Discretionary Trusts

Discretionary Trust

Where assets are subject to a discretionary trust as defined, there is a once-off 6 percent charge and an annual charge after that. The tax is applied on the date when

• the assets become subject to a discretionary trust (in the sense defined)
• at the date of death of the person creating the will/trust or
• when, if later, the date on which there are no so-called “principal objects” (beneficiaries)  over the age of 21.

The first once-off (6%) tax charge becomes payable in respect of the deemed disposition of the discretionary trust assets to the trustees. This is the date of the inheritance or the valuation date, whichever is later.

The valuation date in respect of the subsequent annual (1%) tax charge is the last day of the year.  It applies to the assets within the scope of the discretionary trust as of that date.

Special Definition

A “discretionary trust” for gift and inheritance tax purposes has a different meaning than its general meaning.  Under a true discretionary trust, the beneficiary has no entitlement to assets unless and until they are appointed from the trust.  He may be a potential beneficiary, but he has no entitlement to anything more than a general right to be considered.

For inheritance tax purposes, a discretionary trust is defined as a trust or other arrangement where no person has a beneficial interest in possession of the assets concerned. A beneficial interest in possession is an immediate and present right to the assets.

There must be a present right of enjoyment.  It appears to be sufficient that there is a present right to enjoy the whole of the income in the assets concerned.  This is so notwithstanding that the capital may not be vested or no person has an immediate right to it.

A trust may allow funds to be accumulated until a certain age.  In this case, there will not generally be an immediate entitlement to possession of the assets.

Once the assets are appointed (transferred or applied),  they are held for the benefit of a particular beneficiary, and they cease to be held within the discretionary trust.  On this occasion, the recipient becomes beneficially entitled to those assets and an inheritance or gift tax liability may arise. This depends on whether the person providing the funds to the trust is still alive or has died.

Deemed Inheritance

Discretionary trust tax operates by there being deemed to be an inheritance by the trustee or equivalent of the assets the subject of the trust, i.e. in respect of which there is no interest in possession.  See the section in relation to the valuation date. in relation to the date upon which the initial 6 percent discretionary trust tax arises.

The principal objects, as defined, must be over 21 years of age.  The principal objects mean the objects of the trust who are a spouse of the disponer, a child of the disponer or a child of a predeceased child. It includes children of a civil partner [or spouse] of the disponer.

The trustees are deemed to take an absolute interest in the trust assets at the valuation date.  The general principles applicable to market valuation apply to the assets, the subject of the discretionary trust.

Administration of Estate

In strict terms, the discretionary trust may arise after the estate has been administered or the assets are ascertained.  This is because those assets are still being determined and administered and are not yet usually held in trust.

The legislation deems property /assets to be the subject of the discretionary trust at the date of death when a discretionary trust is created under a will.  This prevents an argument from being made that the assets are not the subject of the trust until administered or until the valuation date arose.

In the case of a residuary estate passing into a discretionary trust under a person’s will, the valuation date will normally be the date of the ascertainment of the residue of the estate, and the 6% initial charge is, therefore, payable within four months of that date.
In situations where the administration of an estate lasts for a number of years, a number of annual 1% charges may also have arisen before the valuation date for the initial 6% charge arises.

In these situations, the valuation dates for any of the accrued annual 1% charges will be the valuation date for the initial 6% charge.
DTT is payable, for the initial 6% charge, and for any accrued 1% charges, on the value of the trust property at the valuation date for the initial 6% charge.

Interaction of  Charges

If the initial 6 percent charge is paid once, it is not payable again on the same assets if they subsequently fall back into the trust.

There is a refund of the 3 percent of the 6 percent charge if the asset is vested within five years of the date of death of the disponer, the date of death of the relevant life tenant or the date of which the youngest principal object attains 21 years of age. The appointment must be absolute.

The 1 percent annual tax does not apply in the year in which the initial tax is charged or within one year of that date. The same rules apply in respect of valuation as apply generally to CAT.

Some Anti-Avoidance

Finance Act 2012 extended the 6 per cent initial charge and the 1 per cent annual Discretionary Trust Tax to  ‘‘foundations’’.A foundation is any legal entity, wherever established, to which an individual transfers property.

Some examples of foundations are entities known as anstalts and etablissements in Liechtenstein and foundations, stiftungs, anlagestiftungs and familienstiftungs in Switzerland.

Finance Act 2012 also provided anti-avoidance related to dispositions involving powers of appointment. This is designed to ensure that the 6 per cent and 1 per cent charges imposed on certain discretionary trusts are not prejudiced where the grant of a general power of appointment forms part of an arrangement whose sole or main purpose is the avoidance of CAT.

Future Interests

Future interests and interests in expectancy are not subject to gift or inheritance tax and discretionary trust tax until they vest in possession.  Although there is no person in immediate possession of the future interest, it is wholly outside the charge to tax and discretionary trust tax.

This follows as it is incapable of being appointed or accelerated. This is consistent with the general principles and the policy of the inheritance tax legislation.

Exemptions

There are a number of exemptions from discretionary trust tax.

• trusts for public or charitable purposes,
• registered unit trusts,
• pension schemes,
• trust for  persons who are incapable of managing their affairs because of age, improvidence or physical or mental or legal incapacity.
• trusts of the benefit of certain houses and gardens which are certified and accepted by the Revenue to be of national, scientific, historic or artistic merit; conditions must be met in respect of continued access.
• gifts and inheritance to the States.

A discretionary trust that is at any time a party to any arrangements the main purpose, or one of the main purposes, of which is to secure a tax advantage for any person shall be regarded as not having been created exclusively for purposes which, in accordance with the law of the State, are public or charitable.

The provisions for business and agricultural relief do not apply to the annual charge. The terms of reliefs by their conditions would not usually be available to the principal or annual charge.

Improvidence

Discretionary trusts are exempt from DTT, where it can be shown to Revenue’s satisfaction that they have been created exclusively for the benefit of one or more named individuals who are incapable of managing their affairs because of improvidence.

They may be established for the protection of individuals who exhibit various types of improvident behaviours, such as –

• individuals who have a compulsion such as gambling or substance addiction;
• individuals with special needs who are easily influenced and vulnerable to being financially exploited;
• individuals who are spendthrifts to the point that they cannot manage their own money.

To qualify for the exemption, the trustees must satisfy Revenue that the object of the trust has demonstrated a pattern of reckless spending to such an extent that he or she is incapable of managing his or her own financial affairs. It is not necessary that the improvident behaviour be actively exhibited at the establishment of the trust provided that a pattern of improvident behaviour was previously evident and it is
reasonable to assume that, based on past behaviours, the individual is likely to resume improvident behaviour if he or she were to receive an unrestricted benefit.

Return and Payment Obligation

The obligation to account for and pay the tax lies on the trustee.  The trustees must make a return and are primarily accountable.A beneficiary for whom trust assets are applied may also be liable.

Discretionary trust tax is payable within four months of the valuation date of the inheritance deemed to be taken by the trustees. Where returns are not filed within four months of the relevant valuation date, a surcharge is applied.

The annual charge is at the rate of one percent.  There is provision whereby the Revenue may accept values and hold them for three years to ease the administrative burden.  This is applicable where the property is subject to the annual charge and each of the relevant dates in the following two dates.  However, if there is fraud or misrepresentation or a change in the nature or structure of the assets, the asset may be revalued.

The same general principles in terms of interest, overpayment, penalties etc., apply as apply to mainstream inheritance tax. No credit is given in respect of discretionary trust acts against mainstream CAT.