A more recent version of these Discretionary Trusts notes – written by Cambridge And Oxilp And College Of Law students – is available here.
The following is a more accessble plain text extract of the PDF sample above, taken from our Private Client Notes. Due to the challenges of extracting text from PDFs, it will have odd formatting:
Discretionary trusts 1) Advantages and disadvantages of discretionary trusts
Allows for the needs of beneficiaries changing over the years
2) Can be express how estate is distributed through a letter of wishes
Letter of wishes is not legally binding but gives guidance as to how the trustees should distribute capital and income
For a lifetime discretionary trust settlor can also be trustee
3) Can provide for future beneficiaries who are not yet alive (e.g. future grandchildren)
4) Can name a substitution class as a backup beneficiary where all beneficiaries have died before trust is wound up
E.g. A charity
5) Assets aren't class as belonging to the beneficiary
This is useful for bankrupt or divorcing beneficiaries
6) Quite favourable tax regime
1) Lack of certainty
Beneficiaries do not know what they will receive or when they'll receive it
2) Letter of wishes is not binding on the trustees
1 2) Types of discretionary trust
1) Lifetime settlement
a) Favourable tax treatment
b) Can control the beneficiaries' spending a? Letter of wishes
c) Consider whether client has sufficient assets to make the gift
d) Often used for holiday homes. However settlor must pay rent to avoid a reservation of benefit under s.102 Finance Act 1986
1) A discretionary trust of residue
a) The residuary estate is held on trust with the power to apply capital or income amongst a wide group of beneficiaries.
b) Useful for beneficiaries with personal issues (divorce / bankruptcy) as they are not treated as owning the assets.
c) Can control the beneficiaries' spending a? Letter of wishes
2) A two year discretionary trust of residue
a) Takes priority over the gift of residue by allowing the trustees to redirect all or part of the residuary estate, within 2 years
b) Dispositions over 3 months after death but before 2 years are deemed to have taken place on death under the deceased's will for IHT
c) The conditions in s.144 IHTA 1984 must be satisfied:
1) There must be no interest in possession subsisting in the settled property; and
2) An event occurs within 2 years of the testator's death that would otherwise lead to a inheritance tax charge
E.g. A distribution from a 2 year discretionary trust within 2 years of death where there would usually be an exit charge
d) If the conditions are met there will be no exit (IHT) charge
e) There is no equivalent rules for CGT so distributions from this 2 year discretionary trust will be treated as taxable disposals
3) A discretionary trust legacy
a) Were common before introduction of transferable nil rate band
b) First to die leaves an amount equal to the nil rate band to the trustees with power to apply capital or income amongst beneficiaries (family).
2 3) Other considerations
1) Who are the parties to a lifetime settlement of a discretionary trust?
The settlor and the trustees
What is the rule against perpetuities?
a) A private trust cannot be perpetual
b) A trust must end and the capital vest in a beneficiary within a limited period of time
What is the perpetuity period?
There is a 125 year perpetuity period - The Perpetuities and Accumulations Act 2009
What is the meaning of accumulations?
a) When trustees do not pay income to beneficiaries
b) The retained income is said to be accumulated
What is the accumulation period?
4) Retirement / death of trustees
The entire lifetime of a trust, which will be a maximum of 125 years (the perpetuity period) - The Perpetuities and Accumulations Act 2009
a) The choice of a new trustee rests with the continuing trustees
- s.36 Trustee Act 1925
b) This can be altered by the trust instrument
5) Trustees exercising powers relating to land
- s.11 Trusts of Land and Appointment of
a) When dealing with land, the trustees must consult any beneficiaries:
Of full age; and
Beneficially entitled to an interest in possession
Trustee Act 1996 b) So far as is consistent with 'the general interest of the trust' trustees must give effect to the wishes of the beneficiaries or where there is a dispute, give effect to the majority
c) It is common for the trust instrument to exclude this power
6) Beneficiaries removing and changing trustees - s.19 Trusts of Land and Appointment of Trustee Act 1996
a) A beneficiary can direct trustees to retire and appoint new specified replacement trustees if the beneficiary is:
Sui juris; and
Entitled to the whole beneficial interest
3 b) It is common for the trust instrument to exclude this power
4) Taxation of discretionary trusts
a) Creation of the discretionary trust Settlor a? Trustee
Creation of a lifetime (inter vivos) discretionary trust
1) This is an LCT - ascertain its size
2) Deduct lifetime exemptions
AE PS3000 x 2 = PS6000
PS500,000 - PS6000 = PS494,000
1) Family maintenance
2) Spousal exemption WORKED EXAMPLE
3) Annual exemption
Hazel, (single) always makes use of her AE! She transfers PS350,000 to a discretionary settlement in Feb 2015. The trustees pay the IHT due as a result of the transfer.
- NRB available so only PS5,000 in lifetime. (PS25k in excess of NRB is chargeable) LIFE = 20%
4) Small gifts
5) Normal expenditure out of income
6) Gifts in consideration of marriage / civil partnership
She dies on 6 January 2020 with a death estate of PS200,000.
7) Charity exemption
The trust fund is now worth PS400,000. 8) Business property relief
How much IHT will the trustees of the discretionary settlement will pay as a result of Hazel's death?
9) Agricultural property relief Tax 40% on PS25k is PS10k BUT Hazel survived 4/5 years from date of transfer so tapering relief is 60% =
This amounts to PS6,000.
3) Deduct unused nil rate band
PS494,000 - PS325,000 = PS169,000
Credit is given for the tax paid originally so LESS PS5,000 = PS1,000 4) Tax at 20% immediately on disposal into trust
PS169,000 x 0.2 = PS33,800
5) If dies within 7 years, reassess at 40%
PS169,000 x 0.4 = PS67,600
6) Apply taper relief for relevant number of years
3-4 years = 80% of original figure
PS67,600 x 0.8 = PS54,080
Transfers with 6-7 years before death 20% of death charge
7) Give credit for tax already paid at 4)
PS54,080 - PS33,800 = PS20,280 tax to be paid
If the tax already paid is greater than the tax to be paid, i.e. the figure is negative, the tax man does NOT give a rebate, there is simply nothing to pay
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