What are the tax implications?
Discretionary trusts generally fall into the ‘relevant property regime’ which applies special rates of tax.
Relevant property includes assets such as property, money, and shares.
If you make a gift into a discretionary trust during your lifetime and the open market value of the gift exceeds the ‘nil rate band’, which is currently £325,000, then you will have to pay Inheritance Tax at 20% on anything above the nil rate band. You must be aware that any gifts or transfers made in the previous 7 years will reduce the available nil rate band. If the tax is to be paid by you, and not deducted from the assets being transferred into the trust, grossing up applies and the rate of tax will be 25%.
If you die within 7 years of making a transfer into a discretionary trust, any Inheritance Tax charges will be recalculated at the death rate. The tax will also be subject to a relief, known as ‘taper relief’ which begins 3 years after the transfer and reduces the amount of tax to pay every year that passes.
A periodic charge
Every 10 years, the value of the trust fund is taxed at a maximum rate of 6%. This is payable by the trustees out of the trust fund.
When the trust is created the 10-year periods are automatically counted. If the assets are not relevant property for the full period, then this charge is reduced.
An exit charge is applied over any reduction in the value of the trust fund, for example when assets are distributed to the beneficiaries. The exit charge is proportional to the number of quarter years that have passed in the current 10-year period.
An exit charge may also apply in situations where the assets no longer fall under the relevant property regime.
The exit charge rate is taxed at a maximum rate of 6%.
In additional to this, any income which is generated by the trust is taxed at the trustee rate (higher rate) and any gains are also taxed at the higher trustee rate.