What are the tax implications?
FLITs generally fall into the ‘relevant property regime’ which applies special rates of tax.
Relevant property includes assets such as property, money, and shares.
If you make a gift into a trust during your lifetime and the open market value of the gift exceeds the ‘nil rate band’, which is currently £325,000, then you will have to pay Inheritance Tax at 20% on anything above the nil rate band. You must be aware that any gifts or transfers made in the previous 7 years will reduce the available nil rate band. If the tax is to be paid by you, and not deducted from the assets being transferred into the trust, grossing up applies and the rate of tax will be 25%.
If you die within 7 years of making a transfer into a discretionary trust, any Inheritance Tax charges will be recalculated at the death rate. The tax will also be subject to a relief, known as ‘taper relief’ which begins 3 years after the transfer and reduces the amount of tax to pay every year that passes.
A periodic charge
Every 10 years, the value of the trust fund is taxed at a maximum rate of 6%. This is payable by the trustees out of the trust fund.
When the trust is created the 10-year periods are automatically counted. If the assets are not relevant property for the full period, then this charge is reduced.
An exit charge is applied over any reduction in the value of the trust fund, for example when assets are distributed to the beneficiaries. The exit charge is proportional to the number of quarter years that have passed in the current 10-year period.
An exit charge may also apply in situations where the assets no longer fall under the relevant property regime.
The exit charge rate is taxed at a maximum rate of 6%.
Capital Gains Tax
When a lifetime trust is created, any assets transferred into the trust may be subject to capital gains tax, payable by the creator of the trust. This is because it is treated as a disposal of an asset, so if the value of the asset at the time of the disposal is more than what it was acquired for, capital gains tax may be payable.
Capital gains tax may also be payable when the beneficiaries become entitled to the asset in the trust as this would also be treated as a disposal of an asset. The market value of any assets will be reviewed, and any gain will result in capital gains tax being made payable.
Holdover relief may apply.
The income received by the life tenant must be calculated along with their personal income, which may result in income tax being payable on the trust income.