The Government’s view on the use of trusts for estate planning is that such structures are little more than tax avoidance arrangements.
Whether or not that’s so in 2006 the Government made wholesale changes to the Inheritance Tax (IHT) regime that applies to trusts, in the hope that such changes would ensure an increase in the IHT yield. As ever with such major changes whilst one door closes another opens so options for estate planning became available because of those reforms.
A taxpayer may wish to mitigate IHT by seeking to pass on capital but cannot afford to because of the need to retain the income that such capital produces. These two goals of IHT mitigation and income retention can now be combined by considering a what is called a self-settlement.
A self-settlement involves the taxpayer transferring a sum of money to trustees - perhaps a little less than the current IHT threshold of £325,000, on terms that the trust income accrues to the taxpayer during his life with the fund on his death passing to his children. The trustees have no power to advance capital to the taxpayer. The trustees invest the fund in buy-to-let property.
Such an arrangement is capable of removing capital from the taxpayer’s estate, whilst he retains the right to income, without falling foul of the principal tax anti-avoidance traps. The taxpayer’s IHT nil rate band will have been substantially utilised - but it will become available again providing he survives by seven years the transfer of funds.
In other cases where the capital sum to be transferred is more significant - so that for IHT purposes it is no longer covered by the nil rate band and a charge to IHT would arise on that transfer - the arrangements can nonetheless be modified so no IHT is incurred.
Put very simply - the modifications involve the taxpayer’s right to income being contingent on surviving a short period of several months and can be further amended for cases where the right to receive income is not required.
Before the 2006 changes the taxpayer’s right to income would have rendered both structures ineffective.
The use of trusts in estate planning involves considering Inheritance Tax and Capital Gains Tax, complex anti-avoidance measures, and other issues wider than simply the tax position. Any action should only be considered following research or professional advice.
