What role does an Excluded Property Trust play in inheritance tax planning?
An Excluded Property Trust is a trust based inheritance tax planning arrangement for those individuals who are resident in the UK but who are not yet domiciled within the UK.
Typically it’s for individuals who wish to purchase an offshore bond and have an Excluded Property Trust wrapped around it.
If the individual subsequently becomes domiciled within the UK, the assets inside the Excluded Property Trust can remain outside the scope of inheritance tax.
What is an Excluded Property Trust?
An Excluded Property Trust (EPT) may be suitable for clients who are currently resident in the UK but not yet domiciled here. Domicile is a legal concept and is initially decided at birth, normally as the permanent home of an individual’s father. However, as an adult your domicile may change, for example if you settle permanently or indefinitely in another country. The current HMRC rules state that an individual will be deemed domicile in the UK if they have been resident here for at least 15 of the last 20 tax years. Our domicile status article contains further information.
An individual who is domiciled within the UK is assessed for inheritance tax (IHT) on worldwide assets. The EPT is for currently non domiciled clients who are likely to have assets in excess of the IHT thresholds and who want to mitigate IHT when they eventually become UK domiciled.
How is an EPT structured?
Typically an EPT is a discretionary trust that can be used with new or existing offshore bonds. Top ups (i.e. increments) may be possible before the settlor becomes domiciled within the UK. Settled property situated outside the UK is excluded property if the settlor was domiciled outside the UK “at the time the property became comprised in the settlement” (S48(3)(a) IHTA 1984.
Note that it may also be possible for the trust fund to comprise holdings in Authorised Investment Funds (e.g. OEICs) as these may also constitute excluded property.
How do you set up an EPT?
In the main, if it’s a new offshore bond being placed into a new trust then both the bond application and the trust deed may be dated the same day. It would be prudent to ensure that the funds come from a non UK bank account. If the individual has an existing offshore bond being placed into trust, then the trust deed will be dated when the last person signs.
What access do settlors and the beneficiaries have to the trust fund?
The settlor has full access to the trust fund. Joint settlors are possible if both are non-UK domiciled. With it being a discretionary trust, there is normally a built in class which consists of settlor, spouse, widow, widower, children, grandchildren and so on. The settlor is also normally the first named trustee. Under a discretionary trust, it is up to the trustees to decide who will benefit and when they will benefit from the trust fund. As long as the beneficiary is in the class of beneficiaries, the trustees can allocate funds to that person. This is why clients should choose their trustees wisely as ultimately they will be dealing with the trust fund after their death. The client may want to lodge a letter of wishes with the trustees to provide guidance, after his/her death, as to how the trust fund might be divided up.
Remember the beneficiaries cannot demand monies from the trustees. The trustees can access the trust fund at any point in time for the benefit of any of the beneficiaries.
What inheritance tax is payable when using an EPT?
None, as the settlor is non UK domiciled when he/she transfers excluded property to the trust. There is no chargeable lifetime transfer (CLT) as the transfer is exempt under the excluded property rules.
The assets of the trust will not form part of the settlor’s estate on death nor the beneficiaries as long as they remain within the trust. The trust fund must continue to hold excluded property.
Once the client has acquired a domicile of choice within the UK or is deemed domicile by HMRC, they should not top up the bond within the trust or add any further assets to the trust. The settlor must be domiciled outside the UK “at the time the property became comprised in the settlement”.
The EPT is for clients who are currently not domiciled within the UK or treated as domiciled within the UK who want to mitigate IHT when they later become UK domiciled. The trust fund will not be subject to IHT providing it holds ‘excluded property’.
On 7 November 2018, HMRC issued a consultation document “The Taxation of Trusts: A review”. In simple terms, the consultation sets out the government’s thinking on making trusts fairer, simpler and more transparent. At the time of writing, the government is not making specific proposals for reform. Instead, the government will weigh up the views and evidence presented and consider the options for targeted reforms.
On 23 November 2018, the Office of Tax Simplification published its First Report regarding its review of the IHT regime. This concluded that too many people have to fill in IHT forms, with the process being complex and old fashioned. The recommendations therefore relate to administrative issues. The second report covering wider areas of concern (technical and design issues) was published in July 2019.