EDITORIAL: NIKI PATEL nikisha.patel@scottishwidows.co.uk
Having looked at the inheritance tax treatment when a discretionary trust is created and when capital appointments are made, moving another step on, I now focus on the tenth year anniversary charge known as the ‘periodic charge.’
DISCRETIONARY TRUSTS TEN YEARS ON…
WHAT IS A PERIODIC CHARGE AND WHEN DOES ONE ARISE? The periodic charge is a charge to inheritance tax which arises on each tenth anniversary following creation of the trust.
For the purposes of the ten year anniversary charge, property settled at outset does not need to be ‘relevant property’ (i.e. property held on a discretionary basis), but can also be non-relevant property.
My article on exit charges explained and gave examples of what constitutes relevant property, which in brief is any property in which there is no ‘qualifying interest in possession.’ However, in some circumstances a discretionary trust may also comprise nonrelevant property, that is, property which is held under an interest in possession. This is an important factor to bear in mind especially following the significant changes to the inheritance tax treatment of certain trusts following the 2006 Budget.
In a case where a pre 22 March 2006 interest in possession trust inadvertently becomes taxable under the relevant property regime (i.e. as a discretionary trust), the anniversary date for the purposes of the periodic charge is determined by the date the trust began. This is the date that the trust deed is signed, witnessed and the property has been settled. So let’s say a trust was executed on 5 May 2000 and is now taxable as a discretionary trust.
In this case, a ten year anniversary charge will arise on 5 May 2010, even though this is just over 4 years from the actual date of the 2006 Budget. This is why it is vital for trustees to be mindful of their actions and consider seeking appropriate advice before making decisions bearing tax consequences!
HOW IS THE PERIODIC CHARGE CALCULATED? The rate is calculated using a standard formula (next page), and will give rise to an inheritance tax charge at a maximum of 6% on the value of relevant property in the trust fund above the then available nil rate band.
Note for the purposes of the periodic charge business property relief (BPR) and agricultural property relief (APR) are taken into account, so that the value on which tax is charged will be the net amount after deducting any BPR/APR available.
The resulting taxable value is then reduced by the nil rate band at the tenth year anniversary less any chargeable lifetime transfers made by the settlor in the seven years prior to creating the original settlement. It is also necessary to deduct any distributions made by the trustees in the ten years prior to the tenth year anniversary. This is to prevent trustees distributing trust funds in order to reduce the value of the trust fund below the available nil rate band and thereby avoid an inheritance tax charge.
For professional adviser use only, not to be relied upon by any other person.
techtalk This article originally appeared in Apr 2010 edition of techtalk. Please visit www.scottishwidows.co.uk/techtalk for the latest issue.
For professional adviser use only, not to be relied upon by any other person.
Once the exact rate has been determined, it will be applied to the current value of relevant property comprised in the trust.
The formula £ £
Current value of relevant property in the trust before the tenth anniversary X
Initial value of any property comprised in a related settlement (i.e. a trust created by the same settlor on the same day) X
Initial value of non-relevant property in the trust X A Nil rate band at the time of tenth year anniversary X
Less: Gross chargeable transfers made by the settlor in the 7 yrs before the trust was set up (X) Trustees’ capital distributions (i.e exits) in the ten years before this anniversary (X) (X) B Tax = B x 20% = C Effective rate = C/A x 100 Actual rate = effective rate x 30% IHT payable = Current value of relevant property x the actual rate.
As you can see the principles are very similar to that of the exit charge so hopefully the formula does not give you too much of a headache! However, before I move on to some examples, is it time for a coffee break or are you more of a tea lover? After all, Tax, Effective and Actual, should not be too difficult to remember!
Example 1
Victoria executed a discretionary trust on 1 October 1999. Prior to this she had made one gross chargeable transfer of £150,000 in September 1996. The current value of the trust fund on 1 October 2009 was £450,000.
