Many parents, grandparents and other relatives who are in the financial position to make gifts to succeeding generations are reluctant do so because of the family risks involved. These may include assets intended for minors falling under the unwanted control of their parents, assets falling into the hands of the immature, irresponsible or even predators. Or it may be that members of the next generation are anticipated but unborn.
As a result, such individuals may fail to take advantage of the benign UK inheritance tax regime that allows them to make outright gifts to succeeding generations without incurring a charge to tax so long as they survive seven years after making the gift. Striking the balance between making gifts early for tax efficiency and minimising the family risk seems an unnecessary problem.
The answer is to make the gift into an accumulation and maintenance trust (A&M trust). The gift is treated as a potentially exempt transfer (PET) for inheritance tax purposes. By taking this route, the gift can be made sooner rather than later and minimise the tax risk. But tapering term whole life assurance should be arranged.
The characteristics of an A&M trust are: an absolute interest in either the capital or the income must pass to the beneficiary by the age of 25; if it is not desirable that capital passes at that age this can be postponed, if necessary for life, but capital can be advanced to beneficiaries if required; children as yet unborn can be included in the beneficial class; and different shares can be allocated to different beneficiaries.
The privileged inheritance tax treatment afforded to A&M trusts extends to trusts created offshore. As an offshore trust has many income tax and capital gains tax planning opportunities any donor considering using an A&M trust for the above reasons should seriously consider creating it offshore.
Capital gains realised by an offshore A&M trust created since 1991 by a parent for his children will be assessable on the parent even though he is excluded from benefit under the trust. But the parental settlor has a right of recovery for this tax against the trust under TCGA 1992 schedule V paragraph 6.
This rule does not apply where the trust is created by a grandparent or more distant relative. In this case there is no capital gains tax payable when gains are realised by the offshore trustees and gains are taxed (under TCGA 1992 section 87) when capital payments are made to UK resident and domiciled beneficiaries.
A further capital gains tax advantage can arise if the A&M trust is created while the settlor is not resident in the UK. TCGA 1992 section 87 applies in a year of assessment if the settlor was, during the year in which he created the trust, domiciled and either resident or ordinarily resident in the UK. If the trust was created while the settlor was not resident or ordinarily resident then, so long as he lives outside the UK, the trust is not liable for capital gains tax.
UK source income arising from an offshore A&M trust is assessable for income tax at the rate applicable to trusts – equal to the basic rate plus 10 per cent – but foreign income is outside the scope of UK income tax. The use of an offshore fund can convert UK source income into foreign income.
Distributions to a beneficiary made out of current or accumulated income would be assessable on a parental settlor under ICTA 1988 section 660B as long as the beneficiary is an unmarried minor. A parental settlor can obtain credit for tax suffered by the trustees against his liability under section 660B and he can reclaim any tax he does pay under section 660D.
Where the settlor is not the parent or the beneficiary is married or has attained age 18, the beneficiary is assessed and he can also obtain credit for tax suffered by the trustees. A beneficiary cannot claim for tax suffered by him on distributions; but young beneficiaries usually obtain a repayment of tax.
The effect of these concessions is to treat income dis-tributed by the trustees as arising directly to either the settlor or the beneficiary. Under both concessions the undistributed income for the previous six years can be distributed and franked in this way.
Note that offshore trustees cannot issue a form R185 like their onshore equivalents in respect of income distributions but are required to agree the analysis of the distributions with the Inland Revenue's financial intermediaries and claims office. As the income distributed in any year of assessment can be drawn from income arising in that year and the previous six years sophisticated software is required to perform the calculations and advisers should ensure that offshore trustees have this available. Also, capital distributions can be assessed as income under ICTA 1988 section 740 (which cannot be franked under the concession) if there is undistributed income in the settlement.
There is scope for UK domiciled, resident and non-resident individuals to cascade wealth held as non-privileged investment assets down the generations by using an offshore A&M trust. In the cases of non-UK domiciled, resident individuals – or where the assets to be gifted are privileged assets in the form of business or agricultural property – there is also scope, but that is another story.