Under Inheritance Tax (IHT) law, certain types of trust have a ten-yearly charge to IHT on the value of the trust assets. The legislation, which imposes IHT of 6 per cent on the ‘relevant property’ in the trust settlement, was introduced in 2006 and applied from 2008, so the first periodic charges are now in point.

When a wealthy family created two trusts in 2000 and 2004 and settled more than £18 million in them, the relevant legislation had not been passed. The current trustees of the trust were appointed in 2008. The trusts were very similar in terminology but had different beneficiaries. Each provided that the children (including those not yet born) who were beneficiaries of the trust would acquire an ‘interest in possession’ of the trust assets when they reached the age of 25.

When the trusts were created, IHT law operated differently, such that until a beneficiary obtained an interest in the trust assets, the assets were not regarded as part of any individual’s estate, and after that they would be regarded as part of the beneficiary’s estate for IHT purposes, but there was no ‘exit charge’ when the legal rights in the assets changed from the trustees to the beneficiaries.

When IHT law changed in 2006, the tax system applying to such trusts therefore became considerably less benign, but the option was available to convert trusts into different forms which had less onerous tax treatment, provided that the beneficiaries took absolute entitlement no later than their 25th birthday and were living at the time the trust was created. Alternatively, the trustees could have distributed the trust assets (by setting up ‘bare trusts’ for minor children) so that they became the owners of (had ‘absolute entitlement to’) the trust assets, of which they would have absolute control when they reached majority.

The trustees set about converting the trusts to be more ‘tax friendly’. As always, the devil was in the detail. The deeds of appointment contained a clause stating that the trustees ‘revocably appoint and declare that the Trust Fund shall from the date of this Deed be held by the Trustees upon the trusts powers and provisions …’.

The one small word ‘revocably’ led to an appearance in court, because if the provisions of the new trust had been revoked, the original trust would have applied and the ten-yearly charge would have been due. However, the presence of a ‘saving clause’ designed to prevent the trustees’ action leading to unfortunate IHT consequences proved to be sufficient for them to argue successfully that the trust deed should be rectified, saving more than £1 million in IHT.

Source: Private Client Library Content