Inheritance Tax Treatment of Trusts

The 2006 Budget and Finance Bill include proposals to radically change the inheritance tax treatment of certain types of Trusts.

The existing legislation surrounding Trusts and the 2006 Finance Bill clauses are complex and further complicated by the fact that some of the new provisions are drafted in English legal terms that do not have a clear meaning in Scotland. The changes which will apply after 21 March 2006 are outlined below.

If you have set up a Trust for a child or grandchild or are contemplating this then the type of Trust will generally be one of the following:

• Discretionary Trust
  - gifts into such a Trust are immediately chargeable to inheritance tax at the 20% lifetime rate to the extent that the assets transferred exceed your £285,000 nil rate band. After that, such Trusts are liable to periodic charges to inheritance tax and, in particular, a charge at a maximum effective rate of 6% every 10 years.
• Accumulation and Maintenance Settlements
  - these are a form of Discretionary Trust where, pre-budget, the beneficiary must become absolutely entitled to at least the income by age 25, although the capital can be retained within the Trust for longer. Prior to the budget, gifts into such a Trust were potentially exempt transfers and the 10 year charge did not apply.
• Interest in Possession Trusts
  - these are often referred to as Liferent Trusts. Gifts into the Trust were potentially exempt transfers. On the death of the liferentor, the value of the Trust assets were added to the other assets of the deceased and inheritance tax computed on the whole with the tax being paid pro-rata by the executors and trustees from the respective assets.
  
  The proposals do not alter the regime for Discretionary Trusts at all.

Existing Accumulation and Maintenance Settlements will continue under the existing regime until 6 April 2008. If by 6 April 2008 the Trust has been altered such that beneficiaries become entitled to capital outright on or before age 18 then the Trust will continue with the existing treatment applying.

Otherwise, there may be a 10 yearly charge and also an inheritance tax charge when assets leave the Trust. Whether such a charge will arise in practice will be dependent upon the value of the Trust assets and the availability of a nil rate band.

Accumulation and Maintenance Settlements and Liferent Trusts created after 21 March 2006 will be treated in the same way as Discretionary Trusts in that:

• Gifts into the Trust will not be potentially exempt transfers.
• There will be 10 yearly inheritance tax charges.
• When assets leave the Trust there will be an inheritance tax charge.
• The termination of a liferent will not have an inheritance tax effect.
• Where the Interest in Possession terminates on death the Trust assets are not added to the estate of the deceased and there will, therefore, not be an inheritance tax charge.
• As stated at the beginning, this is a fairly involved area and you should contact us if it seems likely that you will be affected by the proposals.