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Registering a trust for a client

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Tax planning with trusts in the modern era

Relevant property - post-2006

The Finance Act 2006 was a watershed for tax planning using trusts. Whilst many of the advantages associated with family trusts were curtailed, they are still a valuable tool in your arsenal for inheritance tax (IHT) planning for clients. Post-2006, most trusts (including discretionary trusts) set up will be “relevant property” trusts.

Relevant property means no qualifying interest in possession exists, i.e. the beneficiaries have no right or entitlement to the trust assets or income. The trustees have full discretion whether to distribute or not. If they do, they have discretion over which beneficiaries to distribute to and how much to distribute.

Relevant property trusts are subject to an IHT charge whenever assets enter or leave the trust, and on every ten-year anniversary of the trust’s creation.

IHT entry charge

Gifting assets to a discretionary trust will be a chargeable lifetime transfer for your client. If the value of the gift exceeds their available nil rate band (NRB) (currently £325,000), a charge to IHT will arise on the excess. This will be at 20% if the trustees agree to pay the tax, but if your client pays the IHT, it will be at 25%. This is because the payment of tax by the settlor is seen as a further gift to the trust, therefore grossing up the tax rate is required in order to pay the IHT on the further gift.

Practice point 1. The amount of your client’s NRB available to offset against the gift is reduced by any chargeable transfers made by them in the seven years prior to the creation of the trust.

Practice point 2. Where the assets gifted are agricultural or business assets, the value of the gift can be reduced by agricultural property relief (APR) or business property relief (BPR), usually by 100%.

Practice point 3. If the unfortunate should happen and your client doesn’t survive the creation of the trust by seven years, additional IHT may be payable. This would be paid from your client’s estate. It cannot be paid by the trust.

IHT exit charges

Whenever capital assets leave the trust there will be IHT implications for the trustees. It is likely that your client will become a trustee in order to retain some control over the assets they have gifted. Your client needs to be aware of the IHT implications of operating a discretionary trust.

An IHT exit charge will be triggered when assets are distributed to a beneficiary. It is calculated differently depending on whether the exit event is before or after the first ten-year anniversary of the trust’s creation. An exit before the first ten-year anniversary is calculated using a six-step approach, which is illustrated by the following case study.

Case study

Edward set up a discretionary trust on 1 April 2015, gifting £1 million in cash into the trust as well as shares in an unquoted trading company worth £250,000. This is the only gift that Edward has made during his life. Edward paid any IHT arising on the transfer into the trust. The trustees distributed £200,000 in cash to a beneficiary on 1 April 2019 and paid the IHT arising.

Step 1. Ascertain the initial value of the assets when the trust was set up (and any further gifts into the trust by the settlor), less any IHT paid by the trustees, i.e. £1,250,000.

Step 2. Deduct the NRB from Step 1. The NRB is £325,000 and is reduced for any chargeable transfers of the settlor made in the seven years prior to setting up the trust, i.e. £1,250,000 - £325,000 = £925,000.

Step 3. Tax any balance at 20%. This gives a hypothetical tax charge, so £925,000 x 20% = £185,000.

Step 4. Divide the hypothetical tax charge from Step 3 by the initial value of the trust assets at Step 1, then multiply by 100%. This gives the effective rate of tax: £185,000/£1,250,000 x 100% = 14.8%.

Step 5. Multiply the effective rate of tax at Step 4 by 30%, adjusting the 30% for n/40, where n is the number of complete quarters since the creation of the trust. This gives the actual rate of tax: 14.8% x (30% x 16/40) = 1.776%.

Step 6. Multiply the actual rate of tax at Step 5 by the value of the assets leaving the trust. The value of the assets should be reduced by APR and/or BPR if available. If the trustees are to pay the tax, the actual rate of tax should be grossed up: 1.776%/(100-1.776) x £200,000 = £3,616. This is the exit charge.

Practice point 1. The exit charge does not have to be paid by the trust. The beneficiary receiving the assets could pay the tax instead. If so, Step 6 would simply be 1.776% x £200,000 = £3,552.

Practice point 2. If the initial value of the trust assets is less than the value of the NRB of the settlor on the creation of the trust, no exit charge will ever apply.

For an exit charge triggered after the first ten-year anniversary, the tax rate to be applied at Step 6 is simply the actual tax rate used in the last ten-year charge calculation (see below), adjusted for the number of complete quarters that have passed since the last ten-year charge, i.e. the n/40 adjustment.

Practice point 3. If the NRB in force at the time of the exit is different to the NRB in force at the time of the ten-year charge, the ten-year charge must be recalculated using the updated NRB in order to ascertain the correct tax rate to use.

Ten-year charge

Once a trust has been in existence for ten years, an IHT charge will arise based on the market value of the trust assets on the day before each ten-year anniversary. The charge is calculated using a similar six-step approach to the exit charge before the first ten-year anniversary.

Case study continued

On 1 April 2025 the value of the assets in Edward’s trust has grown to £1.2 million in cash, and the shares in the unquoted trading company are worth £500,000.

