A relatively common form of lifetime gift by parents is to transfer investment (e.g. buy-to-let) property into trust for their children. For example, a parent may wish to create a discretionary trust to provide for the children’s school fees, or start building up a fund towards their university education. A trust may also be part of an inheritance tax (IHT) lifetime planning exercise by the parent.
There are a number of tax issues to consider in the above example of UK property gifted to a UK resident discretionary trust. This article highlights a selection of potential tax implications to consider.
- A ‘minor’ relief restriction
The transfer of the property to a discretionary trust in the above example will be a disposal at market value for capital gains tax (CGT) purposes. This could result in a chargeable gain for the parent, even though no proceeds are received for the property.
A form of CGT relief (‘holdover’ relief) generally applies to transfers on which IHT is chargeable, such as a gift of property to a discretionary trust (TCGA 1992, s 260(2)(a)). However, this relief is subject to various conditions and exceptions, including that the trust must not be ‘settlor interested’.
For example, the parent (and spouse or civil partner) must not have an interest in the settlement, and there must be no arrangement under which they may acquire an interest (TCGA 1992, s 169B(2)). It is important to note that a parent who is the settlor will be regarded as having an interest in the settlement broadly if their dependent child can benefit from the trust.
A ‘dependent child’ means a child (including a stepchild) who is under 18 years old, unmarried and does not have a civil partner (TCGA 1992, s 169F(4A)). Thus transferring an investment property into a discretionary trust for such a child can be problematic, if the property is standing at a gain.
- IHT and valuations
For IHT purposes, the property transfer to a discretionary trust will be an immediately chargeable lifetime transfer. Depending on the value of the property, the transfer must be reported to HM Revenue and Customs (HMRC) by submitting an IHT return (unless it is an ‘excepted transfer’, within SI 2008/605), and any IHT liability (after deducting the annual exemption, and the nil rate band (£325,000 for 2016/17), if available) must be paid within statutory time limits if penalties, plus interest (on any IHT paid late), are to be avoided.
HMRC enquiries into land valuations produce large amounts of additional IHT and interest because many valuations are too low. HMRC may also seek to impose penalties if the undervaluation has arisen because reasonable care was not taken. A professional valuation of the property interest for IHT purposes should therefore be obtained.
- That’s settled!
Income tax anti-avoidance legislation (the ‘settlements’ provisions) can result in the trust’s property rental income being treated as the parent’s income, if the parent retains an interest in the settled property (ITTOIA 2005, s 624), such as by being a potential beneficiary of the trust (nb this should also be avoided for IHT reasons; see FA 1986, s 102).
The settlements anti-avoidance rules can also apply if the discretionary trust’s income is paid to, or for the benefit of, a ‘relevant child’ (i.e. a minor, who is unmarried and not in a civil partnership) of the parent, and that income exceeds £100 (ITTOIA 2005, s 629). However, this tax treatment applies to the extent that the trust income is distributed to (or for) the child; income accumulated and retained within the trust is not affected unless and until it is paid to the child (if unmarried and not in a civil partnership) (see s 631).
The above tax considerations are not an exhaustive list. There may be other tax implications to consider (e.g. stamp duty land tax, for properties in England, Wales or Northern Ireland), depending on the circumstances. Professional (i.e. tax and other legal) assistance should be sought as appropriate.
The above article was first published by Tax Insider (November 2015) (www.taxinsider.co.uk).