During the lifetime of the trust, there is the possibility of a charge to IHT every 10 years, to the extent that the value of the trust at the time exceeds the IHT nil rate band (currently £325,000), up to 6 per cent. And if IHT applies at that stage it will set the rate of IHT that applies to distributions of capital in the following 10 years.
The upside for IHT purposes is that whatever is held in the trust is not part of the vulnerable child’s estate for IHT purposes and will not suffer a charge to IHT on their death.
CGT
A transfer into this type of trust is a deemed disposal for CGT purposes.
Because the trust is potentially chargeable to IHT on creation (if you exceed your IHT nil rate band – normally £325,000) and has the potential for 10-yearly and capital distribution exit charges, there is the option of 'holding over' CGT that would normally be payable on creation.
A transfer into this type of trust is a deemed disposal for CGT purposes and CGT is calculated in the same way as it would be if you sold the asset and triggered a capital gain.
You can sign an election with HMRC to 'holdover' the capital gain so that the trust acquires the asset based on your original acquisition value.
It does not avoid CGT, it merely passes on the liability to the trust.
Under current rules, if the trustees then distribute the asset with the inbuilt gain to a beneficiary, they can sign one more holdover election so that the beneficiary who owns the property has the inbuilt gain.
Retaining the asset until their death would washout the capital gain although, the asset would then be included in their estate for IHT purposes.
The trust can realise capital gains each year exempt up to the trust limit, currently £1,500.
Income tax
A downside of this type of trust is that income is liable to income tax at the rate applicable to trusts.
Trust income up to £1,000 is taxed at the standard rates of:
- Dividend income: 7.5 per cent.
- All other income: 20 per cent.
Trust income over £1,000 is taxed at the following rates:
- Dividend income: 39.35 per cent.
- All other income: 45 per cent.
That said, if income is distributed to a non/low rate taxpayer, they can reclaim the difference from HMRC between their rate and the trust rate.
2. Disabled persons trust
This is a hybrid of a discretionary trust and has certain tax breaks as the trust must predominantly be used for an individual who is classified as a vulnerable person.
IHT
Unlike the discretionary trust referred to above, there is no possibility of IHT applying when an asset is transferred into the trust.
