CGT and IHT calculation methodology

Hi - new to the forum. I hope someone can help.

Grandparents have set up a discretionary trust which owns a house, which is used for short holiday stays by the family. This arrangement has been running for 15 years or so.

Three grown up children are named beneficiaries. One of those three children is to ‘buy’ the other two out, but rather than put on the open market and do this as a formal transaction, we have simply revised the Letter of Wishes within the Trust. Intention to keep the trust running and for property to remain within it.

But we now need to know how much CGT and IHT would be payable if (hypothetically) the property were instead to be sold on the open market and trust wound up.

CGT payable on gain since original transfer into trust 15 years ago, less allowances, at 28%. Is this correct?

There was an IHT charge on the 10th anniversary - so what IHT rate (notionally) would be payable today? On the full value of the house?

(House value at inception £300k. At 10 yr anniversary, £700k. Now, £1m).

Accountant says this is ‘complex’ and will take time to answer, but frankly they’re a bit useless. It can’t be that hard. Any help or pointers from this forum would be hugely appreciated.

Thank you!

Can any one other than the settlor revise a letter of wishes? The trustees are, of course free to ignore the settlors’ wishes; it is they who have the discretion to what they want with the income or assets.

You need to ask yourself: who should make the sale? The trustees or beneficiaries? Whatever the answer the vendors will need to make a CGT return or returns within 60 days of completion of the sale and pay the tax by the same deadline.

The 10-year IHT return will be filed late and HMRC will want penalties and interest on late paid tax. The tax is likely to exceed £20K. Ordinarily you could have opted to spread payment of the tax over 10 years as the trust property is, um, property. But filing late might prevent that and in any event a sale would bring forward the due date of the outstanding instalments.

There will be a further IHT charge when you bring the trust to an end.

Thanks for this - much appreciated.
Yes the settlor has revised the letter of wishes. And the 10 year IHT bill was paid around 5 years ago (at 10 yr anniversary).

The idea here is to keep things simple and avoid the ‘frictions’ of an open market sale. The question is, by how much should the two (adult) children who are giving up their interest in the trust, be compensated by their sibling who is effectively buying them out.

From the market value of the house (the sole asset of the trust), we need to deduct what the CGT and IHT charges will have been, had the house been sold conventionally by the trustees, together with a resulting winding up of the trust.

It’s really the IHT bit I’m struggling with here. And it boils down to a simple question. How do you calculate IHT on a 15 year old trust that is being wound up, when the only asset is a house, and the 10 year IHT bill was already settled back when it fell due…?

I don’t understand what the two children have given up. If the only thing that has happened is a redrafting of the settlor’s wishes then the children haven’t exercised any volition. Even if they had done something they haven’t given up a right to a share in the property as they had no such rights. Any use of he house they (did) have was at the largess of the trustees.

If the property was still the settlor’s personal property and he decided to give it to son A then sons B & C haven’t given up anything. Life isn’t fair. Cordelia gave up nothing when Lear decided to split his kingdom into only two parts.

If the object is for A to be the sole owner with B & C receiving cash in ‘compensation’, consider appointing the property to A, B & C with holdover elections and then A buys out B & C. B & C will have CGT to pay & A SDLT or other transaction tax. But there may be other ways of achieving your object. Seek legal advice.

One answer to the IHT question is google ‘exit charge’ .A better answer it to seek advice from someone versed in trust taxation.

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I think you want to calculate the liabilities on a notional sale so that the trust continues but with earmarking of funds so that in future one fund would represent the house and another fund the purchase price at today’s values. So you calculate the tax payable on an immediate sale and distribution of the sale proceeds and deduct this from the current market value; divide by three and the 2 children “giving up” their interests will be entitled to two-thirds of the net as a notional fixed entitlement (with notional interest/indexation or expressed as a percentage of the total fund equal to its current percentage). The trust will continue on the basis that the house will be distributed to one child only (or his family) plus or minus any changes in value with a notional reserve for tax represented by the notional tax calculated on the notional sale.

The notional rate of IHT is calculated as the percentage charged at the last 10 year anniversary adjusted by reference to complete quarters from then to date. It is probably an over sophistication to allow for the usual device of appointing part of the property to the beneficiaries so trustees and they can all sell and use their annual exemptions if available.

It would surely be prudent to get the beneficiaries to at least confirm in writing that they go along with it. I doubt the trustees can enter a binding agreement under seal because they would be fettering their future discretion. Better would be to use available powers of appointment to create within the trust the very beneficial interests they all want which should be feasible without any charge to CGT or IHT. Elaborate but better than a buy out by one beneficiary at market value or at a discount and distribution to the others of two-thirds of the proceeds/all the discounted proceed incurring tax charges that can remain in effect reinvested in the house (which is why there must surely be some recognition of the unfair effect of giving a fixed sum entitlement to two of them). If their amount is expressed as the same percentage of the future fund as it represents of the current fund then they will share in any overall increase or decrease in vale of the house less any actual liabilities.

Jack Harper

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Thanks Jack - you got it. Spot on. All trustees, settlor, and beneficiaries are on side; no conflicts. And we are indeed calculating CGT by taking into account the usual device of appointing the property to beneficiaries and deploying all their allowances (notionally).
And I’ve now found this Trust IHT charges which explains exactly how to calculate the IHT exit charge after 10 years. So we’re good.
Thanks again.

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The mitigation of CGT in principle involving appointment of trust assets to beneficiaries assumes that hold-over relief claims under TCGA 1992 s260 could have been made (assumes sale(s) soon after appointments); otherwise, limited CGT mitigation is obtained on the values indicated

Malcolm Finney

Though I get the theoretical basis of the plan the practical outcome is very different to either a buyout of the property by one beneficiary at market or a discounted price, or a sale to an arm’s length purchaser, or even raising a mortgage on the property to pay out 2 beneficiaries, in that it raises absolutely no cash. A discretionary beneficiary has in law only a hope of benefiting but while a settlor’s wishes are not sacrosanct they are relevant. It seems likely that such wishes and the reasonable expectations of all 3 beneficiaries (perhaps even actively encouraged by the settlor) are that they (and perhaps their families) are likely to benefit broadly equally from the trust fund. They are unlikely to be the only eligible discretionary objects, alive or to be born, and they too might have similar ideas.

A skewed arrangement apparently, even if viewed with hindsight, favouring one beneficiary over another, can be a recipe for future trouble, however arguably within formal scope of the trustees’ powers. I have dealt with several offshore trusts where the tax considerations dictated a full distribution to one or more family members who were NDNR. There could be no prior agreement to this effect but the hope was that they would take advantage of that status to make dispositions to other members in a tax-efficient manner and the risk was knowingly accepted that they might not. Particularly in such a situation, but really always, much depends on the identity and personality of trustees and beneficiaries and family dynamics and politics. But the trustees took advice about what it was proper for them to do and the beneficiaries were separately advised. That seems eminently desirable in the circumstances of the present query.

Jack Harper