The Rysaffe case is often referred to within trust planning. It demonstrates that there are various ways of using multiple trusts in order to achieve effective tax planning.
It is worth remembering that although the taxation of discretionary trusts is nothing new, generally the flexibility in the pre-2006 regime meant that in many instances, where clients and financial advisers were planning inheritance tax (IHT) solutions, the potentially exempt transfer (PET) regime was simpler and potentially more cost-effective.
The relevant property regime that Interest in Possession (IIP) and Accumulation and Maintenance (A&M) trusts find themselves post-2006 treat these trusts similar to discretionary trusts for IHT purposes. The added complexities this brings does not mean IHT planning is no longer viable, it just means we need to look at the longer-term view and really understand the objectives of our clients.
The flexibility that can be achieved with discretionary trusts can make the issue of paying tax up-front (where previously there was none) a lot more palatable, as this document explains.
The 'Rysaffe principle' relates to Rysaffe Trustee Co (CI) v Inland Revenue Commissioners* (2003) where a series of trusts were created on consecutive days. The principle being that by establishing a series of smaller trusts, rather than just one trust, you can reduce the impact of the 10-yearly periodic charge and exit charge by benefiting from a nil-rate band (NRB) for each individual trust.
Background to the case
The Inland Revenue (now HM Revenue & Customs) contended:
‘That the making of all the settlements were associated operations and that therefore the settlor had made one composite settlement by an extended disposition.’
After an initial successful hearing both High Court and a unanimous Court of Appeal Judgement stated that Section 42 Inheritance Tax Act (IHTA) 1984 was to apply on the basis that the word 'disposition' had its ordinary meaning and was not to be extended to include a disposition by associated operations.
A key statement from the judge, Park J, dealing with the associated operations point was as follows:
‘All the parcels of shares were properly comprised in settlements for the purposes of Section 64. The associated operations provisions had nothing to do with that analysis. There were 10-yearly charges on all of the parcels of shares. It is (I assume) true that in aggregate the five 10-yearly charges would be lower than the single charge which would have applied if there had only been one settlement. But that is not a valid reason for artificially importing the associated operations provisions into the exercise and using them to impose the false hypothesis that there was only one settlement when in fact and in law there were five.’
Additionally, from a planner's point of view it is worth considering Section 62 IHTA 1984 relating to 'related settlements'. In summary for a trust to be a related settlement:
a) the settlor is the same in each case, and
b) the trusts commenced on the same day.
So, trusts created on different days do not fall within this definition. Therefore, by creating a series of trusts on different days you may reduce the inheritance tax payable, as the example below demonstrates.
Example scenarios
£500,000 invested into a bond under a discretionary trust and no previous chargeable lifetime transfers.
Scenario 1:
Initial charge (Entry tax):
If the £500,000 is invested into one bond under a single trust, there will be a chargeable lifetime transfer (CLT) in respect of the amount above their available NRB. We will assume the full NRB is available.
Value of transfer into the discretionary trust = £500,000
Less settlor's available NRB = £325,000
Excess = £175,000
Tax at lifetime rate of 20% on the excess over the NRB = £35,000 entry charge (£43,750 if paid by the settlor)
First 10- year review (periodic charge):
The value of the trust fund at the 10-year Periodic Charge is £790,000.
Trust fund value = £790,000
Less current available NRB = £350,000
(assume increased to £350,000)
Excess = £440,000
Tax on excess at lifetime rate = (£440,000*20%) £88,000
Tax as a % of ‘chargeable value’ = (£88,000/£790,000) 11.14%
3/10 of the effective rate = (11.14*3/10) 3.34%
Tax on trust fund = (£790,000 * 3.34%) £26,386 periodic charge
Scenario 2:
If the £500,000 is invested as four separate bonds, each with a premium of £125,000 and write each policy subject to different discretionary trusts on different days, there will still be an initial charge as only the settlor's available NRB is assessed on the initial transfer into the trust (CLT):
Initial charge
Value of transfer into trust 1 = £125,000
Less settlor's available NRB = £325,000
Excess = £0
Tax at lifetime rate of 20% on the excess over the NRB = £0
Value of transfer into trust 2 = £125,000
Less settlor's available NRB = £200,000 (£325,000 minus gift into trust 1)
Excess = £0
Tax at lifetime rate of 20% on the excess over the NRB = £0
Value of transfer into trust 3 = £125,000
Less settlor's available NRB = £75,000 (£325,000 minus gifts into trusts 1 & 2)
Excess = £50,000
Tax at lifetime rate of 20% on the excess over the NRB = £10,000 (£12,500 if paid by the settlor)
Value of transfer into trust 4 = £125,000
Less settlor's available NRB = £0
Excess = £125,000
