An insurance policy was settled into trust in 1998. The type of trust will determine the IHT treatment and the income tax treatment will depend upon whether the chargeable event gain is realised by the trustees or the beneficiaries. BKL tax adviser Terry Jordan examines this for Taxation magazine’s Readers’ Forum.
A trust distributes the proceeds of a single-premium life policy
My client is a trust established in 1998 by M for her two children who at that time were 22 and 17. The trust invested in a single-premium life policy and has had no other assets.
The settlor/trustee now wishes to cash in the policy, distribute the proceeds equally to the two beneficiaries and wind up the trust.
I am told to assume that the children are basic or 40% taxpayers.
I am assuming that the life policy rules mean that the profit on cashing in the policy will be subject to income tax (with a number of 5% credits for the intervening years).
However, what are the rules for the distribution to the children? Would this be a distribution of capital or income?
Given the amounts involved, I do not think that an exit charge will be in point – but will a tax return be necessary for inheritance tax purposes in any event? No return was made in 2008. What I do not want, however, is an exposure to double taxation if it can be avoided.
I am sure that there is a simple answer, but I am afraid that a hidden elephant trap might catch me out.
Query 18,608 – Vernon
Reply from Terry “Lacuna” Jordan, BKL
We have not been told the nature of the trust. In my experience if a trust company document was used the trust was probably “interest in possession” (present right to present enjoyment) for the two children at inception.
Such precedent deeds normally ousted the provisions of the Trust Act 1925, s 31 that would otherwise have prevented an interest in possession subsisting before a beneficiary’s 18th birthday.
If it was the case that the children enjoyed pre-22 March 2006 “interests in possession” under the trust the value has always been part of their inheritance tax “estates” and paying capital to the children will be an “enlargement” of their interests with no inheritance tax consequences.
Conversely, if the trust has always been within the relevant property regime there would have been a 10-year charge to inheritance tax in 2008 and the potential now for a proportionate or “exit” charge to arise on absolute appointment of capital.
Whether a return is necessary will be determined by the provisions of the Inheritance Tax (Delivery of Accounts) (Excepted Settlements) Regulations SI 2008/606. Broadly, if values do not exceed 80% of the nil-rate band no return is necessary.
If a policy is held on trust, the settlor will normally be subject to income tax on a chargeable event if still available to charge. A settlor who dies may, in some cases, be chargeable on an event occurring after death. This would be the case if the policy held by the trustees is on the life of someone other than the settlor and continues after the settlor dies.
When a chargeable event occurs after a UK resident settlor dies, but before the end of the tax year, the gain will be chargeable as part of the total income of the deceased settlor for that tax year.
Should the gain arise on an event after the end of the tax year in which the settlor died, the trustees will be taxed on the gain, subject to transitional provisions for policies in existence before 17 March 1998.
An assignment for no consideration does not give rise to a chargeable event. Accordingly, the choice appears to be between the trustee encashing in the current tax year, in which case the gain would be added to M’s income and taxed accordingly or assigning the benefit to beneficiaries who would then be liable on encashment at their own marginal rates. In either event the children would receive capital, not income.
Other responses to the query are available on the Taxation website.