Inheritance TaxWillsUnderstanding Relevant Property Trusts

Various types of trusts can be created to manage and mitigate tax liabilities. Among these, relevant property trusts are a common choice. This article examines the intricacies of relevant property trusts, exploring the tax implications, and the specific charges they incur.

What is a Relevant Property Trust?

A relevant property trust is a trust which does not qualify for any other specific tax treatment. This includes trusts which are not:

• Qualifying Interests in Possession
• Trusts for bereaved minors and young persons
• Charitable trusts

Discretionary trusts are the most common form of relevant property trusts. The assets within these trusts are not considered part of the beneficiaries’ estates for inheritance tax purposes. Instead, they are governed by the relevant property regime, which imposes its own set of inheritance tax rules.

Relevant Property Trust Tax Charges

Relevant property trusts are subject to three primary types of charges: entry charges, exit charges, and anniversary charges.

Entry Charge

The entry charge applies to lifetime transfers into a relevant property trust, levied at 20% on any value exceeding the available nil rate band (currently £325,000). This charge does not apply to assets placed into the trust upon death, as these are taxed as part of the deceased’s estate.

Exit Charge

Exit charges occur when there is a reduction in the trust fund’s value, triggered by:

• Distribution of assets by trustees (unless transferred to another relevant property trust)
• Assets ceasing to be relevant property but remaining in trust, such as when trustees make an appointment qualifying as a disabled person’s interest.

The exit charge is calculated based on the number of quarters since the trust’s creation or the last ten-year anniversary. There are no charges if the trust capital is below the available nil rate band.

For trusts created by will, there are no exit charges on exits within the first two years of death as the reading back of S144 Inheritance Tax Act 1984 applies and it is considered as if the will had made that gift. There are also no exit charge on exits in the first quarter following a trust’s ten-year anniversary.

Exit charges apply only to trust capital, not income, although income distributions may incur income tax liabilities.

Anniversary Charge

Every ten years, a relevant property trust incurs an anniversary charge, calculated as a percentage of the trust’s value at that time. No charge is imposed if the trust’s capital is below the available nil rate band.

The rationale behind anniversary charges is to approximate the inheritance tax that would apply if assets remained in personal ownership and were transferred once per generation.

Calculating Anniversary and Exit Charges

The exact formula to calculate anniversary and exit charges are complex. Each involve applying an initial tax charge of 20%, and then reduce that 20% by a number of factors to come up with a smaller percentage. That percentage is then applied to the value of the exit or full value of the trust fund respectively. As general rule, every 10 years the combined value of any exit charges and the anniversary charge will be no more than 6%.

Additional Considerations

Transferring assets in or out of a relevant property trust is considered a disposal for CGT purposes, potentially triggering a CGT liability if the assets have appreciated. Holdover relief may defer this liability.

Trust-generated income is subject to higher tax rates than individual income. Trustees must file annual tax returns and pay any due taxes.

In most cases, a relevant property trust will now need to be registered with HMRC under the Trust Registration Service (TRS).

Conclusion

Relevant property trusts are an important tool in estate tax planning, offering a way to manage and potentially reduce tax liabilities. However, they come with complex tax implications. Proper understanding and management of these trusts require careful planning and professional advice to ensure compliance and tax efficiency.

 

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