14th July 2016
How to Calculate IHT on Relevant Property Trusts
A recent request from a customer was to discuss relevant property trusts and the type of question that could come up in an exam. This will be of interest to those revising for the CII AF1 exam.
Firstly, let’s be clear that ‘relevant property trusts’ are discretionary trusts and most lifetime trusts created on or after 22 March 2006.
A common question that comes up in the Advanced Financial Planning on tax and trusts (AF1) is the inheritance tax on relevant property trusts. An AF1 student will be expected to know how to calculate the IHT; whereas, an R03 student will generally just be expected to know the theory.
When the trust is created, this is classed as a chargeable lifetime transfer, and if the settlement is over the nil rate band (or the cumulative amount is), 20% tax is payable upfront. If the settlor dies within 7 years, there may be further tax to pay; although, taper relief will be available after 3 years to reduce it.
A Typical AF1 Exam Question
Exit charges and periodic charges may also apply. Let’s look at a typical AF1 exam question.
‘A discretionary trust is set up 10 years ago. The initial value of the trust was £200,000, and the value 10 years later is £400,000. Calculate the periodic charge’.
We are told that the value at the 10th year is £400,000. From this value, we can deduct the nil rate band of £325,000. This leaves us with £75,000. The periodic charge is calculated as 30% of 20% (20% is the lifetime rate) or 6%. £75,000 x 6% = £4,500. The effective rate of tax is calculated by dividing £4,500 by the value of the trust £4,500/£400,000. This works out as 1.125%.
If one year later (11 years after the trust is created), we assume that the trustees give one of the beneficiaries a capital sum of £80,000, this will trigger an exit charge. The exit charge is calculated as a percentage of the value of that capital distribution.
Written by Brand Financial Training
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