Loan Trusts and Nil Rate Bands

Trusts Discussion
1

Here is a hypothetical situation:

A lady has a full NRB available and creates a lifetime discretionary trust using her £325,000. Less than 7 years later, she creates a loan trust with a life assurance company and loans £100,000. Obviously there is no initial IHT as the premium paid on the bond is a loan. However, my assumption is that on the occasion of the 10 year anniversary, there will be a charge to IHT on the net value in the trust because the settlor had no nil rate band available, so the loan trust has no NRB. Am I right?

If so, what happens if the two trusts were created the other way round?

Your thoughts would be much appreciated.

Lorna Sansom
Blandy & Blandy LLP

2

I assume that the loan trust is discretionary as well. If so, I don’t think that it will have no nil rate band for the purposes of periodic charge calculations - rather, it will have whatever the nil rate band is at each ten-yearly anniversary, reduced by £325,000. Had the loan trust been created first, however, both trusts would have had a full nil rate band for the purposes of periodic charge calculations.

It appears that, for loan trusts reaching a ten-yearly anniversary, there is a difference between the figure used to calculate the periodic charge and that used for the limit for the reporting requirement. When a discretionary loan trust gets to a ten-yearly anniversary, it is perfectly acceptable to deduct the outstanding balance of loan from the value of the trust assets (probably an investment bond) when calculating the amount on which any periodic charge is based. However, even if there is no periodic charge, consideration needs to be given as to whether it is necessary to send an account to HMRC.

The IHT Manual (see http://www.hmrc.gov.uk/manuals/ihtmanual/IHTM06124.htm) states that:

Where a ten year charge has arisen and the settlement passes the general conditions, it will qualify as an excepted settlement where the value of the notional aggregate chargeable transfer specified in IHTA84/S66(3) does not exceed 80% of the nil rate band.

I am a little puzzled by the opening words (“Where a ten year charge has arisen”) but, presumably, a ten year charge arises even if it is calculated to be nil. The Manual then goes on to say:

For the purposes of calculating the value of the notional chargeable transfer, no relief that might be due should be deducted AND ANY LIABILITIES THAT MAY BE DEDUCTIBLE FROM ASSETS IN CHARGE SHOULD ALSO BE IGNORED [my emphasis].

This appears to be based on regulation 4 of the Inheritance Tax (Delivery of Accounts)(Excepted Settlements) Regulations 2008 (see http://www.legislation.gov.uk/uksi/2008/606/regulation/4/made). You will see
that sub-regulation 4(5) says:

Where, in reliance on these Regulations, no person was required to deliver an account under section 216 of the property comprised in the settlement on an occasion of a chargeable event under section 65 in respect of the settlement in the ten years before the chargeable event in paragraph (4), the amounts on which any charges to tax were imposed under section 65 shall, for the purpose of determining the value transferred by a chargeable transfer of the description specified in section 66(3), BE WITHOUT DEDUCTION FOR LIABILITIES or reliefs contained in the 1984 Act [my emphasis].

It seems to me that the effect of the words in red is that, for a discretionary loan trust, where the value of the bond is greater than 80% of the nil rate band at a ten-yearly anniversary, a report is required even if the value of the trust fund, net of the outstanding balance of loan, is less than 80% of the nil rate band. Having said that, I did find the Regulations and the provisions in the IHT Act very convoluted, and I ended up going round in circles.

Paul Thompson
Canada Life

3

If the first trust (which I will call the Disc Trust) entirely used up the lady’s NRB, because the addition/settlement to the Disc Trust was a chargeable transfer, then the Loan Trust will effectively have no NRB available to it. Certainly this is the case in more recent history; beware the idiosyncrasies of the tax treatment of some older trusts.

If the Loan Trust was settled with only a nominal sum (which might have been covered by the settlor’s £3k annual IHT exemption - the loan trusts I have seen were constituted with £1,000 or less), then if it had been settled before the Disc Trust, then the Disc Trust would still ‘have its full NRB’, as would the Loan Trust (subject to any earlier chargeable transfers). The loan to the Loan Trust would not normally constitute a chargeable transfer as there would be no ‘transfer of value’, but it could be, depending on the precise terms of the loan: there could have been a transfer of value if the loan was interest free and not repayable on demand, in which case there was some material value to the loan which would be chargeable (although not the full value of the loan - typically only the value of the commercial interest foregone).

Therefore, if the settlor had her time over again, it would seem sensible on these facts to have done it the other way around.

This all assumes that the Loan Trust is a relevant property trust, which it might not be. It might be a bare trust or a qualifying IIP of some sort (whether pre-FA2006 IIP, a TSI or a DPI), in which case it will not be an issue anyway.

Paul Davidoff
Moon Beever

4

[Following on from my other reply…]

The same issue arises where a person wants to make a substantial PET and also set up a trust in quick succession (including, for example, writing a life policy in trust): it can be advantageous to settle the trust first, if that can be done, since, if the donor dies within 7 years, the PET will become chargeable. If the failed PET had been made before the trust, it would from that point onwards use up the trust’s own NRB. IHT will still be charged on both gifts (to the trust and the failed PET) on the death of the donor, whichever way round they occur. However, the person liable for the IHT would be different: supposing the gift to the trust and the failed PET were both of the NRB amount and the settlor/donor had a single NRB: the IHT liability on the settlor/donor’s death would fall on the recipient of the later gift, the earlier recipient having the benefit of the NRB on death.

If there was a failed PET in excess of the available NRB was made within the seven years before the donor also wrote a life policy in trust (let’s say it is to pay £500,000 on the donor’s death - the trust being a relevant property trust, as most are these days), then when the £500,000 is distributed from the trust to a beneficiary, there could well be some material IHT charge under the relevant property regime, as well as on the 10 year anniversaries of the trust. If the trust has no available NRB and it reaches a ten year anniversary after the settlor dies and before the distribution, then there could be a 6% charge on the full value (6% of £500,000 = £30,000), followed by an exit charge on a subsequent distribution; if a distribution of the funds takes place after the death of the settlor but before the next ten year anniversary, then there might still be some IHT ‘exit charge’, depending on the valuation of the policy as part of the exit charge calculation.

Paul Davidoff
Moon Beever