Inheritance Tax
Inheritance Tax (IHT) – Periodic and Exit Charges
On each tenth anniversary of the creation of the Trust an IHT return may be needed and there may be some tax to pay. This is known as a “periodic charge”. You first need to assess the total value of all property (not just the house or share in the house) that is in the Trust. If there are two Trusts (as in a husband & wife situation), the calculation is done separately with only one half of the house value considered in each Trust.
If the value in the trust exceeds the nil-rate band (NRB) at the anniversary date then tax will be payable at an effective rate of 6% on the excess and a return form IHT100 must be filed within six months. The NRB has been fixed at £325,000 since April 2009. If the total value is less than 80% of the NRB then an IHT100 is not required. If over 80% then an IHT100 must be filed even though no tax is due.
An exit charge (HMRC call these proportionate charges) can potentially arise when any capital leaves the Trust. By capital we mean assets such as a share in the house, or proceeds of its sale, cash originally transferred to the trust and investment bonds, or the proceeds from cashing in an investment bond. Interest or dividends arising from investments is not capital and can be distributed to a beneficiary without an IHT exit charge.
In addition, there are income tax issues to consider if any income arises/is distributed.
Selling a house and using the proceeds to buy another within the trust will not result in an IHT liability. It is not the sale but the distribution of the proceeds, or part of them, which triggers an exit charge.
If you wind up the trust before the first ten-year anniversary there will be no exit charge whatever the value of the trust assets provided that no IHT was payable on formation of the trust. (There would not normally have been a charge if the value of the assets transferred to the trust did not exceed £325,000.)
If there was no periodic charge at the first ten-year anniversary, then there will be no exit charges in the next ten years. After a periodic charge any capital assets leaving the Trust will be liable to a charge, but the tax rate is relatively small.
The above is a very simple summary of what can be a complicated situation.
There is detailed guidance on HMRC’s websites at:
LINK: Trusts and Inheritance Tax
LINK: Tell HMRC that Inheritance Tax is due
For some examples of how IHT periodic and exit charges are calculated, try these links:
LINK: Trust IHT charges
LINK: Exit Charges
If you have passed the first ten-year anniversary and the value of your Trust assets exceeds the NRB it’s probably best to get professional help, expensive though that may be.
Other Inheritance Tax (IHT) complications
There have been posts on the public Facebook page showing that many people may not be aware of two issues which may result in an unexpected IHT liability on a Settlor’s death.
First, although assets in the trust do not belong to the Settlor, they are included in the Settlor’s estate for calculating IHT due on death. An “anti-avoidance” rule known as gifts with reservation of benefit (GROB) applies if any benefit or potential benefit however slight is retained in assets given away. In these FPTs the Settlor usually has the right to receive any income arising from the trust fund and the right to occupy the house rent free (known as a life interest, or in Scotland a liferent). The Settlor is also a beneficiary to whom the trustees can make capital distributions at their discretion. These reserved benefits result in the GROB rule applying and the trust fund has to be added to the Settlor’s assets outside the trust to calculate IHT due. If the total after deducting any exemptions (such as assets left to a surviving spouse or civil partner) exceeds the NRB of £325,000 then IHT is due at 40% on the excess.
Second, the additional Residence Nil Rate Band (RNRB) cannot be used against the value of a house in these Family Protection Trusts. RNRB is an extra tax-free allowance of up to £175,000 per person. It is given against the value of a house, or share of a house, which is left direct to the deceased’s children or grandchildren. It does not apply if the house passes via a discretionary trust such as these FPTs. Any unused RNRB can (like the basic NRB of £325,000) be transferred to a surviving spouse or civil partner. The effect is that combined estates of up to £1,000,000 including a house worth at least £350,000 can escape IHT. This “loss” of the RNRB could increase IHT payable by up to £140,000 (£350,000 x 40%) compared to the position without the trusts. If your estate is large enough for the loss of RNRB to be relevant, then this could be a significant factor in deciding whether or not to keep the trust or dissolve it and pass the house back to the Settlor(s).