Writing for Taxation magazine, BKL tax adviser Terry Jordan offers advice on withdrawals from, payments into and the transfer of a trust.
In 1998 a grandfather (X) created two interest-in-possession trusts from which he was not entitled to benefit. He and his daughter were trustees. One trust contained a life policy, the other a single premium investment bond, both on X’s life. Every year X withdrew £2,000 (the 5% tax-free amount) from the bond and paid £2,450 as the life policy premium. The daughter was the ‘current beneficiary’ of both trusts and entitled to 100% until November 2005 when, by a revocable deed of appointment, X replaced his daughter with his grandson as the 100% ‘current beneficiary’. Previously, the grandson and others were ‘potential beneficiaries’. In April 2010, the grandson and a solicitor were made trustees.
In October 2010, the daughter died and her estate was dealt with by the same solicitor. Inheritance tax was paid on the estate and the balance paid to the grandson as sole beneficiary. In September 2015, X died so the trusts received cash and it was decided to collapse them.
The solicitor says the grandson is entitled to trust income only and capital payment would require an irrevocable appointment. However, he also states that, in November 2005, the daughter made a potentially exempt transfer that failed because she died within seven years. That transfer was not declared and I have some questions.
Should returns have been made for the 5% withdrawals and premium payments? In X’s estate £450 was included as an annual gift to the trusts. Should it have been £2,450? Was the £2,000 a benefit from the trust? Did the daughter make a potentially exempt transfer? She was forced to do this by X.
The solicitor has agreed to pay the interest and penalty on the daughter’s transfer if the grandson agrees to make no further claim and pays the inheritance tax because the solicitor paid him too much from the estate. Is the grandson bound to do this?
Query 19,025 – Bystander
Reply by Terry ‘Lacuna’ Jordan, BKL
Taking matters in order, in 1998 grandfather X’s creation of two interest-in-possession trusts would have constituted potentially exempt transfers for inheritance tax purposes. When settled, the investment bond was apparently worth £40,000. The value of it and the policy was part of the daughter’s estate for inheritance tax purposes.
When in November 2005 the daughter’s interest in possession was terminated in favour of X’s grandson she was deemed to make a potentially exempt transfer (PET) (these arrangements slightly pre-dated ‘transitional serial interests’) and the value went into the grandson’s estate. Because the daughter died within seven years of the termination of her interest the deemed transfer by her became chargeable but the liability for any inheritance tax would have been that of the trustees. We are not told the value of the insurance policy at the date the daughter’s interest terminated, but the value of the bond was not likely to be much in excess of the original investment of £40,000 because withdrawals of 5% had been made each year. Unless the daughter already had substantial lifetime gifts on her inheritance tax ‘clock’ it is likely that the value fell within her nil rate band such that no liability arose and the effect was to reduce the nil rate band available to the daughter’s death estate. The trusts in favour of the grandson were not exhaustive apparently.
No returns would have been necessary for the 5% withdrawals or premiums. X’s top-ups of £450 a year might well have been covered by the normal out-of-income exemption in IHTA 1984, s 21. For completeness this was not apparently a classic ‘back to back’ arrangement including an annuity such that s 263 is engaged.
I think it unlikely that an actual liability would have arisen on the failed deemed PET. If the solicitor was at fault it would seem unfair to penalise the grandson.