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12/03/2010

Effective use of multiple trusts with life assurance policies – the Rysaffe principle

The Rysaffe case is often referred to within trust planning. It demonstrates that there are various ways of using multiple trusts in order to achieve effective trust planning. This article sets out the key Rysaffe principles and gives you example scenarios that you can use with your clients.

It is worth remembering that although the taxation of discretionary trusts is nothing new, generally the flexibility in the old regime meant that in many instances, where clients and financial advisers were planning inheritance tax (IHT) solutions, the potentially exempt transfer (PET) regime was simpler and potentially more cost-effective.

The relevant property regime that Interest in Possession (IIP) and Accumulation and Maintenance (A&M) trusts now find themselves in treats these trusts as similar to discretionary trusts for IHT purposes. The added complexity this brings does not mean IHT planning is no longer viable. It just means you need to look at the longer-term view and really understand the objectives of your clients.

The flexibility that can be achieved in the new regime can make the issue of paying tax up front (where previously there was none) a lot more palatable, as this document explains.

The Rysaffe principle

The 'Rysaffe principle' relates to Rysaffe Trustee Co (CI) v IRC (2003) where a series of trusts were created on consecutive days. The principle is that by establishing a series of smaller trusts rather than just one, you can reduce the impact of the 10-yearly periodic charge and exit charge by benefiting from a nil-rate band (NRB) for each individual trust.

The principle applies equally to single premium investments such as bonds and to regular premium life assurance policies written in trust for inheritance tax planning, or for shareholder or partnership protection.

Background to the case

The Inland Revenue (now HM Revenue & Customs) contended:

‘That the making of all the settlements were associated operations and that therefore the Settlor had made one composite settlement by an extended disposition.’

After an initial successful hearing, both the High Court and a unanimous Court of Appeal Judgement stated that Section 42 IHTA 1984 was to apply on the basis that the word 'disposition' had its ordinary meaning and was not to be extended to include a disposition by associated operations.

A key statement from Park J dealing with the associated operations point was as follows:

‘All the parcels of shares were properly comprised in settlements for the purposes of Section 64. The associated operations provisions had nothing to do with that analysis. There were 10-yearly charges on all of the parcels of shares. It is (I assume) true that in aggregate the five 10-yearly charges would be lower than the single charge which would have applied if there had only been one settlement. But that is not a valid reason for artificially importing the associated operations provisions into the exercise and using them to impose the false hypothesis that there was only one settlement when in fact and in law there were five.’

Additionally, from a planner's point of view it is worth considering Section 62 IHTA 1984 relating to 'related settlements'. In summary, for a trust to be a related settlement:

a) the Settlor is the same in each case, and
b) the trusts commenced on the same day.

So, trusts created on different days do not fall within this definition.

Therefore, by creating a series of trusts on different days you may reduce the inheritance tax payable, as the example below
demonstrates.

Example: £1 million of life cover written under a discretionary trust

Entry tax:

Scenario 1:

If the whole £1 million of cover is written as a single regular premium life assurance policy, under a single trust, there will not normally be an entry charge due to the premiums being exempt.

Scenario 2:

If you set up the cover as four separate policies, each with a sum assured of £250,000, and write each policy subject to a different trust on different days, there should also normally be no entry charge, as above.

10-year periodic charge:

On the tenth anniversary of the life cover being written in trust, a charge may be payable based on the value of the trust property. The way the tax due is calculated will differ between policies with no potential surrender value (term), and unit-linked policies (whole of life).

Term-based life cover policies with no surrender value:

The basis of valuation at the 10-year point is the market value of the policy. As term policies do not accrue a surrender value, the only time a charge might be payable is if the market value was higher than zero due to the ill-health of the life assured.

Whole of life policies (term based or unit linked):

The basis of valuation at the 10-yearly point is the greater of the premiums paid and the market value of the policy.

We have assumed that, after ten years, the NRB is £400,000 in 2018/19 and there have been no other previous CLTs other than those shown.

Examples

The following examples are based on approximate premium rates for a male non-smoker, 55 years old and in good health for a  Skandia Protect guaranteed whole life policy.

Scenario 1 – single policy:

Example:

Yearly premium: £24,000  
Total premiums paid to date: £240,000
Less NRB 2018/19: £400,000
Charge £0

 

Depending on the age and longevity of the life assured, on subsequent 10-year anniversaries, a charge may be payable, as the total premiums paid will eventually exceed the current NRB.

However, if the life assured were in poor health, the market value of the policy would be used. Assuming the market value is
£500,000 the calculation is as follows:

Value estimated by HMRC: £500,00
Less NRB 2018/19: £400,000
Taxable amount = £100,000
Hypothetical tax at 20% (half the death IHT rate) = £20,000
Effective rate = Hypothetical tax
  (£20,000)/Current value of trust
  (£500,000)
   = 4%
of which 30% = 1.2%
10-year anniversary charge = £500,000 x 1.2%
Charge payable = £6,000
   

 

Scenario 2 – multiple policies (four instead of one)

Again the value of the policies is based on the greater of the premiums paid and the market value.

For each of the four trusts:

Yearly premiums: £6,000
Total premiums paid to date: £60,000
Less NRB (2018/19): £400,000
Taxable amount = £0

 

A charge is unlikely at future 10-year anniversaries, as the total premiums paid will probably still be significantly lower than the NRB. Even if the life assured were in ill-health as described above, no charge would be payable.

If each policy were valued at the full sum assured:

Value of trust: £125,000
Less NRB (2018/19): £400,000
Taxable amount = £0


   

Summary

The result is that we have created in Scenario 2 a series of trusts where there are no 10-yearly periodic or exit charges, compared with Scenario 1 where there may be tax to pay at the tenth and each subsequent anniversary and any future exit from the trust.

This planning may not be suitable for all your clients. However, when reviewing the needs of clients for immediate and future planning strategies, it can offer a clear benefit where the trust is expected to be managed for a significant period. This can be, for example, to cover the owner of a business until retirement or beyond.

What are the key considerations?

  • Parliament can change legislation and HMRC practice can change at any time.
  • You need to take care at the implementation stage to ensure the right trust is set up at the right time.
  • Where a CLT is created above the current reporting levels, you need to complete three sets of forms (IHT100, IHT100a and supplementary forms depending on the assets).
  • Significant growth in trust values may mean one or more of the trusts suffers 10-yearly periodic charges and consequently exit charges may apply. If NRBs continue to increase only in line with inflation or below, this could happen.
  • Product pricing may be adversely affected, ie premiums may be higher for protection policies due to varying mortality rates and policy fees.
  • This type of planning will not suit every client, but adds a level of planning which may well be suitable for high net worth individuals looking to create long-term strategies. It is worth remembering that in both the PET and CLT regimes you can, in effect, give away your NRB every seven years.

This article is based on Skandia's interpretation of the law and HM Revenue & Customs practice as at March 2010. We believe that the interpretation is correct, but cannot guarantee it. Tax relief and the tax treatment of both investment funds and trusts may change.

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