It’s a Matter of Trust

It’s a Matter of Trust An Introduction to using Trusts in Basic IHT Planning 12 December 2006 by Kevin Slevin CTA (Fellow), ATT, TEP Slevin Associates Reading

NEW TRUSTS! Lifetime planning: IHT and CGT Issues

Summary • Making Trusts Simple: Matters excluded today. • Why are we here today? • Some IHT Points . . . Not to be overlooked • Back to the Trust Tax Issue

Before we get started • 2006/07 Nil Rate Band £285,000 • 2007/08 Nil Rate Band £300,000 • 2008/09 Nil Rate Band £312,000 • 2009/10 Nil Rate Band £325,000 • Each spouse . . .

Making Trusts simple • Being Selective • Keeping things simple(ish) • Largely ignoring pre 22 March 2006 position

Making Trusts simple • Selective presentation • Excluding all foreign domicile issues • Assuming all clients are UK resident • Ignoring rules re Trusts for orphans and other disadvantaged people • Ignoring the holding private residences • Reservation of benefit rules, and • Pre-owned assets regime counteracts schemes

Why are we here today? • To help identify opportunities where Lifetime Trusts can be used to good effect. • Let’s assume your client is moderately wealthy (but don’t for get that rapidily apprecaiting assets can be gifted into Trusts too).

Why are we here today? • Let’s assume your client is concerned about IHT on his/her death • Have you told him about it? • What does your engagement letter say about IHT? • Let’s also assume your client has assets which he does not wish to loose control over but which he feels able to set aside for the next generation if there is a tax advantage in doing so.

Why are we here today? • We are here to see how a straightforward Trust (or two!) might save IHT for the family unit. • And we are, generally, assuming that no previous gifts have been made – or if they have been made the gifts were not immediately chargeable being gifts to discretionary trusts.

We are not here to draft Trusts! • It’s illegal for anyone other than a solictor to draft a trust deed for another person. • Therefore, might not be covered by an accountants PI policy. • Don’t copy someone else’s work! • You do need an experienced Solicitor

The Key Point of Interest! • Every Trust within the discretionary trust tax treatement (all of those we are discussing today) attracts its own Nil Rate band! • This Nil rate band is identical to that of the settlor (but is reduced by settlors ICLT in last 7 years) • Special rules for trusts formed on same day • Here Nil rate band split!

List solicitors I can recommend • Uhmmm? • STEP • Counsel?

The Key Point of Interest! • Day one – settlement No 1 £285,000 • Over Seven years later settlement No 2 £325,000 • Over Seven years later, Settlement No 3 say, (etc, etc) £325,000 • Both Husband and wife • Assumes no previous ICLGs • Only small IHT in Trust on excess over its NRB • CGT Holdover on gift to Trust – but watch minor beneficiaries – deemed settlor interested

The Key Point of Interest! • Say each spouse shelters £610,000 (£285,000+£325,000) and survives 7 years from final settlement (so as to reinstate his/her nil rate band) • £1,220,000 held in trust . . . little or no IHT • Say, Saving 40% . . . £ 488,000

Before we get stuck in! • We need to make sure we are all up to speed with key points of the IHT code • We will now explore some of the key issues of which advisers must be aware.

IHT Basics • Lifetime gifts to individuals are Potentially Exempt Transfers of value (PETs) • Survive the gift by 7 years and gift drops out of IHT calculation re estate at death • Failure to survive 7 years means: • Value of transfer added in to the estate • As bottom slice (as reduced by Nil Rate band) • TAX tapered if survived by at least 3 years • No IHT taper benefit if gift < Nil rate band

A Few IHT Basics • BUT today we are talking about gifts into Trust and – Post FA 2006 – such gifts cannot be PETs • Any gift to a Trust (ignoring special trusts alluded to) post 21 March 2006 is an ICLT • Immediately Chargeable Lifetime Transfer • Excess over (1) AE £3000 and (2) available nil rate band taxed @40%

A Few IHT Basics • Any lifetime gift falling within the ‘Gifts with Reservation of benefit’ (GWROB) rules is Bad news – the asset being treated as still owned for IHT purposes by the donor. • But ICLT provision still operate where gift into trust! • Trust still taxed in same way (see later) • The gift remains a CGT disposal

A Few IHT Basics • Therefore, GWROB = potential double taxation! • Very limited relieving provision for double taxation • ? PI Claims unless issue clearly spelt out • one cannot tax-efficiently gift an asset and continue to enjoy the advantages of owning same, e.g. a private residence, a holiday home etc • Through rent can be paid for use must be MV(??) • HMRC are believed to look at cases individually and grant relief by concession sometimes.

