I have an old IIP trust formed pre 2006 with three beneficiaries. The trust was formed a number of years ago and holds a large proportion of quoted investments with low CGT base costs, some holdings were held before 1982.
One of the beneficiaries (X) died last year, and under the terms of the trust their interest passes to their adult children.
The deceased’s interest in his share of the underlying assets within the trust form part of his estate in accordance with s49/s50 IHTA 1984.
Whilst there is a CGT uplift in base cost of the investments held in the trust, only the deceased’s interest in those investments will be uplifted, for example if the trust held 90 shares in say BP plc only one-third of the value will have been uplifted the two-thirds balance continuing to have a March 1982 value.
The trustees will have to sell a number of shareholdings to pay the significant IHT charge. My understanding is that if the trust disposes of these shares there will also be an additional CGT charge on the deemed sale and reacquisition on death (s72 TCGA 1992).
It has been suggested that the trustees may wish to view the trust as having three different “pots” or “funds”, with the X Fund holding one third of the investments and uplifted CGT base cost, the remaining fund or pot holding investments with 1982 values. The trustees would then sell investments from the X Fund which given the uplifted CGT base cost would mean that the CGT exposure would be minimal.
I can see from an accounting perspective that this makes sense as it means only the beneficiaries of the X Fund bear the reduction in the value of their fund and income going forward. As the X Fund is now in the relevant property regime it also makes sense when looking at future decennial/exit charges.
However, I am not aware of it being possible from a CGT perspective to segregate the investments in the way described above, my understanding being that each investment would have a pool being a proportion of original cost/1982 value and 2018 value.
I’d be grateful for any thoughts or comments on the above.
Before commenting, it would be useful to know if the original income beneficiaries were given an entitlement to a one-third share of the income, or the income of a one-third share of the trust fund.
If the former, amongst other aspects, the IHT liability comes out of the entire fund and the income continues to be divided into thirds.
If the latter, the IHT liability comes only out of the deceased income beneficiary’s “share”, the other 2 beneficiary’s shares being unaffected.
This also has implications for CGT, and how this might be dealt with.
If the trust instrument provides that the income beneficiaries are each entitled to a third share of the income, as suggested by the wording quoted, then the trust fund will be a single “pot” for all purposes, applying the reasoning in Re Freeston’s Charity (1978).
Any expenses, whether IHT, CGT or even an advance under s.32 Trustee Act 1925 will reduce the pot generating the life tenants’ income. Regardless of the reason why the “pot” is reduced, the life tenants will each be entitled to a one-third share of the income. Those entitled to the deceased life tenant’s share of the income will, therefore, between them receive the same amount of income as each of the surviving life tenants.
Yes, there will be an up[lift in the base value of a one-third share of the trust assets for CGT purposes as at the date of death of the life tenant. However, for CGT purposes, the trust fund represents a single settlement and the gain on any disposal will be assessed to tax applying the usual identifier rules. I am not sure why an actual CGT charge should arise on the death of a life tenant, though.
Whilst it may be possible to effect a partition of the trust fund into separate “settlements”, this would not be retrospective and could give rise to further CGT complications in view of the effect of CGT sub-fund elections. I recall that a few years ago Shan Warnock-Smith (5 Stone Buildings) successfully applied for the partition of a trust subject to the Re Freeston’s principle, albeit only on appeal (Southgate v. Sutton, 2011). Not necessarily an economic solution, depending upon the value of the trust fund and the reason why a partition might be appropriate.
Your description of the trust terms in your reply appears to be at variance with the description of the trust terms in your original posting.
The base cost of the shares for CGT is the average of their acquisition values. You can’t match a disposal to a particular sub-fund for tax purposes (unless a special sub-fund election has previously been made, which is very rare in practice). Likewise the annual exemption is not specifically allocated.
Following on from Paul’s comment, if initially three funds were created each being held on separate trusts then on the death of one of the iip beneficiaries the assets held in that particular fund would under TCGA 1992 s72 give rise to a deemed disposal and reacquisition of those assets within that particular fund (the trust continuing with the deceased’s adult children taking iips therein). However, the deemed gain would not fall subject to a CGT charge. A future sale of the assets in that fund would give rise to a CGT charge on the part of the trustees on any capital gain arising. The gain would be on the disposal proceeds less the market value of the fund as at the date of the prior death. In principle, the share identification rules contained in TCGA 1992 s104 et al would apply (ie sales would be out of a share pool subject to same day and post 30 day acquisitions).
If, however, as appears to be the case that on creation three separate funds were not created then on the death of one of the beneficiaries there will be a proportionate uplift in the value of all the assets of the trust, not just an uplift in one third of the assets (TCGA 1992 s72(2)). No CGT charge arises.
Thus, for example, assume the assets comprise 300 shares with a “pool” base cost of £900 (ie £3 per share). Assume at the date of death of one of the beneficiaries each share has a market value of £8. The trustees will be deemed to have sold a 1/3rd interest in each of the 300 shares. The value of the 1/3rd interest is 1/3 of £8 (£2.67) and its corresponding base cost is 1/3rd of £3 (£1), an uplift of £1.67 per share.
Assuming the need to sell the deceased beneficiary’s interest of 1/3rd in 300 shares when market value per share is £10 the base cost of the 1/3rd interest in the 300 shares will be 300 x £2.67 ie £500 and sale proceeds 300 x £3.3 ie £1,000.
Presumably, in practice the sale of 1/3rd interests in 300 shares is achieved by an appropriation and subsequent sale of 100 shares but with each share’s base cost £2.67 + £2 ie £4.67.