Estate planning using an IPDI

  • Introduction
  • Creation
  • Termination/surrender of IPDI’s, automatic reading-back, and variations
  • Spouse-exempt gifts
  • Planning
  • Family owned companies
  • Future research and development

Introduction

‘The IPDI is an estate-IP, so the property is treated for IHT purposes as if it belonged to the life tenant. The trust property will be subject to tax on L’s death, unless the value of the estate is within the NRB, or an exemption applies. The spouse exemption will in principle apply on the death of the testator if L is the testator’s spouse. This will generally be better than:

(i)       the standard IHT trust regime of 10-year and exit charges, or

(ii)      an Age 18-to-25 trust (which suffers the 4.2% charge) …

So long as the trust endures there is no need for [CGT] hold-over relief. Also, if hold-over relief is needed, it can up to a point (for property within the NRB) be obtained by creating a short term discretionary period … IP trusts are better than discretionary trusts for [income tax] purposes.’ ‘Drafting Trusts and Will Trusts – A Modern Approach’ (13th edition), by James Kessler QC and Charlotte Ford.

Creation

  1. An Immediate Post-Death Interest Trust (‘IPDI’) exists where a will/trust provides for a tenant for life, and not for bereaved minors, or for a disabled person, and the life interest exists continuously from the Testator’s (‘T’s’) death.
  2. A trust created on death where a person becomes immediately entitled to an interest for life will be:

2.1     treated as that beneficiary’s property;

2.2     aggregated with his estate (note that the beneficiary, for example the surviving spouse (‘S’), is treated for IHT as owning the whole of the capital fund see Inland Revenue Press Notice 12 February 1976); and

2.3     if the interest is created in favour of a spouse, or passes on the death of a beneficiary to a spouse, will be a spouse exempt gift.

  1. An IPDI exists and will be taxed under s.49A IHTA 1984 where three conditions are satisfied:

3.1     the trust was effected by will or under the law relating to intestacy;

3.2     the life tenant (for example S) became beneficially entitled to the life interest on the death of T; and

3.3     the trust must not be for bereaved minors and the interest is not that of a disabled person, which requirement must have been satisfied at all times since S became beneficially entitled to the life interest.

  1. The first requirement is satisfied where:

4.1     under T’s will funds are transferred into a pre-existing life interest trust;

4.2     T’s will is varied to create a life interest trust; or

4.3     an appointment is made within 2 years of T’s death that is automatically read-back into his will under s.144.

  1. If T creates an IPDI in favour of S the gift is spouse exempt, and on her death S will be treated as owning the whole of the capital fund, which is aggregated with the rest of her chargeable estate for IHT.
  2. An IPDI can also be created within 2 years of T’s death, by trustees exercising an overriding power of appointment (which extends to both income and capital) under T’s will to give S an immediate interest in possession, resulting in the property out of which the income is appointed benefiting from the spouse exemption.
  3. An IPDI may be terminated by:

7.1     the life-tenant (a ‘surrender’);

7.2     under the express terms of the trust (for example, in the event of re-marriage); or

7.3     by the trustees (defeasance).

  1. If as a result of the termination of a life tenant’s life interest, the property in which the spouse interest subsisted becomes comprised in the estate of another absolutely, then the life tenant will be treated as having made a PET.
  2. Provided S survives for a period of 7 years after the transfer, it will not become chargeable (sections 3a, 51, 52).
  3. If the property passes on to further trusts, it will be treated as a chargeable transfer subject to the IHT gifts with reservation of benefit rules (‘GWR’), hence a tax-efficient termination can no longer be on discretionary trusts for the benefit of the life-tenant and issue.
  4. Under s.102ZA Finance Act 1986, termination of S’s life interest by;

11.1   her own act;

11.2   under the terms of the trust; or

11.3   by the exercise by trustees of overriding powers;

is treated as a gift by S for the purposes of the GWR rules.

  1. The effect of these rules is that:

12.1   S is treated as if the subject-matter of the gift was comprised in her estate at its then market value; or

12.2   if the cessation of the reservation occurred within seven years before her death, S is treated as having made a PET of its value at that time.

  1. However, the GWR rules can only apply where S continues to enjoy a benefit in some way from the property in which her interest has been lost.
  2. The POAT charge contains no equivalent rule. IPDI’s are used to determine the ultimate destination of trust property, and to preserve wealth for the benefit of, for example, T’s children from a former marriage.
  3. On S’s death the remainder interests in T’s estate may be in favour of:

15.1   absolute interests, for example for T’s adult children;

15.2   a discretionary trust, for example for T’s children who are minors or for young grand-children; or

15.3   exempt gifts, e.g. to a UK registered charity.

  1. On S’s death no further IPDI’s can be created over residue left to her on an IPDI.
  2. However a surviving spouse who is left a life interest with no right to capital is likely to have a claim under the Inheritance (Provision for Family and Dependants) Act 1975 (the ‘Inheritance Act’), therefore this strategy may not protect capital unless S remarries.
  3. Under the IHTA 1984 the pecking order between:

18.1   the bereaved minor’s trusts;

18.2   18-25 trusts; and

18.3   IPDI’s,

is: 1st a BMT; 2nd an IPDI; and 3rd an 18-25 (s.71D trust).

