Zurich International Portfolio Bond

Transcription

1 Zurich International Portfolio Bond Discretionary Discounted Gift Trust adviser guide For intermediary use only not for use with your clients.

2 Contents Introduction 3 1. The main benefits of the Discretionary Discounted Gift Trust (DDGT) investor suitability 4 2. Who is the DDGT not suitable for? 4 3. How does the DDGT work? 4 4. The Settlor s Fund 5 5. The inheritance tax effects of the DDGT 7 6. The DDGT and tax avoidance rules The Trustees and Beneficiaries The investments of the DDGT Joint investors and the DDGT Other important questions How do you set up a DDGT? 18 Appendix 19 2

3 Introduction The growing scope of inheritance tax Inheritance tax (IHT) can significantly diminish the amount passing to a person s beneficiaries on death. On a person s death, IHT applies at a flat rate of 40% on the excess over the nil rate band. This is 325,000 for the 2014/15 tax year and will remain frozen until For some married couples (including civil partners) the introduction of the transferable nil rate band by the Finance Act 2008 has helped to reduce the potential IHT bill on their estates. This is because any percentage of the nil rate band not used on the death of the first of such a couple to die can be utilised on the survivor s subsequent death. Whilst this is a welcome relief, many married couples will find that the value of their combined estates may well still exceed the threshold above which IHT is payable. For example, based on a nil rate band of 325,000, on the death of a surviving spouse with a taxable estate of 1 million an IHT charge of 140,000 would still arise even though two full nil rate bands may be available. Using lifetime gifts to reduce IHT One very effective way to avoid IHT is to make lifetime gifts. Lifetime gifts that are potentially exempt transfers (PETs) give rise to no IHT when made. However, following the new rules introduced by the Finance Act 2006, the scope for making PETs has been severely restricted so that only outright gifts to other individuals or gifts to bare (or absolute) trusts and trusts for the disabled qualify as PETs. All other lifetime gifts to trusts will be chargeable lifetime transfers (CLTs). However, no immediate tax liability will arise unless the amount of the gift (plus any CLTs made in the previous seven years) exceeds the nil rate band at the time of the transfer. Also, once the donor has survived a gift by seven years, no liability can arise on the gift and it will not affect the amount of tax payable on the donor s estate either. For a gift to be effective for IHT, the donor cannot retain any access to the property gifted or the income from it as otherwise the gift with reservation (GWR) rules will apply. These rules, which apply when a donor makes a gift and continues to enjoy a benefit from the asset gifted without paying for that benefit, mean the value of the gift continues to form part of the donor s taxable estate for IHT purposes and so no IHT saving results. For many would be donors, as well as requiring access to funds to be given, there will be a desire to exercise control over who will eventually benefit from the gift, on what terms and at what time. It is in these circumstances that a Discounted Gift Trust, such as the DDGT, can help. The DDGT is a lump sum investment plan combined with a suitable trust that helps an investor to mitigate IHT whilst providing them with a regular stream of capital payments and control over the final destination of the amount transferred into trust. In this guide the term spouse includes registered civil partner. Tax rules apply to registered civil partners in the same way as they apply to married couples. 3