Tax at lifetime rate of 20% on the excess over the NRB = £25,000 (£31,250 if paid by the settlor). Total initial charge for all trusts: £35,000 (£43,750 if paid by the settlor)
First 10 - year review:
The value of the trust fund at the 10-year Periodic Charge is £790,000 between the four trusts. So, for each trust fund the calculation is:
Trust 1
Trust fund value = £197,500
Previous CLTs seven years prior to this trust = £0
Less current available NRB = £350,000
(assume increased to £350,000)
Excess = £0
Tax on excess at lifetime rate = (£0*20%) £0
Tax as a % of ‘chargeable value’ = (£0/£197,500) 0%
3/10 of the effective rate = (0%*3/10) 0%
Tax on trust fund = (£197,500 * 0%) £0 periodic charge
Trust 2
Trust fund value = £197,500
Previous CLTs seven years prior to this trust = £125,000
Less current available NRB = £350,000
(assume increased to £350,000)
Excess = £0
Tax on excess at lifetime rate = (£0*20%) £0
Tax as a % of ‘chargeable value’ = (£0/£197,500) 0%
3/10 of the effective rate = (0%*3/10) 0%
Tax on trust fund = (£197,500 * 0%) £0 periodic charge
Trust 3
Trust fund value = £197,500
Previous CLTs seven years prior to this trust = £250,000
Less current available NRB = £350,000
(assume increased to £350,000)
Excess = £97,500
Tax on excess at lifetime rate = (£97,500*20%) £19,500
Tax as a % of ‘chargeable value’ = (£19,500/£197,500) 9.87%
3/10 of the effective rate = (9.87%*3/10) 2.96%
Tax on trust fund = (£197,500 * 2.96%) £5,846 periodic charge
Trust 4
Trust fund value = £197,500
Previous CLTs seven years prior to this trust = £375,000
Less current available NRB = £350,000
(assume increased to £350,000)
Excess = £197,500
Tax on excess at lifetime rate = (£197,500*20%) £39,500
Tax as a % of ‘chargeable value’ = (£39,500/£197,500) 20%
3/10 of the effective rate = (20%*3/10) 6%
Tax on trust fund = (£197,500 * 6%) £11,850 periodic charge
Total tax on 10-year periodic charge: £17,696 some £8,690 less than scenario 1 where one trust is used
Joint settlors
When calculating the IHT on discretionary trusts written by joint settlers, unless the settlers have not contributed equally, then the calculations will be treated as if there were two trusts for half the values with one of the joint settlers as the settlor for each.
For example,
Mr and Mrs Wright pay £500,000 into a discretionary trust. This would be treated as an initial transfer into a discretionary trust (CLT) for £250,000 for each settlor. And that settlor's available NRB would be reduced by the £250,000. Similarly, at the 10-year review, the trust fund will be entitled to two NRBs.
Same day additions
In the Summer Budget 2015 legislation was introduced to counter additions made on the same day to multiple trusts. Where property is added to two or more settlements on the same day and after the commencement of those settlements, the value of the added property together with the value of property settled at the date of commencement will be brought into account in calculating the rate of tax for the purposes of ten-year charges, exit charges.
For example,
Two trusts created by Mr Wright with gifts of an investment bond with a premium of £250,000 on different days. 5 years later he adds £50,000 to each on the same day. At the first 10-year review of the first trust the calculation now looks like this:
| Example | ||
| Trust fund value | £350,000 | 'chargeable value' |
| Previous CLTs seven years prior to this trust | £0 | |
| Gifts into related settlements | £250,000 | |
| Value of additions to other related trusts | £50,000 | |
Less current available NRB = £350,000
(assume increased to £350,000)
Tax on excess at lifetime rate (20%) = £60,000
Tax as a % of ‘chargeable value’ = 9.23%
3/10 of the effective rate = 2.77%
Tax on trust fund = £9,695
Prior to this change in legislation there would be no 10-year charge on this trust as the trust fund was not in excess of the NRB
There are some additions which are exempt including premiums paid under a contract of life insurance where premiums are due at regular intervals of one year or less throughout the contract. Therefore, the use of multiple trusts on protection policies remains unchanged.
Are there any other considerations?
- UK Parliament can change legislation and HM Revenue and Customs practice can change at any time.
- You need to take care at the implementation stage to ensure the right trust is set up at the right time.
- Where a CLT is created above the current reporting levels, you need to complete three sets of forms (IHT100, IHT100a and supplementary forms depending on the assets).
- Significant growth in trust values may mean one or more of the trusts suffer 10-yearly periodic charges and consequently exit charges may apply. If NRBs continue to increase only in line with inflation or below, this could happen.
- The costs of setting up multiple bonds in trusts must be considered against the potential IHT savings.
- This type of planning will not suit every client but adds a level of planning which may well be suitable for high net worth individuals looking to create long-term strategies. It is worth remembering that in both the PET and CLT regimes you can, in effect, give away your NRB every seven years.
- Examples of where this type of planning may not be suitable would include where a client doesn't intend for the trusts to remain in force for ten or more years, or where the IHT savings on the periodic charge are outweighed by the costs of running multiple investments.