability, where does the 14-year shadow come in?
Now we need to consider the tax on Eric’s 2018 failed PET. In considering the tax on the estate, we have to look back at the history of gifts in the seven years before death.
However, when looking at the tax on a failed PET, we have to go back seven years from the date of the PET; and Eric had made a CLT within this seven-year period.