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7 min read 28 Mar 22
A Discounted Gift Trust (DGT) is a trust-based inheritance tax (IHT) planning arrangement for those individuals who wish to undertake IHT planning but who are unable to lose full access to their investment. In a DGT, access is typically provided by means of a series of preset capital payments to the investor who will be the settlor of the trust.
DGTs take many forms.
The term ‘discounted’ is used because the value transferred on establishing the trust is less than the amount invested. This is the logical consequence of the fact that the settlor is entitled to a stream of capital payments. The settlor is typically entitled to payments on specified dates subject only to be alive on those dates. The settlor's transfer or gift is the bond/policy premium less the value of the payments receivable during his/her lifetime.
Payments from the trustees to the settlor in a DGT are capital, not income.
There are two basic types of DGT but many variations on the general DGT theme.
Those based on a bare/absolute trust structure and those based on a discretionary trust structure.
Use of a bare/absolute trust structure triggers an IHT potentially exempt transfer (PET) by the donor. The trust fund is within the beneficiary's IHT estate. (In this context the trust fund is the policy/bond value less the value of the settlor's rights to payment.)
Use of a discretionary trust structure triggers an IHT chargeable lifetime transfer (CLT) by the settlor and the trustees are thereafter within the relevant property regime. The discretionary structure gives greater flexibility.
Joint settlor versions of both structures are widely available.
In a bare/absolute structure, where a chargeable event gain arises in the tax year following that in which the donor dies, the gain is chargeable under section 465(2) ITTOIA 2005, i.e. on the individual who owns the rights under the policy. That individual will be the named beneficiary.
For chargeable events arising during the donor’s lifetime or in the year of the donor’s death, HMRC advised us in an email dated 6 August 2019 that its view is as follows:
Both donor and beneficiary have a material interest in rights (of a different kind) under S470(2)(a) and (b) and so gains are attributed in accordance with their share of the rights on a just and reasonable basis under s471(7)
Regular withdrawals are considered part surrender of rights under s500(a) ITTOIA 2005. S498 directs us to perform the calculation under s507 to determine if a gain has arisen as a result of this part surrender. If a gain has arisen, it has arisen because of the regular withdrawals (and only the donor holds the right to such withdrawals) and any gain will be assessable on the donor as a result - it would be just and reasonable to apply this treatment.
The gain in this case is the falling due of a sum payable as a result of a right (and continuing right) under the policy (500(a)). This is a right held by the beneficiary only, and so they will be assessable on the gain on a just and reasonable basis (s469 ITTOIA05).
If the donor’s only right is the right to regular withdrawals, and this right is terminated on death then it is reasonable to assume that any gain arising after the date of death is likely to be considered a transfer of income/capital to the beneficiary only. Unless a regular withdrawal was made before death, or to the estate after death, then it would be reasonable to assume the gain would be wholly attributable to the beneficiary.
We have asked HMRC for further clarification on aspects of the above. At the time of writing this remains outstanding.
In a discretionary trust structure, chargeable event gains arising on the trustees' bond/policy will be assessed on the settlor whilst alive and UK resident and thereafter, in tax years after death, on UK trustees.
In its Inheritance Tax Manual , HMRC provides details of how a ‘basic’ DGT scheme works.
There’s considerable HMRC comment on the valuation of the ‘transfer’.
It is generally acknowledged (based on comments in the Bower case) that HMRC accepts that DGTs work as intended.
DGTs don’t trigger the reservation of benefit provisions because the settlor's rights are never given away. The settlor's gift to the trustees is subject to the pre-selected payment stream, the right to which is never given away.
The settlor's contingent right (contingent on his/her survival to the selected date) will have no value on death. There is nothing to be included in his/her estate in respect of the payments. Although the deceased is treated as making a transfer of value the instant before death, the value actually transferred takes account of the fact that he/she has died. So the value of the payment stream on death is nil.
The starting point is to estimate the settlor's life expectancy. This is done through an underwriting process. Once the settlor's life expectancy has been established the value of the payments receivable during his/her lifetime is calculated and reduced to current values by use of a discount factor (a reverse interest rate). An adjustment is made for various costs. The value of the settlor's entitlement is deducted from the premium to give the value transferred.
Nil or negligible discount is available where the settlor is, or is ‘rated’ over 90. The value transferred in such cases is broadly the policy premium.
In this case, the High Court decision found in favour of HMRC. The case concerned Mrs Marjorie Bower who established a discounted gift trust in 2002 when she was nearly 91 years of age
Another success for HMRC. The case concerned Mrs Kathleen Watkins who died on 18 March 2006 aged 91 years and one day. On 21 December 2004 (when aged 89 years and nine months) she established a DGT where there were specified level payments of 10% p.a. of the single premium for the trust property (the Skandia bond), payable quarterly for the life of the settlor. This was quantified at £4,250 per quarter, or £53,273 over the actuarially reckoned life expectancy of Mrs Watkins of 3.1337 years. A medical report on Mrs Watkins dated 20 October 2004 was taken into account in the actuarial projection. The value of her interest (i.e. the "discount") was assessed as £52,273. The HMRC view was that the appropriate discount was £4,250 (i.e. one quarter's payment).
The operation of a DGT should not trigger an income tax charge under the POAT regime.
The HMRC view is contained in its Inheritance Tax Manual.
Disclosure of Tax Avoidance Schemes (DOTAS) regulations were introduced way back in 2004 to provide early information to HMRC about schemes containing defined ‘hallmarks’ of tax avoidance. IHT was first brought into DOTAS in April 2011 but only in very limited circumstances. The Government widened the hallmark with new regulations effective from 1 April 2018. The aim is to catch IHT avoidance schemes but not ‘bread and butter’ IHT planning. In short, established IHT planning schemes (e.g. a DGT) whose workings are well understood and agreed are in the clear where
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