Bare Trust as IHT mitigation tool?

by Readers Question

9:57 AM, 11th November 2019
About 4 weeks ago

Bare Trust as IHT mitigation tool?

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Bare Trust as IHT mitigation tool?

I wonder if anyone could comment on this case.

Two sisters own an unencumbered (mortgage free) leasehold flat with share of the freehold on the residue of a 999-year lease, value approximately £1.2-1.5 million, in London as tenants in common. They are both retired and in their late 60s.

To mitigate inheritance tax, they are considering setting up two Bare Trusts, one for each, into which each will transfer their 50% ownership as donor for the benefit of the other.

Since the property is and has always been their only residence, they will be entitled to Private Residence Relief (PRS) and they envisage that there will be no CGT payable on transfer of the asset into a Bare Trust.

As it is their private residence there is no rental income generated therefore no income tax liability arises.

Since they will be transferring property assets into a Bare Trust, they understand that this will be considered Potentially Exempt Transfers (PET) and there will be no liability to IHT on set up and no IHT liability at 10 yearly intervals, as would have been the case with a Discretionary Trust. Should they survive 7 years then the asset in trust becomes IHT free on death of either and can pass to the surviving sister IHT free allowing her to continue living in the flat unencumbered.

Are their assumptions correct? Can a Bare Trust be used in this scenario or is it only a Discretionary Trust that can remove assets from an estate?

Any comments or suggestions welcome.

Frederick



Comments

Mark Alexander

15:00 PM, 11th November 2019
About 4 weeks ago

It is implied here that the beneficiaries of each bare trust will be the other sister. Please confirm this to be the case?

If it is, then both sisters will have gifted and received the same amount of beneficial interest in the property, thus, their net asset position will not have changed. This being the case, it would be a pointless exercise.

Example; sister one dies after say 7 years and one day. Sister two inherits the 50% of beneficial interest she holds on bare trust for sister one.

Iain

7:46 AM, 12th November 2019
About 4 weeks ago

I agree with Mark above, it would be a fruitless exercise and could in fact make the situation much worse.

Bare trusts are really only nominee arrangements and are transparent for tax purposes. So, the beneficiary of the trust owns the asset for IHT purposes.

This means that the sisters are simply swapping their shares in the property and face the same tax exposure on death.

Having said that, each sister will also have made a PET - so if either dies within 7 years of the arrangement then arguably there would be IHT on the share of the property held in trust for the deceased sister AND IHT on the failed PET.

It is very difficult to carry out IHT planning with the family home, and difficult, if not impossible, to prevent a charge to IHT on the death of the first sister in these circumstances. Alternative strategies might include down-sizing to a less valuable property or taking out life policies to fund IHT.

Iain

7:51 AM, 12th November 2019
About 4 weeks ago

Reply to the comment left by Iain at 12/11/2019 - 07:46
I forgot to add, even if there is no gift being made (i.e. there is a swap of the two shares in the property and therefore no gift for IHT purposes), you do then need to consider SDLT. Each sister is acquiring a half-share in the property, and giving their share in the property as consideration, thus SDLT would be payable on the transaction.

Frederick Morrow-Ahmed

12:20 PM, 12th November 2019
About 4 weeks ago

Many thanks to both of you, Mark and Iain, for your excellent and very informative comments. Mark, yes, the beneficiary of each trust would be the other sister.

Would the liability position be different if a Discretionary Trust was set up instead of a Bare Trust?

I know that DTs trigger a set up tax of 20% over the nil rate band and 10-yearly taxes of 6%, followed by another 6% exit charge, but are they a different structure to Bare Trusts?

Many thanks again.

Mark Alexander

13:34 PM, 12th November 2019
About 4 weeks ago

Reply to the comment left by Frederick Morrow-Ahmed at 12/11/2019 - 12:20
Yes, Discretionary Trusts are very different to Declarations of Trust, as are Life Interest Trusts

The specialist firm we refer this work to is Heritage Law in Norwich. If you contact them, please mention my name. We often refer work to each other on a ‘Grace and Favour’ basis, so it is important to us both to understand where the work is coming from. The person I suggest initial contact with is Kathy Long - Tel 01603 894500

The setup cost of a discretionary trust only, including drafting, is circa £550 + VAT. This includes fully insured, regulated advice.

The sisters should also talk to this company about Life Interest Trusts, Wills and Lasting Powers of Attorney.

