How to Calculate IHT on Relevant Property Trusts

A customer requested that we discuss relevant property trusts and the type of question that could come up in an exam. This will be of interest to those revising for the CII AF1 exam.

THIS ARTICLE IS RELEVANT TO EXAMINABLE TAX YEAR 2017/18.

Firstly, let’s be clear that ‘relevant property trusts’ are discretionary trusts and most lifetime trusts created on or after 22 March 2006.

A common question that comes up in the Advanced Financial Planning exam on tax and trusts (AF1) is the IHT on relevant property trusts.  An AF1 student will be expected to know how to calculate the IHT, whereas an R03 student will generally just be expected to know the theory.

When the trust is created, this is classed as a chargeable lifetime transfer and if the settlement is over the nil rate band (or the cumulative amount is), 20% tax is payable upfront by the trustees.  (If the settlor pays, you can use 25% which is 20% grossed up by 20%).  If the settlor dies within 7 years, there may be further tax to pay; although, taper relief will be available after 3 years to reduce it.

A Typical AF1 Exam Question

Exit charges and periodic charges may also apply. Let’s look at a typical AF1 exam question.

‘A discretionary trust is set up 10 years ago.  The initial value of the trust was £200,000 and the value 10 years later is £400,000.  Calculate the periodic charge’.

We are told that the value at the 10^th year is £400,000.  From this value, we can deduct the nil rate band of £325,000.  This leaves us with £75,000.  The periodic charge is calculated as 30% of 20% (20% is the lifetime rate) or 6%.  £75,000 x 6% = £4,500.  The effective rate of tax is calculated by dividing £4,500 by the value of the trust £4,500/£400,000 x 100.  This works out as 1.125%.

If one year later (11 years after the trust is created) we assume that the trustees give one of the beneficiaries a capital sum of £80,000, this will trigger an exit charge.  The exit charge is calculated as a percentage of the value of that capital distribution.

A Further Complication

There is a further complication as we also need to calculate how many 3-month periods there have been since the periodic charge.  As it was just one year later, this is 4 (12 divided by 3).  The capital distribution of £80,000 is therefore multiplied by 4/40 and then by the effective rate of 1.125% calculated at the 10-yearly anniversary.  This gives an exit charge of £90.

For anyone sitting AF1, it’s worth practising both these calculations until they are perfect.

Grab the resources you need!

If you’re studying for your CII AF1 exam, and you’re wanting to alleviate some exam day anxiety, you’ll need to prepare as much as possible. Grab our free taster to try out one of Brand Financial Training’s resources for yourself.  Click the link to download the AF1 calculation workbook taster now!