A STUDY IN GIFTING – DISTRIBUTING BENEFITS FROM A RELEVANT PROPERTY TRUST

In March’s Adviser Update we looked at the ongoing obligations for trustees at the ten-year anniversary dates of relevant property trusts. We are now going to consider the tax implications of making distributions to beneficiaries.

Income

Income is distributed to a beneficiary with a 45% tax credit which is shown on form R185. The beneficiary can then reclaim the difference between the 45% and the rate of income tax they pay, so a basic rate taxpayer, for example, can reclaim 25%.

The trustees must maintain a record of income received and paid from the trust via a ‘tax pool’. Income received (in excess of the first £500 in a tax year which is tax free) is taxed at 45% in respect of interest and 39.35% for dividends. However, as income distributions are always paid with a 45% tax credit, the trustees must ensure that there is enough in the tax pool to cover the credit, or they must either provide any shortfall themselves or restrict the distribution to the amount of credit in the tax pool. For example:

• Dividend Income: £500 received and taxed at 39.35%, resulting in £196.75 tax.
• Distribution to Beneficiary: The trustees wish to pay the balance after tax of £303.25 to a beneficiary, which would be paid with a 45% tax credit (£248.11), giving a gross amount of £551.36.
• Tax Pool Shortfall: Only £196.75 is in the tax pool. To make the full payment, the trustees must account for the tax at 45% (£225). They must therefore pay an additional £28.25 tax, meaning the beneficiary now receives £275 with a tax credit of £225, giving a gross amount of £500.
• Alternative Payment: Trustees could limit the payment to the tax of £196.75, resulting in a payment of £240.47 to the beneficiary, giving a gross amount of £437.22.

Any income which remains undistributed for more than five years will be included as capital for periodic charge purposes at each ten-year anniversary.

Capital

Capital distributed from relevant property trusts may be subject to IHT. If capital is withdrawn during the first ten years, and there was an initial IHT charge when the trust was established, or capital is withdrawn at any other time and there was a periodic IHT charge at the previous ten-year anniversary, an ‘exit charge’ will be applied to the withdrawal.

Where there has not been an initial or periodic charge then there should be no exit charge on withdrawals of capital. However, failed potentially exempt transfers (PETs) following the death of a settlor could lead to a reassessment leading to initial and/or periodic charges being applied retrospectively if the settlor’s and trust’s nil rate bands were exceeded.

Exit charge in first 10 years

Amount settled into trust = £450,000 (no related settlements)

Available nil rate band = £325,000 (no other Chargeable Lifetime Events in previous seven years)

Amount withdrawn after five years (20 quarters) = £50,000

£450,000 – £325,000 = £125,000 x 20% = £25,000 notional transfer

(£25,000 / £450,000) x 100 = 5.56% effective rate

5.56% x 0.30% x (20/40) quarters = 0.83% actual rate

Tax payable = £50,000 x 0.84% = £420

Exit charge after first 10 years

Trust fund at 10 years = £500,000 (assume no withdrawals in first 10 years)

£500,000 – £325,000 = £175,000 notional transfer

£175,000 x 20% = £35,000 IHT on notional transfer

(£35,000 / £500,000) x 100 = 7% effective rate

7% x 30% = 2.1% actual rate

£500,000 x 2.1% = £10,500 periodic charge

£50,000 capital withdrawn at the end of year 16 (24 quarters)

7% x 30% x (24/40 quarters) = 1.26%

£50,000 x 1.26% = £630 exit charge

Where the trustees pay the exit charge for the beneficiary then the actual rate must be grossed up to reflect the loss to the trust being the capital paid out and the tax.

No exit charge arises where a capital distribution is made within three months of a periodic charge date.

So, there are a number of ongoing inheritance tax considerations for trustees of relevant property trusts which will incur costs as specialists will be needed to ensure all necessary submissions are made to HMRC and that the tax due is paid in a timely manner. However, this should be viewed against the backdrop of the control, flexibility and peace of mind achieved by those seeking to pass on wealth using such planning solutions.

All information is based on our understanding and interpretation of applicable law and regulation.

 

 

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