A Few IHT Basics • Any arrangement not caught (for technical reasons) by the GWROB rules, where the donor continues to enjoy a benefit, is likely to fall within Pre-Owned Asset Regime • Therefore, Income Tax Charge arising (outside scope today’s presentation) • Also settlor interested Trust for CGT and any income will be assessed on the settlor

The Basics • Therefore, today we are talking only about outright gifts of assets where neither the donor nor his spouse (or Civil Partner) has any ongoing or potential benefit from the assets held in Trust following the gift. • Watch Hold-over relief restriction where there are minor beneficiaries

IHT Basics • It is not the value of the asset given away which attracts IHT • It is the fall in value in the estate occurring as a consequence of the gift.

IHT Basics Fall in value in the Estate – Property Co: • Fred owns sixty (60%) shares in a Fred Ltd which are valued at £600,000. • Fred gifts 15 shares (25% of his holding) to a trust, retaining 45 shares (45%) • Fred’s IHT gift is not £150k (25% of £600k) • Gift is £600k less value of 45% holding (say 200k) therefore chargeable transfer £400k • Reliably advised this is frequently overlooked.

IHT Basics: Couples Valuing assets held by both Spouses (& CPs) • Where common assets are held by both spouses, say the same class of shares in X Ltd, they are valued as one asset and then apportioned. • Thus two 40% minority interests are valued as one 80% holding and then 50% of value attributed to each spouse • Applies to all assets, e.g. land

IHT Basics: Couples • Watch Associated Operations • Fred owns land worth £500,000 • Wants to gift to Trust for Son - and recognises that ICLT resulting in IHT • Fred gifts one-half to Trust for children, and • One-half to wife on the understanding that she makes a gift land to an identical Trust • Associated operation provisions (??) may prevent utilisation of wife’s Nil Rate band

IHT Basics: Couples • If Fred dies within 7 years, he could be treated as having made both gifts for IHT purposes (i.e. to both Trusts), effectively looking through Fred’s tax planning manoeuvre saying total gift £500,000 • CLT will need revising to as will trust’s tax position (see later). • Wife must be free to deal with asset as she chooses - get independent advice.

IHT Basics: Couples • Reminder: IHT is self-assessable by Executors • Executors need to consider if associated operations rules apply to transactions in seven-year window and calculate tax accordingly • Possible penalties as well as interest.

IHT Basics Business Property Relief reduces taxable transfer value as follows: • Shares in unquoted trading company (broadly) –by 100% (includes AIM shares) • Value of soletraderships – by 100% • An interest in a trading partnership – by 100% • A partner’s asset used in his partnership – by 50% • A shareholder’s assets used in a trading company which he (& spouse or CP) controls – by50% • A minority shareholder’s asset, used as above – by 0%

IHT Basics Business Property Relief reduces taxable transfer value as follows: • An asset used in a soletradership but not gifted as part of the transfer of the business (or the transfer of part of the business) – 0% • Where there is mixed activities in trading companies, i.e. investment and trading activities • Relief can be lost altogether in Singleton Co. • And lost/ restricted proportionately on Holding Co. • Watch excluded activities generally, e.g. Prop dealing

IHT Basics • BPR rule only applies if asset held for two years (see detailed definition of qualifying property outside the scope of today’s talk) • Special rules to facilitate relief for replacement business assets

IHT Basics • The nature of APR can present special problems and there is uncertainty as to how the FA 2006 provisions impact on APR re IIP settlements (Watch professional press for developments.) • Disc. Trustees farming land (incl. using a manager) will benefit from 100% APR for the trust’s IHT after two years ownership but only 50% if they let the land – and do so for 7+ years.

IHT Basics • BPR/APR: Lifetime Gifts • Qualification Test may be Applied Twice! • Once at the date of the gift, and • if death of donor falls within 7 years of making gift, also at the date of death of the donor. • Watch impact of Death on lifetime transfers of business assets and agricultural property

Agricultural Property Warning • The Single Payment (‘SP’) System including the need to hold Payment Entitlements (PEs) is outside the cope of today’s talk but expert advice needs to be sought on any transfer of land to ensure entitlement is not lost or left with donor! • Ditto re Wills (where PEs may be accidentally left to a different beneficiary to the land which gave rise to them!)

