HMRC Consultation- RIP Pilot Trusts?

HMRC have issued a “consultation” on the taxation of assets held in discretionary trusts. If their proposals are implemented (which seems very likely, whatever the responses to the consultation), then this will end the benefits of multiple trusts set up during the Settlor’s life. So will we see the end of such trusts?

This is a technical issue, so it is helpful to set out some background. Discretionary trusts are trusts where no individual has a right to the underlying assets, or to the income from such assets. Instead, everything is at the discretion of the trustees. One of the happy consequences of this is that the assets in such trusts are not part of any individual’s estate and are not subject to Inheritance Tax (“IHT”) on the death of any beneficiary.

How, then, does the government get its money? At present, there is a charge to tax every 10 years (the “periodic charge”) on the assets in a trust above the tax threshold at the 10 year anniversary at a maximum rate of 6%. In addition, there are charges (“exit charges”) on assets leaving the trust between 10 year anniversaries, essentially a proportionate part of the periodic charge.

The calculation of the rate of tax applied at the periodic and exit charges is extremely complicated, and depends in part on the Settlor’s history of gifts, so that it can be very hard to compute. It is common for the costs of the calculation to exceed the amount of tax payable. However, this arrangement does allow for a loophole – each trust set up by a Settlor on a different day has its own tax threshold. By using multiple trusts and splitting the assets between them, it is possible to ensure that no trust has assets above the tax threshold at any time, thus avoiding the periodic and exit charges forever.  Accordingly, it has been common practice to set up trusts on separate days during the Settlor’s life, each with £10 in it, which are intended to receive assets on the death of the Settlor (“pilot trusts”).

It was unlikely this loophole would escape the government’s attention indefinitely. HMRC now propose that all the trusts set up by a single Settlor during his life will have one tax threshold between them. The rate of tax will always be 6%. Multiple trusts will not have any benefits.

It is hard to argue against the logic of this change and no-one will be sorry to see the back of the difficult computations of the rate of tax. There had been rumours that the standard rate would be set at 10%, so 6% is something of a relief. However, does this mean the end of pilot trusts?

As mentioned above, the advantages of discretionary trusts are that the assets in them do not belong to any individual. This can protect assets on the divorce or bankruptcy of any beneficiary, as well as avoiding the 40% charge to IHT on a beneficiary’s death. So there is no doubt that discretionary trusts will continue to be popular. But will it be worth setting up trusts during the Settlor’s life or should they just be included in the Will?

First of all, trusts which are established to receive the benefit of a life assurance policy, or death in service lump sum, will need to be established during the Settlor’s life so that they can be nominated as a recipient of the funds. The advantage here is that the deceased’s spouse can benefit from the tax free sums but they do not form part of his or her estate when they die.

In addition, where the Settlor has more than one child, separate trusts have obvious advantages and are simpler to draft than having multiple trusts in a Will.

My view, therefore, is that we will continue to prepare pilot trusts where appropriate but there will be fewer of them.

 Myerson LLP provide specialist advice relating to wills, probate, probate disputes, inheritance tax planning and powers of attorney to clients in South Manchester and Cheshire.

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