Step 1. Ascertain the current market value of the trust assets, net of any APR or BPR; £1.2 million + £500,000 - BPR £500,000 = £1.2 million.

Step 2. Deduct the NRB from Step 1. The NRB is reduced by any assets transferred from the trust, i.e. exits, in the prior ten years, and any chargeable transfers of the settlor made in the seven years prior to setting up the trust; £1.2 million, £325,000 - £200,000 = £1,075,000.

Step 3. Tax any balance at 20%. This gives a hypothetical tax charge; £1,075,000 x 20% = £215,000.

Step 4. Divide the hypothetical tax charge at Step 3 by the market value of the chargeable trust assets at Step 1, then multiply by 100%. This gives the effective rate of tax: £215,000/£1.2m x 100% = 17.92%.

Step 5. Multiply the effective rate of tax at Step 4 by 30%. This gives the actual rate of tax: 17.92% x 30% = 5.38%.

Step 6. Multiply the actual rate of tax at Step 5 by the market value of the chargeable trust assets at Step 1. This gives the principal charge: 5.38% x £1.2m = £64,500.

Practice point 1. The tax is always due by the trustees so no grossing up is required.

Practice point 2. The maximum ten-year charge tax rate will be 6%.

Discretionary loan trusts

A useful IHT planning technique which you could look at with clients is the concept of a loan trust. Here your client would set up the discretionary trust with a nominal cash sum of £1, and then lend a larger sum to the trustees. They would then invest the cash into a single premium investment bond, with any growth in its value being outside of your client’s estate. The bond growth is a clever way of getting value to your chosen beneficiaries without your client being subject to an IHT entry charge.

If your client needed to supplement their income at any point they could simply receive a loan repayment from the trust. The trustees would need to encash part of the bond to generate the loan repayment funds, but they can withdraw up to 5% of the initial value of the bond as a capital repayment without triggering a tax charge each year. If the 5% annual allowance is not utilised it can roll forward to the following year and accumulate.

Practice point 1. The large cash sum is not a gift but a loan, therefore there is no chargeable lifetime transfer made by your client, other than the £1 gift. Any growth in the value of the bond is also not chargeable on your client, as this has been generated wholly within the trust and not gifted to it.

Practice point 2. As the initial value of the trust assets would be £1, i.e. the value of the bond being matched against the loan, no IHT exit charge would be triggered. In addition, no ten-year charge is likely to occur, unless the value of the bond less the loan still outstanding exceeds the available NRB.

Discounted gift trusts

Another effective IHT planning technique using a discretionary trust is the discounted gift trust. Here your client would gift a large cash sum to the trust, say £1 million. The trustees would invest this into a single premium investment bond where 5% withdrawals per annum can be taken without triggering a tax charge for the trustees.

The trust deed would specifically set the terms of the gift to come with a defined right for your client to receive certain payments back from the trust during their life. As with a loan trust the payments back to your client would come from the 5% withdrawals taken from partial bond encashments. Because of the payments due back to your client, the capital value of these payments is carved out of the value of the initial £1 million gift. Only the net gift is treated as a chargeable lifetime transfer. A discount on the value of the true gift made is given which immediately reduces your client’s IHT exposure.

Practice point. The life insurance company providing the investment bond would use an actuary to value the discount. They would take into account your client’s age, gender, life expectancy and level of expected withdrawals from the trust.

A discounted gift trust therefore allows your client to immediately reduce their IHT exposure without needing to wait seven years, and at the same time still get access to a regular income stream from the capital gifted.

Discretionary two-year trusts

One of the main benefits of a discretionary trust is its flexibility, and this can be particularly useful when planning the terms of your client’s will.

If your client’s circumstances are such that they have ever-changing assets and are not sure which assets to leave to which beneficiaries, a discretionary trust could provide the answer. s.144 Inheritance Tax Act 1984 allows the trustees to distribute assets from the trust to beneficiaries within two years of the deceased’s death, without incurring an IHT exit charge.

Practice point 1. For IHT purposes s.144 deems the distribution of assets be to read back into the will of the deceased, so that it is treated as coming from the deceased and not from the trustees.

Practice point 2. This could be useful in situations where IHT has been paid on a death transfer to a discretionary trust, but where appointing the assets out within the two years to the deceased’s spouse would qualify for the spouse exemption and therefore trigger a repayment of tax.

Compliance

Once the trust is set up you must register it with HMRC and obtain a UTR number. The paper Form 41G (Trust) is no longer accepted. Details about how to go about registering a trust for your clients is available on GOV.UK (see Follow up ).

To successfully use the service, you will need the following information:

• details of the trust assets including address(es) and values
• the identity of the settlor, trustees, protector (if any), all other persons exercising effective control over the trust (if any) and the beneficiaries or class of beneficiaries.

The information related to the individuals required will include:

• name
• date of birth
• NI number if they are UK resident - unless a minor
• an address and passport or ID number for non-UK residents, if there’s no NI number.

An SA900 tax return will then need to be filed each year.

Registering a trust for a client