Writing for Taxation magazine, BKL tax adviser Terry Jordan answers a reader’s query on the tax consequences of transferring assets from one discretionary trust to another.
A discretionary trust was established in 2003 with a perpetuity period of 80 years and an accumulation period of 21. Its principal asset is a 38% holding of shares in a family investment company. There is a small cash balance.
The shares have accumulated a significant capital gain.
The class of beneficiaries includes the grandchildren and remoter descendants of the settlor and their spouses. The default trust is for the settlor’s great-granddaughter absolutely who is severely disabled. The trustees are the daughter, now aged 74, and granddaughter-in-law.
The settlor’s letter of wishes dated in 2003 directs that:
- the great-granddaughter should be considered the principal beneficiary during her lifetime;
- subject to this, the income and capital of the trust should be used for the benefit of the settlor’s grandson and his wife (who is one of the trustees) and their other children (they have a son);
- subject to this, residue is to the remaining class of beneficiaries.
The trustees want to avoid the possibility of trust assets passing into the hands of other grandchildren or remoter descendants under the third point above because they believe this would be contrary to the settlor’s wishes.
They have suggested transferring the existing trust assets to a new discretionary trust with the disabled great-granddaughter as the principal beneficiary and her brother as the sole remaining default beneficiary.
Do readers consider the letter of wishes empowers the trustees to distribute all the income and capital to the great-granddaughter and son or to a new discretionary trust?
If the trust deed permits a transfer to a new trust, we understand this would be exempt from inheritance tax, preventing a claim for capital gains tax holdover relief under TCGA 1992, s 260.
Can we establish a new trust, for the principal benefit of the great-granddaughter while mitigating any tax liabilities?
Query 19,197– Trustee
Reply by Terry ‘Lacuna’ Jordan, BKL
The most practical approach might be a trust variation
Letters of wishes do not normally have legally binding effect. Trustee is aware that capital gains tax holdover relief would not be available under TCGA 1992, s 260 if the assets of the existing trust are transferred to a new one. That is not strictly because the transfer would be exempt from inheritance tax as stated; it is because IHTA 1984, s 81(1) deems the original settlement to subsist and so no charge to inheritance would arise.
The shares could be appointed to a UK resident beneficiary in which case the gain arising could be held over under s 260 on election between the trustees and the beneficiary. However, even if the value was within the beneficiary’s inheritance tax nil rate band, the beneficiary would not be able to claim holdover relief on a transfer to a new trust because it would be settlor-interested and, further, it would be a gift with reservation of benefit.
Thus, the most practical approach will be to investigate how the existing trust might be varied. The starting point is always to see whether there is explicit power for the trustees to vary the original trusts contained in the settlement deed or will that created the trust.
If not, it may be possible to use the statutory power of advancement contained in Trustee Act 1925, s 32, which was originally limited to one-half of the beneficiary’s prospective entitlement to capital. This restriction has been removed by the Inheritance and Trustees’ Powers Act 2014, s 8 for trusts and will trusts created or arising on or after 1 October 2014. Note that this power does not allow the trustees to advance capital to a life tenant in the absence of specific provision in the relevant document, nor would it be of use here because the trusts are discretionary.
If the beneficiaries are all ascertained of full age and have mental capacity they can instruct the trustees in accordance with the rule in Saunders v Vautier (1841) 4 Beav 115. Again, this is unlikely in the present context.
If none of the above is possible, application can be made to the court under the Variation of Trusts Act 1958. The latter is not an approach to be taken lightly in view of the professional costs involved. For an interesting discussion of the principles, reference could be made to Pemberton v Pemberton  EWHC 2345.
The trust property is within the inheritance tax relevant property regime and a ten-year charge arose in 2013. Depending on values and on the premise that the great-granddaughter was disabled when the settlement was created, consideration might be given to converting the trust so that it qualified as a trust for a disabled person under s 89.
For more information, please get in touch with your usual BKL contact or use our enquiry form.