Exempt transfers to existing settlements and the periodic charge

I am trying to find the method of calculating a periodic charge where a discretionary trust received an initial transfer of £325,000 and subsequent annual transfers of £40,000 from surplus income. Can anyone share any experience of dealing with a scenario such as this?

I’ll have a go at this… I don’t think it matters where the additional £40,000 came from. The periodic charge is applied on the 10th anniversary of the establishment of the trust, not from the date the £325,000 went in (if different) and is based on the excess over £325,000 at the 10th anniversary, regardless of whether the excess arose through additional contributions to the trust or through investment growth.

It’s much more complicated to calculate the charge on making withdrawals…

I believe this to be the case, and would welcome any correction to my understanding.

It can matter quite a lot where the injection of of the £40,000 sums came from. If the transfers into settlement were exempt under the normal expenditure out of income rule, s67 IHTA will not be triggered so that the settlor’s cumulation, which permanently affects the rate of tax, will not be revalorised by utilising transfers in the 7 years prior to the date of the addition (or latest addition) rather than prior to the date that the settlement commenced. That would bring in the £325,000 to the rate calculation, ruining the nil rate band component which would otherwise apply. Instead of a settlor being regarded as having a nil cumulation he would have one of £325,000.

Even so the total additions will be charged at a 10 year anniversary, at 6% if they then represent the excess over the £325000 originally settled (ignoring investment performance).

The rate charged on additions before the first 10 year anniversary and between such anniversaries is reduced by quarterly discounts in calculating the next 10 year charge.

Given the inevitably controversial status of the exemption if income transfers must be settled into a relevant property trust it may be prudent to make that a separate settlement. Although this will have a settlor’s cumulation of £325000 only the added amounts will be charged to tax at 6%. The need for and skill of making otherwise identical settlements different has been addressed previously on this forum. If it has to be agreed that the exemption fails the tax cost will be no greater than if only one trust had been used.

Where one trust has been used, as in the initial query, the line must surely be that the normal expenditure exemptions cover the transfers of surplus income, so that they are not chargeable transfer additions as well as being exempt in themselves, leaving the trust with a nil rate band cumulation although with a chargeable amount which exceeds that figure at a subsequent anniversary.

Jack Harper

Thanks Jack,

Ian Wells seems to be only concerned with the periodic charge at the 10th anniversary, not the tax position of the settlor. As I read your final paragraph, you are agreeing with me that the periodic charge is based on the value of the trust at the 10th anniversary.

My comment regarding withdrawals, was to point out that a charge arises on withdrawals at any time, not just the 10th anniversary, assuming the value of the trust exceeds the current NRB.

The periodic charge at the 10th anniversary is calculated partly by reference to the tax position of the settlor i.e. his or her cumulation

Jack Harper

I think the confusion is over the potential impact on the available nil rate band at the tenth anniversary caused by the additional gifts to the trust of £40,000, which would normally reduce the available NRB.

The fact that the additional contributions of £40,000 were from surplus income, and assuming HMRC are happy with that, means the NRB is not reduced by the transfers.

Nevertheless, as £40,000 has been added to the trust fund, and for this example I am ignoring any investment growth and deductible expenses, then at the 10th anniversary assuming a NRB of £325,000 the fund stands at £365,000, so a periodic charge is due of of 6% of £40,000, or £2,400. I hope that’s what Ian was trying to clarify.

If the £40,000 added property arises from normal expenditure out of income transfers (Ie exempt transfers), despite being an exempt transfer is aggregated with the £325,000 initial settled amount to arrive at the value of trust property at the 10th anniversary.

The importance of satisfying the normal expenditure out of income exemption is, as Jack points out, that IHTA 1984 s67 cannot be triggered which if triggered would be prejudicial.

Malcolm Finney

I had missed that the £40,000 from surplus income was gifted ANNUALLY, so increasing the trust fund value at the 10th anniversary by £400,000, not £40,000 as I originally stated and thus making my original answer obsolete. Go to the back of the class, Clarke…