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posted 1 Jul 1996 in Volume 1 Issue 5
Trusts in Practice
A User's Introduction
Bob Trunchion continues his series of articles examining how Trusts can be used in practice.
The last two issues looked at how life interest settlements can be used, this issue's article looks at the next trust in the Elderly Client Advisers armoury; namely the accumulation and maintenance settlement. It is quite likely that accumulation and maintenance settlements (A&M settlements) will be used with increasing frequency over the next couple of years as elderly clients undertake pre election planning. The A&M settlement for grand parents is an especially powerful tool.
An A&M settlement is basically a favoured form of discretionary trust. Subject to certain conditions, the trustees have complete discretion as to whom should receive income and capital and the dates on which they receive such amounts. The conditions mentioned above do impose some constraints on some of these freedoms (and it is these constrains which give rise to the taxation advantages). A point that has been made several times in this series of articles is that when the trust deed is drafted, great care must be taken to make the rules within which the trust operates (obviously within the confines of the law and the family situation) as flexible as possible.
The professional advisor has to remember that a trust set up by a grand parent for their grand child could easily still be in existence in 50 year's time when, the author suspects, even if the tax legislation has not changed (not a good bet to a gambling person!) the trust assets are likely to be unrecognisable compared to the assets originally settled by the grand parents. Whilst family shares could easily be settled initially as the generations progress, the sale of the company or its progression to the Stock Market are obviously possibilities as are a change in the nature in the activities undertaken. All these eventualities could affect the tax treatment applying to the trust even assuming the tax legislation has not changed.
As mentioned above an A&M settlement is just a discretionary settlement with some extra conditions or constraints. The conditions are set out in Section 71 IHTA 1984, namely that:-
1. One or more of the beneficiaries will become entitled to at least the income upon attaining the age of 25 years at the latest (although there is nothing to prevent this from being a defeasible interest): and
2. During the time that no interest in possessions exists the income is accumulated but can be distributed for the maintenance, education or other benefit of the named beneficiaries: and
3. Not more than 25 years have elapsed since the settlement was made or all the beneficiaries are the descendants of a common grand parent (as pointed out in the previous article on A&M settlements, it is very easy to adopt an invalid accumulation period where grand children are involved - generally a 21 year period for accumulation which conflicts with receiving their income at age 25!).
The first advantage of A&M settlement is that the gift to the trustees is a PET for IHT purposes and so provided that the settlor survives 7 years, the transfer to the trustees falls to be exempt from IHT even before business or other reliefs are considered.
Once in the trust, as far as the trustees are concerned, an A&M settlement is a totally IHT free environment until such time that beneficiaries take their interest in possession or an absolute interest in the underlying assets.
From a practical point of view whilst the A&M settlement remains in its discretionary phase the trustees have complete control over the assets.
For income tax purposes there are obvious benefits of payment being made for the education or maintenance of the children during their minority when the trust is settled by grand parents as the distributions are deemed to be the income of that beneficiary and this enables the children's personal allowances to be used and repayments of tax obtained (the trust is required to account for 34% tax in total on its net income). This compares very favourably with the position where the funds for the settlement are directly or indirectly supplied by the parents. Here the parental settlement rules would apply and the income would be taxed on the parents.
The Capital Gains tax rate will be 34% whilst any part of the trust is held in the accumulation or discretionary phase. An asset pregnant with gain held by the trustees during the discretionary phase should be appointed out on life interests to the underlying beneficiaries prior to its sale in which case the tax rate could be reduced to 24% (if the appropriate appointment is made in good time and in the correct fashion). The appointment could be defeasible. If the amount of tax avoided is substantial the provisions of Furniss v Dawson could be invoked by the Revenue.
When dealing with Capital Gains tax however a major problem area is to remember when hold over relief is available. On the creation of the settlement normally either business assets for which a claim under s165 TCGA 1992 can be submitted to hold over again or cash for which no hold over is required, are settled. As mentioned above assets can change their nature and great care should be taken to plan for Capital Gains tax towards the end of the life of a trust. Table A shows when hold over relief may be available.
From the table it can be seen that problems on hold overs can arise on the ending of an A&M settlement where the trust holds investments. Proper drafting of the deed and case law can sometimes enable the trustees to defeat life interest to take the assets back into discretionary phase then appoint them out using the hold over available. If the trust deed is not sufficiently widely drafted then the beneficiaries would have to come together under the rule in Saunders-v-Vautier to try to extend the life of the trust but the Revenue would argue in these circumstances that the settlors of the extended trust are the beneficiaries and therefore no s260 claim could be made.
