Tax status on re-settlement of existing Settlement

The Trustees of a 1960 lifetime discretionary settlement, in 2010, re-settle the assets of that settlement on a flexible life interest trust for the benefit of the original Settlor’s child. This was done following advice from Counsel. Unfortunately that advice is silent on tax advice.

For tax purposes, how would forum members treat the post 2010 settlement; should it be taxed as a Life Interest Trust or as under the originating Settlement, taxed as a Discretionary Trust?

Any views greatly appreciated.

Justin Wallace
Brewer Harding & Rowe

The FLIT, having been created post 21 March 2006, will be within the IHT relevant property regime so there should have been no IHT or CGT event as a result of its creation. Periodic chargers will continue to apply.

For income tax purposes, it will normally be treated as an interest in possession trust.

Paul Saunders FCIB TEP

Independent Trust Consultant

Providing support and advice to fellow professionals

The benefits on creation are as noted by Paul. As it is an RPT it will continue to benefit from there being no chargeable event for IHT on the death of any beneficiary, including a life tenant, and of thus continuing to avoid aggregation with the free estate of a deceased life tenant or with any IPDI fund deemed to be his/hers.

The periodic IHT ten year anniversary chargeable events continue to apply, measured at intervals from a date in 1960, but the trustees can decide whether to manage those by distributing before or after the next such event (if still to occur in the rest of 2020), with CGT hold-over relief if useful, or doing nothing at present.

The main IHT downside of the 2006 reforms was to make a transfer into a new life tenant trust a chargeable transfer rather than a PET, with a silver lining of CGT hold-over relief for non-business non-cash assets; allowing such assets to go in and come out with that relief to a beneficiary, who could then benefit from the step up to market value on his own death or claim the relief again on a subsequent transfer that was not a PET.

In my experience few make chargeable transfers into RPTs unless covered by their nil rate band but there is the opportunity of a future tax-free distribution (whatever the then value of the distributed asset) before the first 10 year anniversary event or for management of later trust charges, utilising the IHT nil rate band and the seriously low 6% maximum marginal rate and possibly CGT hold-over.

Planning viability thus remains despite the demise of the multiplication of trusts with separate NRBs, although trusts are roundly detested by HMRC and HMG. Trusts may be targeted by any future IHT reforms but the insightful report by the APPG acknowledges that they do present some challenges to any replacement of IHT (which they advocate and I support in principle).

Politicians’ attention span cannot cope with the necessarily extended horizon of many trustees (or indeed much else more than 5 years out) and HMRC’s psychopathology prevents their acknowledging that any given trust might exist for a purpose other than the vile nefarious deprivation of the Exchequer.

But, as I say to my medical acquaintances, how would they like it if human anatomy and physiology was totally transformed regularly over future 3 year intervals as is the tax system?

Jack Harper

Assuming a re-settlement then a CGT disposal arises on the creation of the second trust [TCGA 1992 s 71(1)].

The original settlor will also be the settlor of the second trust.This may mean that the second trust is settlor interested for CGT purposes (and possibly for income tax?).

For IHT the second trust will be a relevant property settlement.

Malcolm Finney

Is it conceivable that Counsel would have overlooked that a CGT charge on resettlement by means of a special power of appointment could be avoided by shrewd drafting to include an ultimate gift over (if the new trusts failed) back into the head trust? As HMRC are fully on board with the principle (see CGM37800C) only faulty implementation or bad advice should trigger an unwanted charge on such an occasion.

Counsel’s advice on tax was apparently “silent”. In my experience even Counsel who is primarily an equity specialist and draftsman will be fully alert to the CGT (and IHT) consequences of his advice and the wording of the deed of appointment if he settles it. At the very least he will know that such consequences may be in point and will recommend that specialist tax advice should be taken. Or woe betide him.

It may be that no gain would arise by computation or by exemption or even a loss. In some cases a resettlement is deliberately drafted to cause a disposal e.g where there are brought forward losses to frank any gain or the plan is to crystallise a loss for future use against gains on assets retained after a part resettlement. A full re-settlement which caused a disposal stranding losses on that disposal or available forward within the original settlement with no prospect of further gains to offset them would seem to constitute an own goal

There is insufficent detail in the question about the actual CGT position at re-settlement to comment further. The IHT situation is easier to predict as only an appointment out to a beneficiary absolutely or a transfer to a wholly separate trust is likely to break the fictional chain that the new trust and the original one remain a fiscal unity. The devil is in the deeming.

Jack Harper

I should have commented in my earlier post on the problem of hold-over relief (availability and clawback) for settlor-interested trusts where a re-settlement by trustees causes absolute entitlement. The original settlor remains the settlor of the new trusts, as Malcolm says, so if the original was “settlor-interested” so may the new trusts be (including those of a separate trust to which a transfer is made). Even so, the resettled trusts can be drafted to shed that status.

Even if the settlor and spouse were originally excluded from benefit (so the resettlement must do so too or risk fraud on a power) the problem of minor dependent children as eligible beneficiaries is a potential issue not only on creation but also on resettlement. Mr Kessler’s book on Drafting has an elegant solution in para 13-21 14th Ed, which would seem as appropriate to the exercise of a re-settlement power as on creation.

The problem does not arise if the resettlement is drafted to avoid any absolute entitlement deemed disposal by “reading back” the new trusts into the original.

Jack Harper