4 1. The main benefits of the Discretionary Discounted Gift Trust (DDGT) investor suitability The DDGT enables an investor to: make a tax-efficient investment into an Investment Bond held in trust for the benefit of their family which gives rise to a lifetime gift (a discounted gift) that has a lower value for IHT than the amount of the investment; make a lifetime gift without an immediate IHT liability (as long as the nil rate band is not exceeded) whilst retaining flexibility over who will ultimately benefit from the gift; avoid any IHT implications resulting from the gift on survival of the gift by seven years; ensure that investment growth accrues outside of their estate during their life and (where appropriate) the life of their spouse; enjoy a tax-efficient cash supplement to income for the rest of their life; and where relevant, make a joint investment with a spouse and enjoy a cash supplement to income and control throughout their joint lives. 2. Who is the DDGT not suitable for? Broadly speaking, where the benefits summarised above are not required or valued by the investor, the DDGT will not be suitable. More particularly, the DDGT is not suitable for persons who may require full, immediate or unrestricted access to the capital invested. It also may not be suitable for persons whose income needs are likely to vary significantly in the future. 3. How does the DDGT work? The DDGT comprises of two components a Trust and a Zurich International Portfolio Bond (the Plan) effected with Zurich Life Assurance plc (Zurich) held subject to the Trust. These two components will now be described in more detail. (i) The Trust The investor (who is known as the Settlor ) and additional Trustees appointed by the Settlor execute a Deed of Trust which sets out the terms of the gift. The Settlor gives the Trustees a cheque made payable to Zurich in satisfaction of his commitment to make a cash gift. The Trustees (including the Settlor) will then complete an application form for the Plan see (ii) below using the Settlor s gift as the payment under the Plan. Legal ownership of the Plan then vests in the Trustees. The Trust operates as follows: The Trust Fund will be notionally split into two parts: the Settlor s Fund and the Beneficiaries Fund. Under the Settlor s Fund, the Settlor retains an absolute right to future regular capital payments until his death. This is expressed as a percentage of the initial investment in the Plan. Payments may be made monthly in arrears, monthly deferred for one year or yearly in arrears. The residual fund is known as the Beneficiaries Fund and this is held for the benefit of the Beneficiaries under the Trust. After the Settlor s death, the Trustees can distribute it to the Beneficiaries. The Beneficiaries Fund is held on discretionary trust. This means that no Beneficiary has a fixed right to any benefit. The Appointor (the Settlor during their life, and the Trustees after the Settlor s death) decide who, from the class of Discretionary Beneficiaries, should receive what benefit from the Trust. The Settlor names the Default Beneficiary(ies) at outset. This is/these are the person/people the Settlor would ultimately like to benefit from the Trust after their death. However, the Default Beneficiary(ies) will only benefit if the Appointor makes an absolute appointment to them or when the Trust ends after 125 years with no appointment having been made by the Appointor. 4

5 (ii) The Plan The underlying investment of the DDGT is a Zurich International Portfolio Bond that, depending on the version chosen, will be a whole of life insurance policy or a capital redemption policy. An investment in a nonincome producing asset, such as a life insurance policy or capital redemption policy, means that trust administration is minimised and the investor is substantially sheltered from any personal income tax during the Plan s existence. The Trustees are entitled to draw up to 5% of the initial investment each year, without any tax charge at that time, for up to 20 years and this provides a very convenient and tax effective method for the Trustees to finance the Settlor s entitlement to the capital payments under the Trust. The Trustees can arrange for Zurich to pay withdrawals direct to the Settlor on their behalf by including the Settlor s bank or building society details in the Bank/Building Society details box of the application form. After the Settlor has established the Trust, the Trustees effect the Plan. If the life insurance version is chosen, the Plan should be effected on the lives of some or all of the Beneficiaries (subject to the maximum of ten), usually those named as the Default Beneficiaries, on a joint lives last survivor basis these will normally be the Settlor s children or grandchildren. Because the Plan will encash on the death of the last surviving life insured, it is preferable that there is more than one life insured because this gives more control over encashment of the Plan from both an investment and tax standpoint. 4. The Settlor s Fund Under the Trust, the Settlor is entitled to the Settlor s Fund. This means that when the Settlor survives to the relevant payment date, they will become entitled to a capital sum at that time. These capital sums can be used as income. The following important points should be noted in relation to the Settlor s entitlement to regular capital payments: At outset, the Settlor must choose the initial level of capital payments from the Trust as a percentage of the Plan investment. This cannot later be changed (although it may be possible to give up capital payments see later). The Trustees can use their 5% tax-deferred annual withdrawal allowances to take part surrenders from the Plan and so finance the payments to the Settlor under the terms of the Trust. For administrative ease, the Trustees can instruct Zurich to pay these direct to the Settlor. The DDGT can allow more than one Settlor. For example, for married investors, by making a joint investment, capital payments will continue to the surviving spouse after the first death. The Plan must not be effected on the lives of the Settlor or Settlor s spouse in order to ensure that the arrangement cannot be caught by the IHT anti-avoidance rule in para 7 Schedule 20 Finance Act 1986 see section 6 of this guide for more details. No lives insured are needed if the capital redemption version is chosen. Once the Plan is issued in the name of the Trustees, it is part of the trust property and legally belongs to the Trustees. 5