Another use of this type of trust arises from the case of Stephenson-v-Wishart. In this case an elderly lady had her nursing home fees paid from the capital of the trust. The trust however generated substantial amounts of income but the trustees argued that the income from the trust was accumulated and was not appointed to the recipient where it would be taxed at 40% as her income (with credit for the tax paid by the trust). The courts accepted that the appointment from capital was effective. However the Revenue now use the case in its opposite direction. If the trust deed indicates that accumulated income should accreted to capital after a certain period and it is not used for the maintenance or education of the underlying beneficiaries within that period, using the above rule the Revenue argue that the income which remains undistributed at the appropriate time is an accretion to capital and the 34% tax paid to the Inland Revenue (which could frank future payments to beneficiaries) is lost.
Many uses can be found for A&M trusts including:
1. As a capital tax free fund for any assets.
2. Especially useful where the assets are business or agricultural property.
3. By way of a trust bust operation where a nil rate trust has grown rapidly.
4. As a vehicle for holding a death in service benefit or other appropriate life policies.
5. As a harmless type of trust for grand children which is income tax efficient (especially if the trust is set up as a will trust for and uses up the nil band).
Examples of the above include:
(a) George currently aged 60 sets up an A&M trust in 1997 for his grand children aged 4 and 5 respectively. Beneficiaries receive the income from age 25, capital at the trustees discretion or when the youngest reaches 40. George settles 30% B Limited (from his 100% holding) and B is a trading unquoted company. At the date of transfer the shares are worth £200,000. CGT hold overs (after retirement relief) and BPR lead to no tax arising on the transfer. In 2020, George dies when the shares in the trust are now worth £1.5million. As this is more than 7 years after the trust has been created there are no IHT or CGT implications whatever assets are currently held within the trust. In 2030, the trust comes to an end and the assets vest absolutely in the beneficiaries. At that time there would be no taxation problems assuming B Limited remains a trading company. If the assets no longer qualify as unquoted trading company shares, CGT may be a problem.
Given that both the children are now over 40 and are mature and responsible, unless further tax planning is undertaken, the first charges to capital tax would potentially be on the death of the beneficiaries which is likely to be around 2080.
(b) George goes on a year and sets up a discretionary trust in 1998 for the benefit of his wider family which contains another £200,000 of shares in B Limited. In 2007 (i.e. just before the first principal charge) the shares have accelerated in value and are worth £500,000. However they have also produced through buy backs of shares, dividends etc other assets of £250,000 i.e. in excess of the nil band. Rather than pay IHT a trust "bust" is effected and the shares and some of the assets are appointed out into an A&M trust for some of the grand children - no IHT arises on the appointment as it is to an A&M settlement and in any case the trust rate is still zero and no CGT arises because the trustees remain the same for both settlements. On the grand children reaching 25 the appropriate life interest would accrue and the same pattern as the above example is achieved.
(c) George invests his dividends received from B Limited wisely into a small property investment company. B Limited has a pension fund which provides a death in service benefit of £500,000. George therefore considers setting up an A&M settlement for his grand children whose sole asset is the right to receive the death in service benefit from the company. At George's death, the investment company is now worth £450,000. His will leaves the company to his spouse in its entirety thus eliminating any inherent gain in the shares through the Section 62 uplift on death. The trust can then use the funds produced by the death in service policy to purchase the company from the widow and hold it in an effectively tax free pot until the asset needs to be sold at which time a 24% CGT rate could arise.
One further point about A&M settlements, set up by the grand parent, is that they are not caught by the FA 1991 rules with regard to overseas settlements. If care therefore can be taken to avoid or eliminate CGT on their creation an offshore A&M settlement could be a very valuable tool for holding an asset which is expected to increase rapidly in value. Overseas trusts are however going to be dealt with in later articles and the point is not fully dealt with here.
Conclusion
The A&M settlement, as has been demonstrated above has many uses in the estate planners toolbag where a client is sufficiently wealthy to make life time gifts. The current tax advantages may well be cut back by future administrations (of whatever complexion) but it is unlikely that the tax breaks relating to A&M settlements would be removed altogether due to their unique nature.
Robert Trunchion, Director, MacIntyre Advisory Services, Equipoise House, Grove Place, Bedford MK40 3LE
