Business Relief and Trusts

The two most common trusts are:

1. Discretionary Trust

• Where the trustees decide if and when they distribute any income or capital, so no-one has a right to the underlying trust assets or income.
• No part of the capital of a discretionary trust falls within any individual’s death estate. However, a separate Inheritance Tax regime applies to trust assets. Charges may arise when assets are transferred into a trust (known as an ‘entry charge’)¹, when they are distributed from the trust (known as an ‘exit charge’)² , and on each ten-year anniversary of the trust (known as a ‘periodic charge’)³.
• When property enters a discretionary trust, Inheritance Tax is charged at the lifetime rate of 20% (i.e. chargeable lifetime transfer or commonly referred to as a ‘CLT’), subject to any nil rate band of the settlor, which will be deducted. Inheritance Tax is payable on the diminution in value of the settlor’s estate, which includes tax paid on transfer, if this is paid by the settlor.
• If the settlor dies within 7 years of settling the assets into a discretionary trust, Inheritance Tax at up to 40% will be chargeable above the nil rate band, with a reduction given for the chargeable lifetime transfer paid when the assets were settled. Amounts settled above the nil rate band will benefit from taper relief (a reduction of the headline rate of Inheritance Tax charged) if death of the settlor occurs more than 3 years since the settlement was made.

2. Interest In Possession Trust

• This is where a person (the ‘life tenant’) has an immediate right to the income from, or enjoyment of, the trust assets. As well as having a life tenant, the trust will also have at least one ‘remainderman’. This beneficiary will be entitled to the capital of the trust once the interest in possession comes to an end.
• A life tenant of an Interest In Possession Trust in existence/established prior to 22 March 2006 is treated as owning the property absolutely. Therefore, the creation of such a trust was usually a Potentially Exempt Transfer (‘PET’) by the settlor.
• Where an Interest In Possession Trust is created on or after 22 March 2006, the assets do not fall into the death estate of the life tenant. Instead, such trusts will be treated as discretionary trusts and, accordingly, the Inheritance Tax charging system consisting of an entry, 10-year/periodic and exit charges apply although these can be mitigated by making a Business Relief qualifying investment in the Ingenious Estate Planning service.
• Where a spouse beneficially entitled to an Interest In Possession Trust on or after 22 March 2006 under an Immediate Post-Death Interest (‘IPDI’), the spouse is treated as beneficially entitled to the property in the estate. In consequence, because the spouse is beneficially entitled to the property, the exemption for the surviving spouse is available (i.e. no Inheritance Tax implications for the surviving spouse on settlement). Although the surviving spouse can’t give away or access the trust capital, it still forms part of their death estate, so it will potentially be liable to Inheritance Tax when they pass away. Depending on the terms of the trust, a solution would be for the trust to invest in a Business Relief qualifying investment such as the Ingenious Estate Planning service. Once the investment has been held for at least 2 years, it can be left to the remainderman free from Inheritance Tax upon the death of the surviving spouse.