How to Determine Periodic and Exit Charges on a Discretionary Trust
Discretionary trust taxation came up on a recent CII AF1 paper, and as much as we have covered this subject before, it seems a timely reminder for those thinking of sitting this exam in the future – also useful reading for J02, R03, R06, and AF5 exam takers.
This article is relevant to examinable tax year 2022/23 and is correct as at 4 April 2023.
Here is an example of how to work through a periodic charge and an exit charge calculation on a discretionary trust.
Discretionary Trust Example
Kim set up a discretionary trust in June 2012 with £700,000, and in June 2022, its value was £900,000. What was the periodic charge at year 10?
The charge is at 30% of the lifetime rate which is currently 20%
Value of trust = £900,000 – £325,000 (current nil rate band) = £575,000 x 30% x 20% = £34,500
£34,500/£900,000 x 100 = 3.8% (the effective rate)
The periodic charge is therefore £900,000 x 3.8% = £34,200.
If the trustees make a distribution of the total trust fund in the 11th year and the value of the fund is now £920,000, the exit charge is calculated as follows:
£920,000 x 4/40 (the number of 3-month periods since year 10) = £92,000 x 3.8% (the effective rate at year 10).
The exit charge is therefore £3,496.
Here's a helpful discretionary trust example that will be of interest to CII exam takers preparing for any of the J02, R03, R06 or AF5 exams. Share on X
Remember a periodic charge occurs every 10 years, and it is the responsibility of the trustees to calculate, report and make the payment. The rate used to work out the periodic charge is 30% of the lifetime rate of 20% i.e. 6%. An exit charge can occur when capital distributions are made or when the trust comes to an end (although not where assets are transferred out of the trust within 3 months of its being set up or within 3 months following a 10-year anniversary).
Where a distribution is made in the first 10 years (i.e. before the first periodic charge), an exit charge will occur if there was an IHT charge at outset; however if there was no charge at outset, there are no exit charges in the first 10 years.
Trust taxation is a key part of AF1 but also appears, of course, in J02 and R03.
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