You do not have to be particularly wealthy or a business owner to make use of Will trust provisions to make tax savings and to protect assets into the future. Business owners and investors should however consider trusts to maximise the very generous reliefs that are available to qualifying businesses interests.

There are different types of trust – these can be set up in lifetime or take effect on death under the terms of the Will or a Deed of Variation within two years of the death.

Inheritance Tax and the Nil Rate Band

The UK Inheritance Tax threshold, or “nil rate band”, is the amount up to which an estate will have no Inheritance Tax to pay, currently set at £325,000. If the estate is more than the £325,000 threshold, Inheritance Tax will be due at 40 per cent on the amount over the nil rate band. This is subject to exemptions and reliefs and it is necessary to take into account trusts that have been established in lifetime, as well as gifts made within seven years of the death.

The nil rate band is transferable between spouses. More correctly, the executors of the second spouse can apply to have the unused proportion of the nil rate band from the first spouse available to the estate of the second spouse so that up to £650,000 may be available at current rates before tax is charged.

Setting up a Trust

A discretionary trust is one of the types of trust which can be set up in a Will and can be established for the whole or part of the estate. The Will can specify that it will be set up for the amount of the nil rate band (or such an amount as will not be charged to tax) and in this scenario there will be a tax saving when the assets held by the trust increase in value at a rate that outstrips the increase in the level of the nil rate band itself, so that the “increase” is outwith the estate of the surviving beneficiary, commonly a spouse.

For example, without a discretionary trust…

Janet died in July 2010 leaving her entire estate to her husband John. On John’s death his estate will be able to claim an additional nil rate band. Included in her estate was an investment property at £325,000. John dies in 2015 when the nil rate band is still £325,000 and the investment property is now worth £400,000. Therefore, at the time of Janet’s death the investment property was within her nil rate band, but by the time of John’s death its value has increased by £75,000 – an increase not matched by an equivalent increase in the level of the nil rate band/allowance. Accordingly, without the nil rate band trust arrangement, tax at 40 per cent may be charged on the £75,000 increase – a potential tax bill of £30,000!

In contrast, with a discretionary trust…

If Janet’s Will had put her property into a discretionary trust under which John and their children could benefit, the trust would “use” the nil rate band, BUT on John’s death no Inheritance Tax would be payable on the property.

There are proposals to simplify the taxation and calculation of tax charges on such trust arrangements. Currently there is a 10-year anniversary charge and an exit charge when property leaves the trust. However, with proper planning the trust can be brought to an end at any time during the 10-year period following Janet’s death without any Inheritance Tax charge and with the additional benefit of Capital Gains Tax holdover relief. If on the other hand it is decided to keep the trust in place, the charge on the 10-year anniversary will be at six per cent of the value of the property in excess of the nil rate band at the relevant time. For instance, if the property increases to  £425,000 and the nil rate band remains frozen at £325,000, the tax will be £6,000.

The nil rate band has already been frozen for four years and is likely to remain so until 2017/18 at least and perhaps increase only slightly in future, thereby making a nil rate band trust all the more attractive as an option.

In recent years there have been significant changes to the taxation of trusts and further changes are proposed to “simplify” the way trusts are taxed.

As with all trusts, there are different taxes to consider including income tax and capital gains tax, not just inheritance tax. It is essential to take advice as to whether a particular arrangement suits your needs and to review this on a regular basis.

Contact Johnson Legal Solicitors to find out more about Trusts and Tax Planning – 0131 622 9222.