I’d value thoughts from members of the forum on the following, please:
I am calculating the IHT exit charge due following a distribution from a discretionary will trust during the first ten years since the testator’s death.
As part of the calculation, I need to establish the settlor’s cumulative total. The settlor made PETs of £40,000 in the seven years before he died. He didn’t make any LCTs. However, the PETs have become chargeable because of the settlor’s death within seven years. I had therefore brought these PETs into account when calculating the rate of IHT for the exit charge.
However, a colleague recollects having a similar case a few years ago where HMRC advised that PETs made within the last seven years of the settlor’s life aren’t brought into the calculation for IHT exit charges from a discretionary will trust. The IHT manual at para IHTM42255 says that, for calculating exit charges from trusts, the settlor’s cumulative total includes both immediately chargeable transfers and PETs if the settlor died within seven years of starting the trust. However, it goes on to say that for will trusts “only chargeable transfers seven years before death are cumulative” which suggests that my colleague is right and I can leave the PETs out of account in my calculation.
All the other commentary I’ve managed to find says that PETs become chargeable on death and are therefore taken into account for calculating exit charges, so I thought I’d see what other forum members thought as I would think that this situation arises fairly frequently.
Unfortunately this is a pitfall which RPT trustees can only avoid by due diligence before they accept office or at least before making a distribution within the first 7 years and while the settlor who has made the relevant PET is alive.
S.3A(5) IHTA mandates that a PET is to be regarded as exempt until it is not but this is no protection for the trustees. The calculation of exit and TYA charges of both lifetime and Will RPTs must know the settlor’s cumulation as a key component of the tax rate, identified as occurring up to but not including the transfer into settlement on commencement and a Will trust commenced on death per s.48A. This will only cause difficulty on an exit charge event in the first 7 years of a lifetime trust; on the first TYA and any exit chargeable events after the first 7 years it will be ascertainable whether the settlor’s PETs in the 7 years before commencement have become chargeable by his death.
Trustees will wish to avoid exposure on a distribution whose tax rate will be retrospectively increased by that death. They should not rely on s.240 time limits, bearing in mind that they may be held careless if not deliberate. Their remedy is to postpone the chargeable event or reserve part of the fund or (riskier) take an indemnity from the beneficiary: see s.201(1)(a) and (c).
In any event trustees must surely accept that they need to ascertain their potential exposure by asking the settlor about his PETs and CLTs given that the cumulation will affect the rate on all chargeable events while the settlement lasts. This includes will trusts. But in their case the trustees have no excuse for not knowing the settlor has died or for taking longer than 7 years to find out whether he or she made failed PETs (or CLTs) in the 7 years before death.
Apologies for not commenting on IHTM42255. The narrative under the heading “Will Trusts” is either wrong or woefully misleading by not making it clear that previous “chargeable transfers” must include failed PETs, as CLTs are exactly what they are—albeit retrospectively to the date of the TOV.
If HMRC are really saying that they do not include failed PETs that would mean that Settlors should make PETs when their life expectancy is short in the expectation of transferring an otherwise permanent nil cumulation to a will trust. They would still need to bear in mind the different allocation of their NRB(s) and liability for tax compared with doing nothing.
Per Victor Meldrew: “I don’t believe it!”. The statement taken literally is at odds with the previous content, notably the bracketing of both types of CLT together at the 2 bullet points and the comment about the passage of time. The law absolutely does not support this radical difference between lifetime and Will trusts.