  1. If T by his will gives a minor ‘an immediate right to income with capital vesting at 25 this is not a s.71D trust but instead gives the child an IPDI’.
  2. Therefore s.144 can operate to destroy what appears at first sight to be a s.71D trust.
  3. Where a s.71D trust results from conversion of a discretionary trust within 2 years of T’s death, it will be read-back to the date of T’s death under s.144, in which case no exit charge will arise on the ending of the earlier relevant property trust.
  4. Whereas, if the conversion occurs more than 2 years after T’s death, a s.71D trust comes into existence on that date, resulting in an IHT exit charge arising on the ending of the relevant property trust.

Termination/surrender of IPDI’s automatic reading-back and variations

  1. If trustees exercise their power to terminate an IPDI during S’s lifetime in favour of an individual absolutely, that would cause S to make a PET.
  2. s.3A(1A) provides that,

‘Any reference in this Act to a potentially exempt transfer is also a reference to a transfer of value—

(a)     which is made by an individual on or after 22nd March 2006,

(b)     which, apart from this section, would be a chargeable transfer (or to the extent to which, apart from this section, it would be such a transfer), and

(c)     to the extent that it constitutes—

(i)       a gift to another individual,

(ii)      a gift into a disabled trust, or

(iii)     a gift into a bereaved minor’s trust on the coming to an end of an immediate post-death interest.’

  1. Following the Finance Act 2006, gifts must be made either to an individual outright, to a bare trust, to a disabled trust or, in certain circumstances, to a bereaved minor’s trust in order to qualify as a PET… Thus if A, a life tenant with a qualifying interest in possession, surrenders his qualifying interest so that the trust fund passes to his daughter B absolutely, A will have made a PET…[However] if on the termination of the qualifying interest in possession the trust fund is then held otherwise than absolutely or on bare trusts, e.g. on wide discretionary trusts, not only will the transfer not be a PET, so that A will have made an immediate transfer of value, but, in addition, special anti-avoidance rules may apply.’ (McCutcheon on Inheritance Tax).
  2. Where an IPDI is terminated during S’s lifetime the property can be retained in trust where the trust qualifies as a BMT under s.71A.
  3. Following the introduction of FA 1986, s.102ZA, the surrender or termination of an interest in possession will, from 22 March 2006, be treated for the GWR rules, as if the life tenant had made a gift.
  4. Therefore, if the former life tenant may benefit from the assets previously subject to the interest in possession, the GWR rules can apply.
  5. A PET will be made should the life tenant cease to have a reservation of benefit as at the date the reservation was released.
  6. s.102ZA FA1986 provides that the termination of a life interest will be regarded for the purposes of s.102 and Schedule 20, as a disposal by way of gift by the beneficiary entitled to the interest if the following conditions are met:

30.1   T is beneficially entitled to a life interest in settled property;

30.2   his interest is treated as part of his death estate because he became beneficially entitled to the life interest either:

30.1.1         before 22nd march 2006; or

30.1.2         on or after that date and the life interest is an IPDI or a DPT; and

30.3   the life interest comes to an end during T’s lifetime.

  1. Then T will be deemed to have made a gift of ‘the no longer possessed property’ (see s.102ZA (2) and (3)).
  2. That is the property in which his interest in possession had subsisted immediately before it came to an end, other than any of it to which T became absolutely and beneficially entitled in possession upon termination of his life interest.

 

Spouse exempt gifts

 

  1. The spouse exemption is available (provided the conditions in s.18 on domicile are satisfied) where residue is left to S on an IPDI.
  2. This is particularly useful where:

34.1   T wants to preserve capital for example for children from an earlier marriage; and

34.2   in enabling trustees to exercise overriding powers of appointment to cause PET’s to be made by the spouse.

  1. From 22.03.06 S will only be treated as making a PET (rather than an immediately chargeable transfer) where the appointment is to: 35.1 another beneficiary absolutely;

35.2   a disabled person; or

35.3   into a bereaved minor’s trust.

  1. In the case of a gift to S for life using an IPDI, she becomes entitled to a life interest on T’s death, the trust does not qualify as a BMT or as a DPT, and must not do so throughout the life of the IPDI. Most intended life interests will take effect as IPDI’s except for example where unusually a discretionary trust arises before the life interest can take effect. On S’s death, the whole of the capital fund constituted by the gift will be aggregated with her estate to calculate IHT payable on her estate.

