Winding Up A Trust

[bruntsfield]

My mother has a life interest in a Trust, and on her death the Trust fund passes to me and my two sisters absolutely (we are all over 18).

We all want to wind up the Trust, but how do we calculate the capital sum due to my mother (who is age 66)?

[maths]

Effectively you are suggesting a partition of the trust fund.

The three of you can agree whatever values you want or alternatively an actuary may be instructed to carry out formal valuations.

[bruntsfield]

But isn't it important to get a proper value because the amount left after payment to her would be regarded as a gift from her to us?

[maths]

I assume that we are talking about a pre 22nd March 2006 interest in possession.

Assume that the trust property in which the interest subsists is worth £50,000.

Assume that on partition mother gets £10,000 and you £40,000.

Your mother will be treated as making a PET of £50,000 less £10,000 ie £40,000.

Whether any IHT liability arises should she die within 7 years depends upon the availability of her nil rate band.

Any liability would be that of the trustees.

[bruntsfield]

OK. But aren't HMRC interested in the true value gifted rather than what was agreed? In the example you give, the true value of my mother's interest might be £7,500, in which case HMRC would want to treat £42,500 as the gift if she died within 7 years.

This is important because in fact the fund is worth about £400,000 (it includes a house - not her main residence).

[maths]

Your mother has a life interest in trust property worth, say, £400k.

If she died £400K would be treated as part of her estate and IHT levied.

A. On partition if she receives £100K then the balance of £300K is a PET.

B. On partition if she receives £300K then the balance of £100K is a PET.

The trustees could terminate (if they have the power) her interest and appoint the capital out to the remaindermen. In this case the PET would be of the £400K.

In short the parties can agree the split.

However, an actuarial valuation would ensure strict fairness between the parties.

[bruntsfield]

Maths - I think you're missing my concern

I accept that we could agree any amount we want to, but as the amount left to the remaindermen is a PET surely HMRC will want to know the true value of that if my mother died within the 7 years.

So my question is - how do we calculate a true value for each share. You mentioned an actuarial valuation, but do you know roughly how it would be calculated - the cost of an annuity, perhaps?

[Lee Young]

Bruntsfield

I think the point that maths is trying to explain is that it is the amount that the life tenant gives away that is crucial to the inheritance tax computations.

How you work out the division is a choice between coming to an agreement over the split that everyone is happy with or an actuary assessing what the capital value of the life interest is and coming to what would then be considered to be a fair division bearing in mind life expectancies etc.

However that decision is made, the life tenant previously enjoyed a life interest in the whole, and now has received a part free from the trust. The part that the life tenant has not received, ie the bit that goes to the remaindermen, is the bit "given away" for inheritance tax purposes. It is that amount that will sit in the estate for 7 years and then fall away. The bit retained will get caught when the life tenant dies because it is now in the estate

[bruntsfield]

I fully understand how the PET works. My point is that, for example, the Life Tenant and remaindermaen agree an amount of £350,000 to the LT and £50,000 to the remaindermen. Then the LT dies within 7 years - is HMRC going to accept a value of £50,000 or are they going to insist on a proper value, even though the remaindermen received only £50,000? In other words, as with CGT, are they going to argue the transaction took place at an undervalue?

[Lee Young]

Provided the overal amount in the trust (in your example) was £400,000 then the Revenue will be happy with the £50,000 gift caught within 7 y ears - remember the remainder of the trust, the £350,000 is still in the life tenwant's name and therefore also still caught for IHT. The Revenue have not lost out.