Discounted gift trust following death of Settlor

Trusts Discussion
1

We act for the trustees of a Discounted Gift Trust created in May 2005. Subject to Isle of Man law. Trust property is a collective redemption bond (NB not payable to trustees on death of settlor).

Settlor (S) died in January this year and the bond has not yet been redeemed. Our queries relate to the IHT status of the trust, and also the beneficial and tax position of S’s daughter-in-law, W.

The trust document defines two funds initially held by the trustees: A “Settlor’s fund” for the absolute benefit of S (from which S withdrew 5% of the initial investment each year), and a “Residual fund” which is effectively a flexible life interest trust.

Subject to the trustees’ overriding powers, the income of the Residual fund must be paid to specified “Default beneficiaries” absolutely in specified shares. S defined those beneficiaries as her two sons, T and C, each being entitled to a 50% share. Our queries arise from the fact that C died in November 2014, and so predeceased S. He named his widow, W, as his sole executor and residuary legatee.

The trustees have discretionary powers of appointment, advancement, or resettlement over the Residual fund. Relevant Discretionary beneficiaries are defined as the children and descendants of S, the spouses and former spouses of those individuals (but no mention of their widows or widowers), the widower of S, the Default beneficiaries, and any individual accepted by the trustees after nomination by two other beneficiaries.

We believe the current situation to be as follows, but would be grateful for any views – confirmatory or otherwise.

  1. Although the value of the Residual Fund could not be ascertained until after S’s death, it nevertheless existed as a trust fund which was subject to an IIP, in favour of T and C as life tenants in equal shares.
  2. On C’s death, as the residuary legatee specified in his Will, W inherited C’s income interest in the Residual fund.
  3. We believe this created a transitional serial interest, so that this fund is still outside the Relevant Property regime.
  4. S’s death enabled the value of the Residual fund to be ascertained, but did not change the IHT status of the trust which comprises it.

The issues on which we are more uncertain arise from the fact that the trustees are minded to distribute the fund between T, W, and certain of S’s grandchildren. That raises the following questions:

  1. Is W, as C’s residuary legatee, a discretionary beneficiary, having “inherited” the role of “Default beneficiary”? Or should she be nominated by other beneficiaries?
  2. To the extent that W receives less than a 50% share of the trust capital, is she deemed to have made a PET?

Any comments or suggestions gratefully received.

2

Perhaps I am missing something, but if the only trust property is not payable to the trustees on the death of the settlor, now that the settlor has died is there any trust property upon which the terms of the trust can bite?

Paul Saunders FCIB TEP

Independent Trust Consultant

Providing support and advice to fellow professionals

3

I’m going to have a bash at this (happy as always to be corrected):

4

I’m going to have a bash at this (happy as always to be corrected):

  1. At the date that the Capital Redemption Bond was placed into trust, a calculation would have been performed (by the life office actuaries) as to the value of the PET (back in those heady days when transfers into trust could still be PETs) and the value of the discount (brought about by the returning payments to the settlor). This calculation may or may not have been disputed by the Revenue. Each of T and C would have had a qualifying IIP in their half of that PET and that sum (or some uplifted/downgraded value thereof) should have been included within C’s estate on death, but I believe that the spouses exemption would be available because C’s widow (W) (assuming that this accords with the trust deed) would acquire a Transitional Serial Interest. Therefore, the value of fund supporting the IIP/TSI at the time would be largely immaterial.

  2. As mentioned above, W will have a TSI.

  3. Correct on both counts.

  4. Correct.

  5. I don’t see that the terms of C’s Will have a bearing nor is the input of any of the other beneficiaries of the CRB Trust needed – I may have missed the point on this question.

  6. If the trust is wound up absolutely and either of the 50% IIP beneficiaries receives less than half the trust capital then they will be deemed to have made a PET to the person/s receiving a portion of their respective half-share.

5

Thank you so much Paul for your response.

With regard to our question 5, clearly one of us has missed something, but it isn’t clear who! The question arises from the fact that the trustees would like to distribute the trust fund between various family members, including W, C’s widow. We are not sure whether W is currently included as a member of the class of discretionary beneficiaries. This class includes:

a) The children and descendants of the Settlor. (This includes C, who predeceased S.)
b) The spouses and former spouses of the persons described in (a). (W is C’s widow, not his spouse.)
c) The widower of the Settlor.
d) The Default Beneficiaries. (This includes C, but he is now deceased.)
e) Persons added following a nomination by two discretionary beneficiaries.

As we see it, W can only qualify as a discretionary beneficiary if either:
• She is formally nominated by two other beneficiaries: or
• The trustees may exercise their power in favour of C’s estate – so that W is the ultimate recipient as C’s residuary legatee.

We are inclined to the view that the first of these two options is the route to follow. Would you agree?

6

I think the distinction between “spouses” and “widower” is to make it clear that the power cannot be exercised in favour of the settlor’s spouse while the settlor is alive - to avoid the trust being settlor interested.
In my opinion, “spouse or former spouse” would include “widow/widower”. If a child of the settlor died, would you expect their widow(er) to cease immediately to be included in the class of beneficiaries?
If you are concerned and if two beneficiaries are in agreement, you could ask two beneficiaries to nominate W. NB It is likely the precise wording requires the addition to be made by the trustees (not by the two beneficiaries), but there must have been a prior “nomination” by two beneficiaries.
Possibly Section 32 Trustee Act 1961 (NB the Isle of Man legislation - http://www.legislation.gov.im/cms/images/LEGISLATION/PRINCIPAL/1961/1961-0010/TrusteeAct1961_1.pdf - I am not an IoM law specialist, but I suspect it will work in a similar way to the English & Welsh “Trustee Act 1925”) may provide a mechanism to advance up to 50% of the capital of W’s “presumptive share” to W. The trust deed may have extended that to 100% of W’s share.
Another thing that you should double-check is the period during which the power of appointment that you refer to may be exercised. Many of those trusts provided that the power could only be exercised during the period ending two years after the settlor’s death.
If the trustees do still have their power of appointment, they might also have a power to release their power of appointment over a certain part of the trust fund - this may be an express power in the trust deed, or this might be impliedly permissible under IoM (I do not know). If they were to do that in respect of part of the trust fund in which W has her interest, it sounds as though W would then take that portion of the trust fund outright. It would probably be simpler just to exercise the power of appointment, if it is possible to do so and achieve the outcome that you want.

I would also reiterate Paul Saunders’s question about your statement that the bond is “not payable to trustees on death of settlor”. I am not clear what you mean by that. Do you perhaps mean that the settlor was not a sole “life assured” (as may be the case with some investment bonds) and therefore the bond continues to remain invested as it was before the settlor’s death?

Paul Davidoff
New Quadrant Partners Ltd

7

I believe that the underlying investment in this instance is a Capital Redemption Bond as opposed to a life assurance bond. CRBs are subject to the same chargeable event regime as life assurance bonds, but do not include lives assured. CRBs usually have a 99-year term at which point they mature (usually for the value of the underlying investments – normally unitised funds). They can be cancelled during the term (again, usually for the value of the underlying investments at the time).

8

Thank you Paul and Paul for being so helpful. For the avoidance of doubt, I can confirm that the trust asset is a collective redemption bond. Thanks again.

9

The trustees should be aware that they will have a UK income tax liability on the surrender of the capital redemption bond (assuming the trustees are UK resident). They will be taxed on the investment profit [(surrender value + withdrawals) - premium]. If the trustees are not UK resident the tax liability will fall on UK resident beneficiaries to the extent that they receive benefits from the trustees.
It might be possible to reduce the impact of this charge with some careful planning.