Planning

  1. IPDI’s are used to determine the ultimate destination of trust property, and to preserve wealth for the benefit of for example, T’s children from a former marriage. They may also be tax-efficient.
  2. If a property is left into a discretionary trust, the IHT residential nil rate band (‘RNRB’) will not be available even if all beneficiaries are lineal descendants. This is because the beneficiaries are not treated as the beneficial owners of the property. ‘Generally, an IPDI will be effective in providing access to the RNRB because the beneficiary is deemed to own the asset. However, sometimes an IPDI can be set up as a discretionary trust in the first instance. It may therefore be necessary to review its terms to ensure that the RNRB is available. To use the RNRB it will be necessary to transfer part or all of the residence to the life tenant.’ (‘Bricks and mortar – the practical application of the residence nil rate band, including drafting issues and claiming the relief’ by Carl Islam and Stephanie Churchill CTA, which will be published in Taxation (www.taxation.co.uk) on 12 October 2017).
  3. The points to address when considering leaving residue to S on an IPDI include the following:

39.1    if the house is left on trust, the trustees can take the decision as to whether S’s interest should be terminated in whole or in part and PET’s made;

39.2    there may be CGT advantages in transferring the property into trust for S because future disposals that might trigger gains can be minimized;

39.3    if property is left outright to S she cannot make lifetime gifts on trust for T’s children to take effect as PET’s, and therefore such transfers will be chargeable; and

39.4    by contrast, if S is given an IPDI in the will which is then terminated so that the property becomes held on a bereaved minor’s trust during her lifetime that will be a PET.

  1. ‘… the interest in possession could have been left via a power of appointment trust (i.e. a ‘flexible’ IPDI) with the surviving spouse having the life interest, and a range of other beneficiaries, say children and grandchildren, being capable of benefiting on a trustee appointment. This would mean that if the survivor did have sufficient financial security outside of the trust, the trustees could consider making an absolute appointment of part or all of the trust fund to children. That would crystallise a PET by the survivor, which, if he survived it by seven years, would fall outside his taxable estate. As a result, he would still continue to qualify for the full transferable nil rate band on his death.’ (Financial Planning with Trusts by John Wooley).
  2. ‘On the death of a life tenant who is single, there should normally be a discretionary trust. On the death of a life tenant who is married, there is a stark choice to be made:

(i)        The trust fund may pass to the surviving spouse absolutely; or

(ii)       The trust property may continue to be held in trust.

If L’s spouse was disabled when the testator died, there is a third choice: to confer an IP on L’s spouse.

Route (i) qualifies for the IHT spouse exemption. Route (ii) does not …

Either route qualifies for the CGT uplift on the death of L. The decision must be made during the lifetime of L. It cannot be altered after L’s death. It is not necessary to make the final decision when drafting the will of the testator: it is necessary  to make a provisional decision, i.e. one which can be changed subsequently (during the lifetime of L) … The provisional decision may be changed by executing an appropriate deed of appointment during the lifetime of L to confer an absolute interest on L’s surviving spouse. The deed should normally be revocable during the lifetime of L. That is an issue which should be considered when L makes his or her own will.’ ‘Drafting Trusts and Will Trusts – A Modern Approach’ (13th edition), by James Kessler QC and Charlotte Ford.

  1. ‘… a life interest will should be drawn flexibly. The executors/trustees should be given wide, overriding powers of appointment, so that they can either appoint the capital in whole or in part to the surviving spouse absolutely and/or terminate the life interest in whole or part and appoint the capital to one or more of the other beneficiaries named or referred to in the will e.g. children or grandchildren.’ (Ray and McLaughlin’s Practical Inheritance Tax Planning’).

Family owned companies

  1. ‘The key provision is IHTA 1984 s.49(1), which provides:

“(1)      A person beneficially interested to an interest in possession in settled property shall be treated for the purposes of this Act as being beneficially entitled to the property in which the interest subsists.”

There is no mention of the interest being “qualifying” and the legislation refers to a “person” (so including a company) rather than an “individual”.

… a company can have an interest in possession which is not a qualifying interest in possession as it fails to satisfy the conditions in s.59(2). As a result the settled property will fall within the relevant property regime and yet the company may be treated as beneficially entitled to the underlying property in which the interest is possession subsists.’ (‘Trust Taxation And Estate Planning’ 4th Edition by Emma Chamberlain and Chris Whitehouse).

Future research and development

  1. Perhaps testamentary planning using an IPDI is a gateway to IHT planning strategies for a testator who held a 100% beneficial interest in a residential buy-to let property prior to his death.
  2. This is a subject I may research and discuss in a future article in 2018.

 

Publication of my Residential Nil Rate Band Article by Taxation

My article, co-authored with Stephanie Churchill CTA, ‘Bricks and mortar – the practical application of the residence nil rate band, including drafting issues and claiming the relief’ , will be published in Taxation (www.taxation.co.uk) on 12 October 2017.

My article, ‘Equitable compensation arising out of sale of a property ordered under s.14 TLATA’ is scheduled for publication in Trusts & Trustees (Oxford University Press) in December: https://academic.oup.com/tandt

‘Trusts & Trustees is the leading international journal on trust law and practice. The most significant source of information in its field, the journal is essential for all trusts practitioners and lawyers … The journal is ideal for international trust lawyers working in both private practice and in-house in trust companies; trusts practitioners; and those working in trust companies. It will also be an essential source of reference for academics specializing in trusts; members of the judiciary; members of regulatory bodies; and institutional libraries.’ Oxford University Press.

The forthcoming ACTAPS monthly Newsletter (which is global) will also contain an article I wrote last month about ‘Rectification of Wills’.