Periodic charge – 1 October 2009 £ £
Current value of relevant property in the trust 450,000
Initial value of any property comprised in a related settlement
Initial value of non-relevant property in the trust - 450,000 Nil rate band at the time of tenth year anniversary 325,000 Less: Gross chargeable transfers made by the settlor in the 7 yrs before the trust was set up (150,000) (175,000) 275,000
Tax = £275,000 x 20% = 55,000 Effective rate = 55,000/450,000 x 100 = 12.22222% Actual rate = 12.22222% x 30% = 3.66666% IHT payable = £450,000 x 3.66666% = £16,500
Example 2
Freddie set up a discretionary trust on 18 June 1998 for £250,000, of which £100,000 was to be held upon interest in possession and £150,000 on discretionary trusts. Freddie’s only other transfer, was a gross chargeable transfer of £154,000 on 2 May 1995. For the purposes of this example I have assumed that the current value of the discretionary fund is worth £220,000.
Periodic charge – 18 June 2008 £ £
Current value of relevant property in the trust 220,000
Initial value of any property comprised in a related settlement - Initial value of non-relevant property in the trust 100,000 320,000 Nil rate band at the time of tenth year anniversary 325,000
Less: Gross chargeable transfers made by the settlor in the 7 yrs before the trust was set up (154,000) (171,000) 149,000 Tax = £149,000 x 20% = 29,800 Effective rate = 29,800/320,000 x 100 = 9.3125% Actual rate = 9.3125% x 30% = 2.79375% IHT payable = £220,000 x 2.79375% = £6,146
EXIT CHARGE AFTER A TENTH YEAR ANNIVERSARY CHARGE. I mentioned in my article on exit charges that normally when property ceases to be relevant property after a periodic charge, the same rate of inheritance tax which was calculated at the previous tenth year anniversary is used. This is then multiplied by 1/40 for each complete quarter year between the date of the exit and the previous tenth year anniversary.
Example 3
Following on from the above example of Freddie, the actual rate at the tenth year anniversary was 2.79375%. The trustees decide to make a capital distribution of £50,000 to one of the beneficiaries, Olivia on 1 February 2010, who agrees to pay any tax due.
IHT payable by Olivia on the distribution = £50,000 x 2.79375% x *6/40 = £210
*no of quarters between 18 June 2008 – 1 February 2010
The value of a discretionary trust is not included in anyone’s estate for inheritance tax purposes which is why ongoing inheritance tax charges apply. { }
For professional adviser use only, not to be relied upon by any other person. For professional adviser use only, not to be relied upon by any other person.
If however, the nil rate band had changed between the previous tenth year anniversary and the date of the exit, the inheritance tax rate will need to be recalculated. If we assume that the nil rate band had increased to £350,000. In this case, the actual rate of tax on the periodic charge would have been as follows: £ Transfer 320,000 Less nil rate band remaining (350,000-154,000) (196,000)
124,000 Tax = £124,000 x 20% = 24,800 Effective rate = 24,800/320,000 x100 = 7.75% Notional actual rate = 7.75% x 30% x 6/40 = 0.34875% IHT payable by Olivia on the distribution = £50,000 x 0.34875% = £174
As you can see the inheritance tax payable is slightly lower thereby taking account of an increased nil rate band.
ANOTHER TEN YEARS ON… Example 4
Taking the same facts in the example of Freddie, but now moving on another ten years to the next periodic charge. I have assumed that the current value of the discretionary fund is worth £310,000 for the purposes of this example. However, this time we have to take account of the fact that the trustees made a capital distribution to Olivia in the last ten years. For simplicity, the nil rate band is assumed to have remained at £325,000.
Periodic charge – 18 June 2018 £ £
Current value of relevant property in the trust 310,000
Initial value of any property comprised in a related settlement
Initial value of non-relevant property in the trust 100,000 410,000 Nil rate band at the time of tenth year anniversary 325,000
Less: Gross chargeable transfers made by the settlor in the 7 yrs before the trust was set up (154,000)
Trustees’ capital distributions (i.e exits) in the ten years before this anniversary (50,000)
(121,000) 289,000 Tax = £289,000 x 20% = 57,800 Effective rate = 57,800/410,000 x 100 = 14.09756% Actual rate =14.09756% x 30% = 4.22926% IHT payable = £310,000 x 4.22926% = £13,111
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