Retained income and ten year charges

The issue

In general terms, most trusts established on or after 22 March 2006 are subject to the ‘relevant property’ regime which imposes an IHT charge on the capital value of trust assets on each 10 year anniversary of the creation of the trust. This charge will equate to a maximum of 6% of the capital value of the trust. There are also exit charges when capital is distributed or property ceases to be relevant property.

A ten year charge is based on the value of trust property which is capital (as opposed to income). Therefore income which is retained but not accumulated to capital is not generally subject to a ten year charge. Therefore distributions which have been made to a trust from an underlying company would not generally be subject to a charge.

Before 6 April 2014, income which was accumulated to capital during a 10 year period was treated as being added to the settlement on the date of accumulation. This was helpful because the overall rate of tax on those accumulations would be reduced on the basis that the capital had not been relevant property throughout the whole period. This rule still stands for accumulations into capital.

From 6 April 2014, any retained income is deemed to be capital if it has been retained in the settlement for five years or more. Moreover, it is treated as having been relevant property throughout the entire 10 year period meaning that the full 6% charge will apply to it. This means that income which is accumulated to capital has a much more favourable treatment than income which is over five years’ old but still retained as income.

Planning point

An obvious planning point springs out of this. It could well be worth accumulating ‘old’ (more than five years’ old) retained earnings into capital so as to help restrict the charge. This would be preferable to facing the impact of the rules mentioned above.

Example

Take a settlement which will have its next 10 year anniversary on 31 March 2021. £200,000 of retained income arose before 31 March 2016. If nothing is done, £200,000 of income will be taxed at the full rate of 6% (or £12,000). If on the other hand the trustees resolve to accumulate that income on 1 January 2021 (say) then it will be treated as added to the settlement at that point and the tax charge will be only £300.

Forbes Dawson comment

Although this is quite an obscure technical point the tax savings from taking appropriate action can be significant. There are also other planning points that may be appropriate if actioned before the ten year anniversary such as making capital appointments out to beneficiaries. Appropriate advice should always be sought for any trust which is facing a significant charge.

 

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