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Capital Tax Review by Matthew Hutton MA, CTA (fellow), AIIT, TEP

Matthew Hutton MA, CTA (fellow), AIIT, TEP outlines the implications for existing and new ‘reverter to settlor’ trusts following the tax changes announced in FA 2006.

Context

The twin capital tax advantages of reverter to settlor trusts are as follows. For Inheritance Tax (IHT) purposes, there is an exemption from IHT under IHTA 1984 s 53(3), so that any appreciation in value in the trust property between entering and leaving the settlement escapes IHT. And, provided that the settlement continues and the property does not immediately vest outright in the settlor, there is the Capital Gains Tax (CGT) free uplift to market value on death accorded by TCGA 1992 s 72(1)(b). Where, however, the property vests outright, the settlor is treated by s 73(1)(b) as having taken the property at the trustees’ (indexed) base cost. The accepted wisdom therefore has been to have the property revert to the settlor on a life interest trust, with power to advance capital which the trustees would then exercise.

What is the effect of the new regime on the above structure?

While the CGT-free uplift will be achieved, there will be no IHT relief, as on the death of the life tenant the trust will enter the ‘relevant property’ regime. To secure the IHT relief, the property must vest outright, so losing the CGT-free uplift.

Most likely the IHT advantage would be preferable – except in a case where 100% Business Property Relief (BPR) or Agricultural Property Relief (APR) is available. However, this is one situation where urgent action might be required now, for example to change the terms of the trust so as to provide for the automatic entitlement to capital; once the life tenant has died, perhaps unexpectedly, it will be too late.

Application: is there any point now in creating a reverter to settlor trust?

Consider, for example, one traditional use, viz on father’s death (mother surviving) where he might leave his half of the house to his daughter who would then, subject to some caveats (eg bearing in mind IHTA 1984 s 143) make a reverter to settlor trust on her mother for life, remainder to daughter for life with power of advancing capital. Recognising that such a trust would enter the relevant property regime, it would still be effective both to ensure mother’s security of tenure and to facilitate the CGT relief for the trustees on selling at a gain under TCGA 1992 s 225, assuming always that mother is a person entitled to occupy for purposes of the Trusts of Land and Appointment of Trustees Act 1996.

There would be no question of a CGT-free uplift on her death, though the property could be sold shortly thereafter, with it is hoped the benefit of main residence relief and the proceeds advanced to the daughter. There would be no reverter to settlor exemption from IHT, even if an absolute reverter were provided in the trust, but the IHT cost should be zero if the exit happened within the first ten years and thereafter with only a small cost (if any) under the relevant property regime to the extent that the then value of the property exceeded the nil rate band at a ten year anniversary.

Matthew Hutton MA, CTA (fellow), AIIT, TEP
October 2006

More Information

The above article has been taken from Matthew Hutton’s Capital Tax Review, a quarterly update for professional advisers of private clients. For more information, visit http://www.taxationweb.co.uk/books/capital_tax_review.php.

About the Author

Matthew Hutton is a non-practising solicitor (admitted 1979), who has specialised in tax for over 25 years. Having run his own consultancy (latterly through Matthew Hutton Ltd) until 30th September 2000, he now devotes his professional time to writing and lecturing.