UK: Reforming Calculation Of Inheritance Tax On Trusts: From Simplification To Fairness?

Last Updated: 17 July 2014
Article by Lyndsey L.M. West

HMRC Revenue and Customs ("HMRC") has published the results of its third consultation on simplifying the inheritance tax ("IHT") treatment of discretionary trusts. 1

The proposals are also relevant to most non-discretionary trusts if they were established on or after 22 March 2006.

Under the existing rules the above trusts are liable to an IHT charge every ten years on the value in the trust. There are also IHT "exit" charges on capital distributions. Under the proposals these charges still apply but the way in which they are calculated will be simplified as follows

  • each individual will have a so-called settlor's nil rate band ("SNRB") to allocate to any trusts that they establish
  • it will no longer be necessary to gather historical information about the settlor's IHT position and that of all trusts established by him/her
  • the basis of the IHT charges will be a flat rate of 6%

HMRC's stated aim is simplification. Whether the reform will increase or decrease the IHT payable will vary from case to case.

The new SNRB is available to settlors only for trusts established or funds added to existing trusts after 6 June 2014. Such settlors must ensure that they take account of the future availability of the new SNRB. In other cases the old rules still apply for establishing the amount of the personal nil rate band ("NRB") available to any particular trust when calculating anniversary and exit charges. 2

This briefing is based on the Government's consultation document. More detail about how the proposee rules will work in particular cases will be available when the draft legislation is published in the autumn.

Which trusts are affected?

The simplification proposals relate to so called "relevant property" trusts. These are basically:

  • discretionary trusts (i.e. trusts under which trustees may distribute income and capital at their discretion) whenever established
  • certain other kinds of trusts, for example, interest in possession trusts under which beneficiaries are entitled to receive income, set up on or after 22 March 2006 (but excluding certain such trusts set up in wills).

Objectives of the proposals

After the initial establishment of a relevant property trust, IHT is payable on two kinds of occasion.

  • First, IHT is due on every ten year anniversary of a relevant property trust. The maximum rate is 6% although lower rates in practice often apply based on a complex calculation as set out in the IHT legislation
  • IHT is payable on capital distributions out of a relevant property trust. Again the maximum rate is 6% with a lower rate of tax usually applicable in practice.

Under the present rules, in order to calculate anniversary and exit charges trustees have to take into account various different kinds of historical information in order to establish the applicable rate of IHT including:

  • chargeable transfers made by the settlor within seven years before the date of the Settlement
  • the value of the settled property immediately after the settlement commenced
  • the length of time for which property has been comprised in the settlement at the date of charge
  • the value of the property which has left the settlement since the last ten year charge
  • the historical value of the property in any so-called "related settlements", that is settlements established on the same day by the same settlor.

Calculation of the IHT under the current rules can be highly complex. The objectives of the proposal are to simplify the information which trustees must gather to calculate the IHT charges and also to simplify the IHT calculation itself. At the same time HMRC wishes to avoid the risk of settlors being able to fragment their property across a number of different settlements, each with their own NRB, resulting in a lower rate of tax on each trust.

A new "settlor's nil rate band"

The solution for simplification proposed by HMRC is for each settlor to have a settlor's nil rate band ("SNRB") available to be allocated to and between any trusts which they establish. The amount of the SNRB will be the same as the amount of the personal NRB which is currently £325,000. The SNRB would be in addition to, and independent of, the personal NRB which would still be available for gifts. The SNRB would apply only for the purpose of calculating IHT on anniversary charges and exit charges of relevant property trusts.

Settlors wishing to allocate their SNRB to their trusts would need to make an election to specify in percentage terms how much of their SNRB should be allocated to each trust. Any change made by the Government in the amount of the personal NRB (which currently stands at £325,000) would automatically feed through to the SNRB available to any trust to which an allocation had been made. Such an allocation by the settlor would usually be permanent and could not be altered However, an SNRB would become available again, having previously been allocated, if the trust to which it had been allocated were wholly wound up during the settlor's lifetime. In that case the settlor could reallocate the SNRB to other settlements that they had made. There would be no renewal of the SNRB every seven years (by contrast to the seven yearly renewal of the personal NRB).

