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Frequently Asked
Questions
Legal Issues
+ Q – Does RPT create a chargeable transfer?
A gift (settlement) is made when the trust is established, this being a relatively modest sum.
The initial settlement is a chargeable transfer for IHT purposes but in the normal course of events this will fall within the Settlor's £nil rate band, if this is not the case IHT will be payable on the transfer at the lifetime rate of 20%.
+ Q - Why does RPT not create a chargeable transfer?
A transfer on Arms Length Terms cannot (without there being other elements) by its very nature be a transfer of value thus cannot be a chargeable transfer for IHT because
· As it take place at market value there is no diminution in value of the transferor’s estate.
· There is not the requisite element of bounty thus precluding it from being a gift.
+ Q – How does the trust maintain commercial reality?
The RPT consists of a Jersey Purpose trust settled by the Settlor with a relatively nominal sum (the "Initial Settlement"). Thereafter the Settlor and others transact business (predominantly the purchase of schedules of capital payments) with it on arms length commercial terms for full consideration ("Arms Length Terms").
It is crucial to avoid undesirable tax consequences; that transactions with the trust are on arms length terms.
+ Q - What is meant by an arms length transaction?
The HMRC view is set out in a letter to the Law Society dated 18 May 1987
‘Whether an arrangement is for full consideration will of course depend on the precise facts. But among the attributes of an acceptable arrangement would be the existence of a bargain negotiated at arm's length by parties who were independently advised and which followed the normal commercial criteria in force at the time it was negotiated.’
The same letter states elsewhere:
‘In applying the test [i.e. of “full consideration”] we shall take account of all the circumstances surrounding the arrangement including the sharing of profits and losses, the donor's and the donee's interests in the land, and their respective commitment and expertise.
Another view on it is
a transaction is, in general, regarded as being at arm’s length where all the facts and circumstances of the transaction are such as might have been expected if the parties to the transaction had been independent persons dealing at arm’s length i.e. dealing with each other in a normal commercial manner unaffected by any special relationship between them.
+ Q - How do arms length terms differ for the Trust and the Investor?
Arms Length Terms for the Trust
A purpose trust just like anyone else is entitled to enter into a transaction. The test of arms length commercial terms as far as the trust is concerned is relatively easy because it is selling the same thing as other providers in the market place for the same cost, this is arms lengths terms from their side.
Arms Length Terms for the Investor
At first glance the purchaser’s side is the same; however it is a little more difficult. This is because in reality there is an element of motive, which HMRC may reach a conclusion upon based on other surrounding circumstances.
Ask Yourself:
· Can you buy into the thinking behind the purchase?
· Is there supporting evidence?
· Is there conflicting evidence?
· Do the motives for the transaction make sense?
· Could you see yourself in the same position making the same decision?
+ Q – When might a transfer not be an arms length transaction?
It is of related property – this being whilst the terms of the relevant transaction are at open market value other property in the hands of the transferor or transferee (to the knowledge of the transferor) or relevant connected persons result in there having been a value shift greater than the relevant consideration. Typical examples are:
· sets, 1 chair of a set of 10 is worth considerably less than 1/10th of the set;
· shares, a 2% shareholding in an unlisted company which results in the transferor dropping from a 51% shareholding to a 49% shareholding has a much larger reduction on the value of the estate of the transferor than the value of the 2% holding.
These transactions are unlikely to be on Arms Length Terms because the vendor would not normally sell at that price to a third party.
+ Q – Can the trust make loans?
A loan by the RPT is, if it is on arms length commercial terms, not a benefit or distribution from that trust.
At first glance, this might appear to be just a matter of the rate of interest but arms length commercial terms means on both sides of the transaction. Thus from the trust’s perspective the loan must be on terms that it would consider lending to someone other than the borrower this means it must consider:
· Is it a good risk?
· Is security being given?
· Does the lender have the ability to repay?
· Does the rate reflect the above?