Frederick Morrow-Ahmed

14:31 PM, 12th November 2019
About 4 weeks ago

Reply to the comment left by Mark Alexander at 12/11/2019 - 13:34
Many Thanks Mark, I will pass it on

Iain

14:31 PM, 12th November 2019
About 4 weeks ago

Reply to the comment left by Frederick Morrow-Ahmed at 12/11/2019 - 12:20
Yes, the position would be different under a discretionary trust but I wouldn't recommend using one without getting specialist advice.

Firstly, there would be an immediate charge to IHT of at least £170,000 (assuming the property is worth the upper end of your range of values).

Secondly, there would be anniversary and exit charges in respect of the trusts. You can expect these to amount to around £50,000 every 10 years.

Thirdly, you lose the capital gains tax uplift on death although principal private residence relief is still usually available if the beneficiary of a trust occupies trust property.

Fourthly, the sisters would lose the benefit of the residence nil rate band - costing a further £140,000 in IHT (unless the gift also happens to be a gift with reservation of benefit - see below).

Fifthly, there is a serious risk that in any event the gift would be a gift with a reservation of benefit. If so, this would do nothing to reduce the liability on death, but you would still have anniversary and exit charges, and potentially higher CGT overall. There are possible routes out of the GROB provisions but the facts are complicated here. You also need to consider Pre-Owned Assets Tax.

In short, I'm sceptical that the arrangement as envisaged would work, but it may be worth seeking paid advice to confirm one way or the other.

Frederick Morrow-Ahmed

14:40 PM, 12th November 2019
About 4 weeks ago

Reply to the comment left by Iain at 12/11/2019 - 14:31
I think you have written an admirable thesis on the subject and the conclusion is summed up in your first comment:
"It is very difficult to carry out IHT planning with the family home, and difficult, if not impossible, to prevent a charge to IHT..."

Thanks a ton! I hope this helps other readers with similar questions on the topic of Trusts.

Mark Alexander

14:56 PM, 12th November 2019
About 4 weeks ago

Reply to the comment left by Frederick Morrow-Ahmed at 12/11/2019 - 14:40
The following is entirely conceptual and must not be regarded as professional advice.

What if the sisters were to take on a huge dent and to invest the money into a life insurance based bond which was written into trust for each other? Maybe there is a Private Bank out there which could secure the debt against both the property and the bond and use the projected proceeds from the bond as justification for serviceability of the debt?

Such advice would probably need to be considered unregulated on the basis of 'high net worth' status.

Do we have any IFA's who might wish to comment further?

Howard Reuben CeMap CeRER

15:52 PM, 12th November 2019
About 4 weeks ago

This is a matter for a tax adviser, however I also have a couple of notes, too.

Firstly, because of the additional IHT relief for main residence (https://www.gov.uk/government/publications/inheritance-tax-main-residence-nil-rate-band-and-the-existing-nil-rate-band/inheritance-tax-main-residence-nil-rate-band-and-the-existing-nil-rate-band) I think (if this can indeed be applied) then the sum is;

£1.5m (higher value used as 'worst case scenario')
divide by 2 (each sisters share)
= £750K

£750K - £325K (nil rate) - £150K (19/20 - additional rate) = £275k.

£275k x 40% = £110k. = IHT liability

And so it's the £110k which needs 'repaying' / protecting.

(ps the £150k relief is increased to £175k for the 20/21 tax year)

There are so many ways to reduce / mitigate / eradicate and also repay this sum, and here is another one;

* whole-of-life life insurance policy, written in to Trust, for £110k, for a non smoking 'late 60's' person, could be arranged at a (standard rate) monthly premium of approximately £300pm.

For a 59 year old £180pm
For a 49 year old £125pm
For a 39 year old £85pm

And WOL life insurance policies are extremely flexible so as regular reviews are carried out and adjustments to sums assured are required, it's simply an internal amendment and no fees or professional charges are necessary. In fact, we don't charge to set them up in the first place either.

Now, for some people, the immediate thought is that £300pm (for a 'late 60s' policyholder) is a lot of money. However, the actual fiscal balance is > pay out £110,000 (at any time from today onwards) .... or £300pm. If - in the worst possible situation - the lady died one day after the policy started, all that has been paid out is £300. And in return, her Trustee would then have the full £110,000 to pay the tax man.

Insurance is a risk and there are balances to consider.

So, this is just another option, in addition to the estate planning Trusts, loan arrangements, investment bonds, etc.

The above is not personalised advice but simply a generic overview of possible options (which will only be formalised after our Advisers have carried out a proper Fact Find, received the specific IHT tax liability from a professional tax adviser, and we then provide recommendations and insured advice).

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