Making Trusts simple • BPR turn-off?? • We are Not overlooking BPR • Yet recognising that many who currently potentially benefit from BPR may not be keen to plan now to save IHT post sale of their business unless they own other fully chargeable investment assets. • Ditto APR • BUT clients do sell businesses don’t they!

Don’t forget IHT Impact of a Sale • James owns 100% of James and Co (1974) Ltd – exclusively trading company making pens • Valued at £2m – IHT payable 40% of Zero = £000 • James sells his shares for £2m cash and retires • IHT payable £800k Sale increase in IHT exposure £800k • Action Pre retirement to reduce size of holding could ultimately save IHT . . . unless he can’t bare to part with any of his wealth. • Why does James not consider giving 10% of shares to a family trust? No real loss of control.

Basics Trust Points • Bare Trusts • Ignored today • Settlor • Can be more than one settlor to a trust • Ignored today as not a good idea for IHT • Trustees • Settlements v Trusts? • Treat as same today

Basics Trust Points • Interest in Possession Trust • Discretionary Trust • A&M Trust • An IHT concept – pre 22 March 2006 • Special rules until April 2008 • May touch on later • The Trustee Acts • Trustees charging?

Basics Trust Points • Can Trustees Borrow? • Can Trustees make property available rent free to a beneficiary? • Can the PPR exemption operate? • Gift into Trust – no Stamp Duty payable • Gift into Trust – No Stamp Duty Land Tax

Turning to tax . . .

A gift into Trust: CGT • Disposal for CGT purposes (unless £s cash) • S165 Hold-over does not apply • S260 Hold-over can apply • Election required! • Not if settlor interested trust

CGT: Assets of Trust • Trustees liable to CGT on disposal to 3rd parties – unless settlor interested trusts • When settlor assessed. • Trustees can claim relief such as taper relief as set out in Sch A1 • Transfer to beneficiaries is a CGT disposal • Section 260 relief available if beneficiary agrees

A gift into Trust: IHT • Disposal for IHT purposes is an immediately chargeable lifetime transfer • Nil rate band available, • 50% of lifetime rate, i.e. 20% • IHT payable by instalments re land and buildings and certain other assets • Over 10 years • Interest arises

IHT: Assets of Trust • Deemed IHT charge every ten years! But each Trust (generally) has its own NRB • AND rate capped at 30% of lifetime rate, i.e..30% of 50% of 40% = 6% • But where settlor has nil previous ICLT, IHT in trust can be much lower than 6%

Remember a capital taxes perspective . . . • it now matters not whether the trust is: • discretionary, • accumulation and maintenance, or • interest in possession • the longstanding tax regime applicable to discretionary trust now applies equally to all new trusts being discussed here today.

EXAMPLE: SETTING UP George’s Susan’s Trust Trust Fall in estate due to gifts of interest in two properties Valued at £290,000 each 290,000 290,000 Less annual IHT exemption: 2006/07 ( 3,000) (3,000) 2005/06 ( 3,000) (3,000) Chargeable to IHT 284,000284,000 IHT Payable (NR Band) Nil Nil

The ten-year charge • Properties valued at £475,000 each. Say Nil rate band 2016/17 £360,000 • £475,000-360,000 = 115,000 @20% = £23,000 • Effective £23,000/475,000 X 100 = 4.842% • Actual rate 30/100 of 4.842 = 1.452% • IHT 1.452% of £475,000 = £6,897 (n.b. For each Trust) But not £182,800 later!

2nd ten-year charge • A similar exercise creating a similar low effective rate of tax arises every 10 years • But let’s say both trusts end after a total of 15 years, on Susan’s death – assets to adult children. • CGT Holdover Relief available under S260 TCGA 1992 on disposal by trustees • IHT exposure . . .

Exit charge (post 10 years) • Say Nil rate band 2021/22 £400,000 • 475,000-400,000 = 75,000 @20% = 15,000* • Revised effective rate 15,000/475,000 X 100 = 3.158% • Actual rate 30/100 of 3.158 X 20/40= 0.4737% *recalculation of ten-year effective rate to reflect changes in level of NLB IHT on assets leaving each trust 0.4737% of £600,000* = £2,842 *value at exit

Overall . . . • Obviously figures influenced growth in value of property • If property value grows at same rate as nil rate band Zero tax • CGT uplift on death does not apply • Swapping a deferred CGT charge for substantial reduction in IHT

It’s a Matter of Trust