It is common to find it suggested that a loan of this nature can have the interest rolled up for a period and then the loan is remade at a higher amount to cover the rolled up interest. There is nothing intrinsically wrong with this approach but the trust must consider all the points above just as if it was a new loan but this time:
· the borrower is older;
· amount is bigger;
· the borrowers circumstance may have changed;
so this may not be possible.
+ Q - Can the settlor borrow from the trust?
The effect of the loan by the settlor will be a disallowance of the debt created for IHT purposes. The loan would be taxable as income.
+ Q - Can an investor borrow from the trust?
Yes - a loan to the erstwhile owner is no different to the RPT lending to anyone else. However, the transaction needs to be on commercial terms and for it to be on commercial terms you have to be able to answer yes to the following questions:
· Is the rate of interest the same as could be obtained elsewhere.
· Is the borrower a person in terms of risk to whom that sum would be lent on those terms
· Would the lender be happy to make that loan on the same terms to someone else who met the same conditions (and be believed when they said yes) note that commercial terms include the credit worthiness of the borrower as well as the rates
+ Q – What about pre owned assets charge or reservation of benefits?
Purchasing capital payments and / or an annuity on arms length commercial terms from the trust is what removes the assets from the estate thus circumventing:
The pre owned assets problem;
Reservation of benefit.
+ Q – Can an investor buy rights for others?
If the investor buys capital payments and / or an annuity for the benefit of a designated individual, this transfer of value would be deemed a settlement on that individual, which creates a Potentially Exempt Transfer.
+ Q - Is there a lower age constraint for RPT?
No real age constraint… only that the transaction must make sense. For example, an individual aged 40 might buy a series of deferred capital payments for use as an alternative ‘pension’.
+ Q – What happens to the trust after the investor’s death?
The assets are held for a purpose rather than for the benefit of ‘Beneficiaries’, which means that after the investor’s death no-one is treated as owning the plan for inheritance tax purposes:
The trust can be maintained with assets within the trust continuing to enjoy the tax privileged environment;
If the trust is dissolved and assets are distributed there is no tax to pay.
What Assets Can Be Used To Buy
Rights?
+ Primary Residence
Where an investor’s primary residence is used to buy the rights, the entire value of a property is transferred to the trust; subject to the investor(s) prior right to reside for the remainder of their life(s).
Where no income or capital is required - the value accredited to the purchase price is based on what might be attained by selling the property to a provider of home reversion plans. The value is therefore, the market value discounted by 5.5% p.a., for each year of the life expectancy of the person occupying who has the longest life expectancy.
Where income or capital is required – a lifetime mortgage is used to provide the income &/or capital. The residual value is then used to buy the rights, which is assumed to be the market value discounted by 7.5% p.a., for each year of the life expectancy of the person occupying who has the longest life expectancy. The greater discounting reflects the additional risk taken on by the trust.
Moving Home – The trust has the power to invest in any reasonable asset and therefore it is exchanging one property investment for another. However, consideration needs to be given to ensuring sufficient liquidity remains within the trust to honour its annuity obligations.
The investor retains a lifetime interest in the property, which means that on moving home, their interest is valued and an equivalent value (less costs) is credited to the new property. The investor will be required to maintain the property in a good condition, and keep it fully insured at all times.
+ Assets with a Capital Gain
You can use assets that have an associated capital gain. The process involves taking a loan (using the asset as security) you can use the loaned capital to buy the payment rights.
· This is immediately effective for IHT planning; as IHT is raised on the net value (assets less liabilities) of your estate.
· The investment provides diversification of the portfolio.
· The loan when invested provides gearing of the assets.
· Options for the trust to acquire assets at an agreed price can be bought from the investor, by the trust. In this way, any growth on assets remaining within the estate will fall within the trust.
· On death, the assets are cleaned of capital gains; therefore the beneficiaries of your estate can indirectly enjoy the full value of the assets when sold.
Alternatively, assets ‘pregnant’ with a capital gain could be scheduled for inclusion within the trust over a period of years; thereby, using your annual exemption to CGT.
