Inheritance Tax and Trusts
Gift With Reservation In Discretionary Trust
If you want to avoid a gift put into a discretionary trust being treated as a gift with reservation for inheritance tax purposes, you should exclude yourself from any benefit in the trust.
HMRC has stated that if the donor is a potential beneficiary under a discretionary trust, or even under a power of appointment trust where someone else has an interest in possession, it will regard this as a reservation of benefit.
The standard advice for clients using these trusts is to make sure that they cannot themselves benefit in any way by excluding themselves from benefit in the trust. The donor can still be a trustee, but he or she should not be able to benefit from any trustee charging clause. HMRC does not regard an interest-free loan on its own, or the retention by the settlor of a reversionary interest in a gift to the trust as a gift with reservation, but neither of these answers represent the best advice to a client who is setting up a trust.
Annual IHT Exemption For Lifetime Transfers
The annual inheritance tax exemption for lifetime transfers is £3,000. Any unused exemption from the previous year can be rolled forward giving a total exemption of £6,000.
Any unused balance is lost if it is not used in the next year, and that year’s exemption must be fully used first. It cannot be carried forward to year three.
Transfers Without IHT And CGT
The main IHT/CGT advantage of transferring an asset directly to someone other than your spouse or civil partner, rather than transferring it via a trust, is that there is no lifetime charge on direct transfers over the nil rate band.
A direct transfer (outright gift) is a Potentially Exempt Transfer for IHT. The main advantage of a PET is that there is no lifetime charge of 20% on transfers over the nil rate IHT band. However, if the donor does not survive the seven-year Potentially Exempt Transfer period, IHT will be payable on the whole of the excess.
It is also important to consider any CGT consequences of direct transfers: a gift to a spouse or civil partner will not be a disposal, whereas a gift to any other person will be. In contrast, chargeable gains on transfers into and out of trusts may be subject to an election for CGT holdover relief.
In some circumstances, this may be a reason to make a chargeable transfer rather than a PET.