If the settlor fails to make an election by the time of an event giving rise to an IHT charge in relation to the trust, then the trustees would be obliged to calculate any IHT due on the basis that no SNRB is available for the trust in question.

Death of the Settlor

On the settlor's death, the personal representatives could elect to allocate any unused SNRB to settlements created by the will (they would have two years to do this) or to make sure that the deceased's SNRB had been fully allocated between settlements made during the settlor's lifetime and on death.

Additions to existing settlements From 7 June 2014, any new funds added to a trust in existence at that date would be treated as a separate fund within the settlement for purposes of the new rules. After the legislation is in force, the settlor may allocate part of his/her SNRB to additions made to such trusts. When do the new rules apply?

The SNRB will apply for the purpose of calculating ten year anniversary and exit charges from 6 April 2015 but will be relevant to:

  • trusts created after 6 June 2014;
  • funds added after 6 June 2014 to existing trusts; and
  • settled funds affected by changes made after 6 June 2014 to existing settlements as a result of which relevant property comes into being, as where for example, a life interest in possession settlement created before 22 March 2006 is amended by the trustees so as to become a relevant property trust.

By applying the new rules to trusts and additions made after 6 June 2014, HMRC aims to prevent settlors from fragmenting their property between several trusts each of which may have an NRB, as is possible in some circumstances under the existing rules. Settlors will need to allocate their new SNRB to such settlements on or after 6 April 2015 so that future relevant property charges can be correctly calculated. However, any tax charges arising before 6 April 2015 but in respect of settlements or additions made after 6 June 2014 will be calculated in accordance with the current rules.

Trusts already in existence retain their existing personal NRBs. From 6 April 2015 settlors may allocate a full SNRB in relation to any new settlements (and additions to preexisting settlements) they make regardless of how many existing trusts they have and the personal NRBs that those trusts have to take forward under the new rules.

What IHT rate applies?

The IHT charge on ten year anniversaries and exits will be based on a new flat rate of 6%. This contrasts to the current position in which the tax rate is calculated by reference to a so-called "hypothetical transfer" which depends on various factors including the historical IHT position of the trust, and the settlor's previous transfers as well as the historic value of related trusts.

Under the new rules the flat rate of 6% will be adjusted downwards for any particular ten year anniversary or exit, for example, to take account of allocation by the settlor of all or part of his/her SNRB to the trust in question or the length of time for which property has been held in the trust.

It appears from the consultation document that the new flat rate of 6% will be relevant to ten year anniversary and exit charges on all trusts from April 2015, including for trusts established or funded on or before 6 April 2014.


Although the reform is billed as a simplification, in certain circumstances it will create more complexity than the existing rules. This is particularly the case for existing trusts to which funds are added after 6 June 2014 since they will become subject to two different IHT regimes. Perhaps with this in view, the new consultation is framed in terms of "fairness" rather than of "simplification". However, there is an asymmetry between the rule for the personal NRB, which is renewable every seven years, and the rule for the SNRB relevant to calculating ten year anniversary and exit charges, which is not so renewable.

Even though settlors will not be able to allocate the new SNRB until 6 April 2015, it will be important for settlors establishing new trusts or making additions to existing trusts to take account of the new rules to ensure that any future SNRB is utilised as fully as possible.

Following publication of draft legislation, expected in the autumn, it will be possible to advise with greater certainty on the effects of the new rules in particular cases.


1 The consultation is entitled "Inheritance tax: A fairer way of calculating trust charges" (6 June 2014). An earlier consultation resulted in new rules for the taxation of undistributed income held within discretionary trusts: see our briefing entitled "Do discretionary trustees need to act on undistributed trust income?" (March 2014).

2 The NRB is the part of any chargeable transfer on which IHT is due at 0%. The amount of NRB (and under these proposals, of SNRB) available to discretionary trusts and to most other trusts established since March 22 2006 affects the amount of IHT due in respect of ten-yearly anniversary charges and capital distributions.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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