+ Deposit Accounts
These are ideal investments to use within the trust, as cash will provide the required trust’ liquidity and once invested will enjoy greater tax efficiency.
+ ISAs & PEPs
These assets are usually best kept outside the trust to provide a tax-free income.
+ Capital Investment Bonds
These can be assigned to the Trust and therefore do not need to be realised and reinvested. The assignment however, will create a ‘chargeable event’, which would incur a tax charge if the annualised gain made, when added to your current income, makes the transferor a higher rate tax payer.
Rights Acquired
& Withdrawal
of Benefits + Q – Can the Investor buy a deferred annuity?
We have been asked by some advisers for a deferred annuity; this can mean an annuity which either (a) kicks in at a pre-determined date/age or (b) an annuity which kicks in when the investor says so. A deferred annuity of the (b) type would be vulnerable to attack from HMRC.
By not exercising the option to commence the annuity payments; did the investor make a settlement on the trust? To answer this they would have to examine the reason for not exercising the option. Was it:
· To get a better annuity rate, as the income isn’t needed yet; or
· To increase the benefit falling within the trust.
If someone in good health buys the deferred annuity at 50 and dies at 60 the first motivation is plausible. However, if the investor dies at 75, not having commenced the annuity payments, the second motivation is far more plausible.
If someone in good health buys the deferred annuity at 80; the second motivation is always far more plausible, regardless of when death occurs.
If HMRC believe (and that belief is confirmed by the Special Commissioners as it would be) the second motivation was more likely, you and the client have a big problem as the original transaction had a bounteous intent; resulting in the original settlement being a settlor interested settlement. The tax consequences of this would put the investor in a worse position than they would have been in without any planning.
Similar problems arise if any transactions between the trust and the investor are not on arms length terms. If the annuities bought or assets transferred to the trust are not on arms length terms; once again you either create a settlor interested trust or a chargeable transfer.
+ Q - When is a deferred annuity appropriate?
It is perfectly possible to have a deferred annuity provided that its terms (e.g. start date and rate etc are ascertained at the time of purchase and there are no circumstance subsequently whereby the annuitant can alter the terms to the benefit of the trust as this would macerate a separate settlement for IHT purposes by that act or omission
It is our view that products are more likely to succeed where they are based on sound commercial terms.
+ Q - What withdrawals can be made during the investor’s lifetime?
Withdrawals, during the Investor’s lifetime can be made in a variety of ways. The appropriate method of withdrawal will be influenced by whether the withdrawal is made for the benefit of the Settlor, Investor or someone else.
· The investor receives the capital payments they bought from the trust.
· Deferred payments might converted to immediate capital payments.
· Items may be bought as investments by the Trust and used by the Settlor, Investor or others on normal commercial terms.
· If the investor wants a capital item that could not be seen as an investment, such as a Bentley, then the fund could buy the Bentley and lease it to the investor.
· The trust has the power to lend on commercial terms and the interest due on a loan may be paid or allowed to accumulate. In deciding the proportion of the fund that can be loaned, commercial terms dictate that consideration will be given to whether the loan is secured or unsecured and the borrowing individual’s net wealth. Loans can be made to the Investor and others; however, loans to the Settlor of the Trust should generally be avoided as there are adverse tax consequences.
+ Q - What withdrawals can be made after the investor’s death?
Buying an annuity will reduce the value of the Investor’s estate on death; however, any assets that remain within the Trust at this time will then be apportioned in a manner consistent with the Trust’s purpose.
It is therefore, for the Investor to determine (via a letter of wishes) who they would like to benefit at this time. On the Investor’s passing, the Trust’ Protectors can then decide whether to dissolve or continue with the Trust.
· If the trust is dissolved and assets are distributed there is only a very modest charge to IHT (generally in the range of 0.025% – 4%) to pay.
· Alternatively, the trust can be maintained with assets within the trust continuing to enjoy the tax privileged environment.
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