value of transfer to discretionary trust

by **djamieson** on Thu Sep 15, 2011 7:58 pm

Scenario - A is the sole owner of a house worth 300k. There is a mortgage of 100k secured over the house. A sets up a discretionary trust and transfers the equitable interest in the house to the trustees (there is nothing in the mortgage terms and conditions to prevent this).What is the value of this chargeable lifetime transfer ? As I understand it, as A has retained the legal interest in the house he also remains liable to his lender for repayment of the mortgage. However I also understand that as A, having transferred the equitable interest , is effectively a bare trustee in respect of the house he has a right of indemnity from the discretionary trustees in relation to the mortgage. Is this correct and if so does this mean that the value of the transfer to the discretionary trust is the value of the house less the amount outstanding on the mortgage, on the basis that while A's estate has been reduced by the value of the house , it has simultaneously been increased to the extent of the discretionary trustees' obligation to indemnify him in respect of the mortgage? Any comments would be appreciated, thank you.

by **maths** on Thu Sep 15, 2011 9:41 pm

There is nothing to prevent A settling his equitable interest in the property on a discretionary trust.

A would need to be excluded as a beneficiary, otherwise the gift would be a gift with reservation.

However, despite the settlement of the equitable interest, it does not automatically follow that the trustees agree to either indemnify A or agree to discharge the mortgage debt.

If the trustees take the property and agree to discharge the debt then the chargeable lifetime transfer effected by A equals the equity in the property (ie value of property less mortgage debt).

If the trustees take the property but do not agree to discharge the debt then the chargeable lifetime transfer effected by A equals the value of the property.

Irrespective of any arrangement between A and the trustees this does not affect A’s obligation under the borrowing from the mortgage company.

by **djamieson** on Thu Sep 15, 2011 10:07 pm

Thank you. I think you are saying that the discretionary trustees have no obligation to indemnify A .The contrary has been suggested to me, on the basis, I believe that A as the holder of the legal but not of the equitable interest is in the same position as a bare trustee ie he has the right to be indemnified by the beneficial owners , in this case the discretionary trustees.I wonder if you have any views on this?

by **maths** on Thu Sep 15, 2011 11:45 pm

indemnified by the beneficial owners , in this case the discretionary trustees.

The discretionary trustees are not the beneficial owners of the property transferred.

A has transferred the beneficial interest in the property to the trustees, not as beneficiaries, but to hold such property on trust (discretionary in this case) for the class of beneficiaries detailed in the trust deed.

by **djamieson** on Fri Sep 16, 2011 7:32 am

Could it not be argued that the discretionary trustees have an obligation to indemnify A to the extent of the value of the discretionary trust assets?

by **maths** on Fri Sep 16, 2011 2:19 pm

I would say, no.

A bare trust is one where the beneficiary has an absolute entitlement as against the bare trustee to all income and capital. Thus, if X declares he owns property as bare trustee for Y and after that date X purchases and sells a property any capital gain is that of Y not X ie everything X does is effectively deemed to be the actions of Y.

In your case, A has transferred the beneficial interest in the property to discretionary trustees (DT) but A has retained the legal title. DT have an absolute entitlement to the income and capital as against A; thus if A sold the property any gain would be that of DT.

However, A cannot force DT to accept the property subject to the mortgage unless DT agree. If the property is transferred and DT does not assume liability for the mortgage A cannot thereafter look to DT for indemnification.

I'm not sure what's behind your arguments?

by **djamieson** on Fri Sep 16, 2011 2:56 pm

Thank you , I am not trying to argue for or against the right to be indemnified , I am just trying to understand the logic behind the calculation of the value of the transfer to the discretionary trust

by **maths** on Fri Sep 16, 2011 3:16 pm

Say property worth 500 and debt 350.

It seems to me that the chargeable lifetime transfer for IHT would be as follows:

Property transferred to trust but trustees do not accept the liability:

transferor's estate would following the transfer have been reduced by 500.

Property transferred to trust but trustees do accept the liability:

transferor's estate would following the transfer have been reduced by 500 (ie the property) but the transferor's liability of 350 has in effect become that of the trustees (ie transferor is indemnified) and thus net loss is 150.

by **djamieson** on Sat Sep 17, 2011 10:11 am

Thanks.So if A is setting up a lifetime discretionary trust in order to protect his assets, including a mortgaged property , from eg care costs (I am satisfied as to the effectiveness of the dt for this purpose) if he wants to make full use of his available NRB and avoid lifetime IHT on the transfer to the trust he should oblige the trustees to indemnify him in respect of the mortgage to ensure that only the net value of the property is included in the value of the transfer.In this case the mortgage is on an equity release basis so presumably when the house is eventually sold by the discretionary trustees they will simply fulfill their obligation to A by redeeming the ER from the sale proceeds and that will be that. I appreciate that the IHT position would not be so straightforward if the mortgage was capital and interest repayment as presumably the repayments would in practice continue to be paid by A and if he did not seek recovery from the discretionary trustees that in itself would constitute a CLT by A, but in the case of an ER mortgage that wouldn't seem to be a problem?

by **maths** on Sat Sep 17, 2011 7:31 pm

As in my earlier post, the trustees cannot be forced to accept the property encumbered with the attaching charge.

In order for them to accept the property they would need to examine the conditions of the mortgage and satisfy themselves that the trust cannot be exposed (eg if the debt on death could exceed the value of the property) etc.

IHT and CGT would need to be considered.