Where assets are subject to a discretionary trust as defined, there is a once-off 6 percent charge and an annual charge after that. Tax applied on the date when assets become subject to a discretionary tax [in the sense defined) at the date of death of the person creating the will/trust or when, if later, that date on which there are no so-called principal objects over the age of 21.
The first once-off tax charge becomes payable in respect of the deemed disposition in respect of the discretionary trust assets. This is the date of the inheritance or the valuation date in the above sense, whichever is later. The valuation date in respect of the subsequent annual charge is the last day of the year. It applies in respect of assets within the scope of the discretionary trust as on that date.
A discretionary trust, for gift and inheritance tax purposes, has a different meaning to its general meaning. Under a true discretionary trust, the beneficiary has no entitlement to assets unless and until they are appointed from the trust. He may be a potential beneficiary, but he has no entitlement to anything more than a general right to be considered. This is a true discretionary trust.
For inheritance tax purposes, a discretionary trust is defined as a trust or other arrangement whereby no person has a beneficial interest in possession. A beneficial interest in possession is an immediate and present right to the assets or their income.
A trust may allow funds to be accumulated until a certain age. In this case, there will not generally be an immediate entitlement to possession. Once the assets are appointed, however, they are held for the benefit of a particular beneficiary and they cease to be held within a discretionary trust. On this occasion, the recipient becomes beneficially entitled and an inheritance or gift tax liability may arise.
There must be a present right of enjoyment. It appears to be sufficient that there is a present right to enjoy the whole of the income in the assets concerned. This is so notwithstanding that the capital may not be vested or no person has an immediate right to it.
Discretionary trust tax operates by there being deemed to be an inheritance by the trustee or equivalent of the assets the subject of the trust, i.e. in respect of which there is no interest in possession. See the section in relation to the valuation date in relation to the date upon which the initial 6 percent discretionary trust tax arises.
The principal objects as defined must be over 21 years of age. The principal objects mean the objects of the trust who are spouse and civil partner of the disponer, child of the disponer, child of a predeceased child. It includes children of a civil partner [or spouse] of the disponer.
In strict terms, the discretionary trust may arise after the estate has been administered or the assets are ascertained. However, the legislation deems the property to be the subject of the discretionary trust at the date of death when a discretionary trust is created under a will. This prevents an argument being made that the assets are not the subject of the trust until administered or until the valuation date arose.
The trustees are deemed to take an absolute interest in the trust assets at the valuation date. The general principles applicable to market valuation applies to the assets, the subject of the discretionary trust.
Future interests and interests in expectancy are not subject to gift or inheritance tax and discretionary trust tax until they vest in possession. Although there is no person in immediate possession of the future interest, it is wholly outside the charge to tax and discretionary trust tax. This follows as it is incapable of being appointed or accelerated. This is consistent with the general principles and the policy of the inheritance tax legislation.
Interaction of One-Off and Annual Charge
If the initial 6 percent charge is paid once, it is not payable again on the same assets if they subsequently fall back into the trust. The obligation to account for and pay the tax lies principally on the trustee. A beneficiary for whom trust assets are applied may also be liable.
There is a refund of the 3 percent of the 6 percent charge if the asset is vested within five years of the date of death of the disponer, the date of death of the relevant life tenant or the date of which the youngest principal object attains 21 years of age. The appointment must be absolute.
The 1 percent annual tax does not apply in the year in which the initial tax is charged or within one year of that date. The same rules apply in respect of valuation as apply generally. The trustees must make a return and are primarily accountable. The same exemptions as those mentioned above apply. The provisions for business and agricultural relief do not apply to the annual charge.
The charge is at the rate of one percent. There is provision whereby the Revenue may accept values and hold them for three years to ease the administrative burden. This is applicable where the property is subject to the annual charge and each of the relevant date in the following two dates. However, if there is fraud or misrepresentation or a change in the nature or structure of the assets, the asset may be revalued.
The same general principles in terms of interest, overpayment, penalties etc. apply as apply to mainstream inheritance tax.
No credit is given in respect of discretionary trust acts against mainstream CAT.
Finance Act 2012 extended the 6 per cent initial charge and the 1 per cent annual Discretionary Trust Tax to entities known as ‘‘foundations’’. It also ensures that property will be treated as being subject to a discretionary trust on the date of the disponer’s death where such a discretionary trust is created in his or her will. The amendment applies on and from 8 February 2012.
Modernisation and Payment
Consequential on the modernisation of CAT in 2010. The changes include clarification that the 4-month period of grace continues to apply to Discretionary Trust Tax, the abolition of the provision dealing with the apportionment of benefits taken on the same day and changes the method of how payments on account of CAT are to be dealt with. The amendment applies on and from 8 February 2012.
Powers of Appointment
Finance Act 2012 related to dispositions involving powers of appointment. The amendment ensures that the disponer will be treated as the original settlor and the disposition will be treated as the original settlement where the exercise of, the failure to exercise, or the release of, a general power of appointment form part of an arrangement whose sole or main purpose is the avoidance of CAT.
The Act ensures that the 6 per cent and 1 per cent charges imposed on certain discretionary trusts will not be prejudiced where the grant of a general power of appointment forms part of an arrangement whose sole or main purpose is the avoidance of CAT. The amendment applies to gifts and inheritances (including inheritances taken by discretionary trusts under section 15(1) or section 20(1) of the Act) taken on or after 8 February 2012.
There are a number of exemptions from discretionary trust tax.
- public and charitable schemes,
- registered unit trusts,
- pension schemes,
- trust for incapacitated persons; they must be incapable of managing their affairs because of age, improvidence or physical or mental or legal incapacity.
- trusts of the benefit of certain houses and gardens which are certified and accepted by the Revenue to be of national, scientific, historic or artistic merit; conditions must be met in respect of continued access.
- gifts and inheritance to the state
- free use of a property for the benefit of the trustees.
McMahon Legal, Legal Guide Limited and Paul McMahon have no liability arising from reliance on anything contained in this article nor on this website.