Introduction   >>   Using Trusts for Tax Planning   >>   The Basics of Trusts   >>   Why Use Trusts?   >>   Example 1   >>   Example 2

Tax: Why Use Trusts?

With effect from 22 March 2006, all types of Trusts (as defined for this presentation) created on or after 22 March 2006 will be treated in the same way as regards IHT. The rules already applying to discretionary settlements before Budget Day 2006 now extend to all trusts featured in today's presentation. (The types of trust excluded from today's presentation are referred to earlier.)

From a capital taxation perspective, it matters not whether the trust is labelled as:

• discretionary,
• accumulation and maintenance, or
• interest in possession

because the longstanding tax regime applicable to discretionary trust now applies equally to all trusts.

Before exploring the position it is important to note that many clients will find the new tax regime highly attractive. This key development needs to be understood by practitioners and their clients. Just how trusts can be put to use in any given situation depends of the facts of the case but scope there is because the Chancellor's measures will have the effect of clearing the clouds of confusion surrounding trusts previously caused by the uncertainty arising from the different tax treatments.

Nothing has been changed by FA 2006 as regards the taxation treatment discretionary trusts but they are set to be come more popular than ever before.

Creating the settlement

A settlement is usually by the settlor making a gift into trust of cash or some other assets, usually shares or land/buildings. Such gift is both disposal for CGT purposes (unless an exempt asset, e.g. cash) and an immediately chargeable lifetime transfer for IHT. It is not a Potentially Exempt Transfer ('PET').

Such a gift will be deemed to take place at open market value for CGT purposes.

HOLDOVER RELIEF

Holdover relief under section 165 TCGA 1992 (re business assets) is not available because Section 260 holdover relief is generally claimable. Section 260, which applies to all types of assets (not just qualifying business assets) takes precedence over section 165. It should be noted that one of the requirements of Section 260 is that the transfer in question must be an immediately chargeable transfer for IHT purposes. A gift to the trustees of a settlement is an immediately chargeable transfer for IHT purposes and HMRC accept this is so even if the amount of the gift falls below the nil rate band.

Holdover relief is not available if it is a 'settlor interested' trust. See above.

After creation: CGT

The trustees are liable to CGT on capital gains arising on disposals made by them unless the settlor (or his spouse etc) is interested in the trust when the capital gain is assessable on the settlor. FA 2006 extended the rules defining settlor interested trusts to include trusts potentially benefiting children of the settlor when they are minors.

A disposal is deemed to take place by the Trustees at open market value when a beneficiary becomes absolutely entitled to an assets.

Section 260 Holdover Relief is claimable if the beneficiary agrees to join in the election as the transfer to the beneficiary is a chargeable occasion for IHT purposes (one of the requirements of Section 260).

IHT during life of settlement : The Ten-Yearly Charge

Section 64 of the IHT Act 1984 imposes the ten-yearly charge.

S64. Where immediately before a ten-year anniversary all or any part of the property comprised in a settlement is relevant property, tax shall be charged at the rate applicable under sections 66 and 67 below on the value of the property or part at that time.

Where, immediately before a ten-year anniversary, all or part of the settled property is 'relevant property', tax is to be charged on the value of the property or part at that time. (See S66 and 67). 'Immediately before a ten-year anniversary' is construed as referring to the day before the anniversary.

However, this charge is capped at 30% of the lifetime rate. The lifetime rate is currently 50% of the death rate, i.e. 50% of 40% = 20%. Therefore the 10-yearly charge is capped at 30% of 20% + 6%. As we will see, depending upon the settlor's circumstances at the point of the gift, the actual rate can be much lower than 6%

In valuing the property, the business and agricultural reliefs are allowed in appropriate cases: S103(1) and S115(1)

Section 165 IHTA prevents any deduction for the notional capital gains tax that would be payable if the property had been actually sold at the valuation date.

Examples

The two examples given work through the savings you can expect by setting up trusts...

• Example 1
• Example 2