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Taxation Readers’ Forum: Insurance bond – discretionary trust tax

/ 18 August 2020

Terry Jordan

Writing for Taxation magazine’s Readers’ Forum, BKL tax consultant Terry Jordan responds to a reader’s query about managing the taxation of a discretionary trust.

‘A couple, both now deceased, set up a trust using a standard discretionary trust deed from the company with which they had invested some money in an onshore insurance bond.

The bond was one that terminated on the death of the second to die which occurred when the wife died this year. The husband had died four years before.

My interpretation of the tax position is that one half of the chargeable event gain will be taxed on the wife (as settlor of her trust) and the other in the hands of the trustees (of the husband’s trust). This will give the husband’s trust a fairly large tax liability and, after crediting the notional basic rate tax, the larger part of this tax liability goes into the ‘tax pool’.

However, given that the proceeds of the chargeable event gain are the sole asset of the trust and are capital in nature, it seems that one cannot distribute any of this money as income so as to use the tax pool efficiently.

Is there any alternative to this gloomy analysis which I suspect is not uncommon?’ Query 19,603 – Trustee.

Terry Jordan’s reply: Do not overlook inheritance tax ten-year or exit charges

‘If a policy is held on trust, the settlor will normally be chargeable if still available to charge. A settlor who dies may in some cases be chargeable on an event occurring after death, for example if the policy held by trustees is on the life of someone other than the settlor and continues following the settlor’s death. When a chargeable event occurs after a UK resident settlor’s death but before the end of the tax year, the gain will be chargeable as part of the total income of the deceased settlor for that tax year.

If the gain arises on an event after the end of the tax year in which the settlor died, the trustees will be taxed on the gain, subject to transitional provisions for policies in existence before 17 March 1998.

If the trust and the policy were in existence before 17 March 1998 and at least one of its creators was an individual and one of the creators died before 17 March 1998 then as long as the policy has not been varied on or after 17 March 1998 to increase benefits or extend its term, there is no charge on the trustees and no charge on the settlor provided the chargeable event occurs in a tax year later than that of the settlor’s death (ITTOIA 2005, Sch 2 para 112).

In the present case, as Trustee has identified, the husband is not ‘available’ to charge in respect of his settlement and the charge falls on the trustees. The tax payable goes into the tax pool but in practical terms would only be available to frank income distributions to beneficiaries and here the receipt of the proceeds is capital in nature.

With hindsight, it might have been better to have additional lives assured as well as the couple. In that case, the bond might have been assigned to the beneficiaries before encashment with perhaps a lower overall tax bill. Reference could usefully be made to Kevin Read’s article ‘In bond we trust’ (Taxation, 9 January 2014, page 18).

Depending on values, it may be necessary to consider the inheritance tax implications because the trust is within the relevant property regime of ten-year and proportionate or ‘exit’ charges.’

The article is also available on the Taxation website.

For more information, please get in touch with your usual BKL contact or use our enquiry form.

Terry Jordan

Senior Adviser, Private Client

T +44 (0)20 8922 9360
E terry.jordan@bkl.co.uk

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