6 Frequently asked questions: (i) Can the Settlor change the amount of capital payments they are entitled to? Once the Trust is established, the Settlor cannot directly change the amount of the income entitlement. If there is a wish to reduce or give up some of the capital payments, this can be done by the Settlor executing a suitable Deed of Release. Such action will have important tax and legal consequences and any deed should be drafted by a solicitor and only after the Settlor has taken professional advice. Zurich cannot advise on such dealings as this is not the intention of the DDGT and the Settlor should seek their own professional advice if circumstances change. In no circumstances can the level of capital payments increase. (ii) Can the Settlor defer entitlement to capital payments? Under the DDGT, the Settlor has the following options: 1. monthly in arrears, 2. monthly deferred for one year or 3. yearly in arrears. So the latest the payments must start is one year after the Plan start date. (iii) Can the Settlor s spouse receive capital payments? This is only possible if both spouses are making the gift as joint Settlors. Of course, if the spouse isn t a Settlor, they will be a Discretionary Beneficiary and able to benefit from the Trust Fund following the Settlor s death at the Trustees discretion. (iv) Does the Settlor have to take capital payments from the DDGT? Yes, on survival to the appropriate date, as the Settlor then satisfies the contingency and becomes entitled to the capital amount. If having survived to the appropriate date the Settlor does not need the capital payment, a gift of the cash received can be made. This would (depending on the circumstances) normally be a PET. Alternatively, if it is known in advance that a forthcoming capital payment is not needed, the right to the capital payment or payments could be given up in advance, as explained in question (v). (v) What if the Settlor no longer needs the capital payments? The Settlor could either: (i) separately gift cash to Beneficiaries out of the capital payments they receive from the Trustees; or (ii) waive the right to all or some of the capital payments under the Trust. In order to waive all or a part of the entitlement, the Settlor would need to provide the Trustees with a Deed of Release drafted by their legal advisers. They should also take appropriate advice on the implications of this. The Trustees would then need to send a copy to Zurich so that no automatic payment is made to the Settlor. The Settlor could give up one capital payment or a series of such payments. If one payment only is given up this will be a CLT by the Settlor equal to the amount of the capital payment given up. This may well be covered by the Settlor s annual exemption. If a series of capital entitlements is being given up, this will require an actuarial valuation based on the Settlor s age and state of health to determine the value given up. As such actions are not contemplated under the DDGT, Zurich will not be able to assist with the valuation on such an occasion. Giving up an entitlement will also be a CLT and there could, depending on the circumstances, be immediate IHT implications. This is a complex area and Zurich can take no responsibility for this. Advice should be sought from your client s legal advisers. In order to avoid possible tax complications, the Trust does not give the Settlor any specific power to give up the right to capital payments. Any such action would therefore need to be taken by the Settlor outside of the terms of the Trust. It is strongly recommended that the Settlor should first consult professional advisers over how the right to capital payments could be given up and what the tax implications would be. As already explained, external professional advice will have to be supplied and any documentation drafted by the Settlor s solicitor. 6

7 (vi) How are the capital payments taxed? The Settlor is entitled to a stream of capital payments at stated frequencies. These are known as reversionary interests. These payments are capital and therefore not subject to income tax. In the case of Stevenson -v- Wishart (1987) 1 WLR 1204, the Court of Appeal decided that if capital payments are made out of a trust to a beneficiary entitled to that capital, those payments would be treated as capital unless paid as a result of a specific direction in the trust to supplement trust income with capital. The capital payments are funded by the Trustees taking withdrawals from the Plan sufficient to meet the capital payments due to the Settlor. The Trustees are entitled to withdraw up to 5% of the initial investment each year, for 20 years, with no income tax at that time. Any withdrawals that exceed these 5% allowances will be assessed to income tax on the Settlor if alive and UK resident. The usual rules which apply to the taxation of chargeable event gains apply see section 8 of this guide, part B of the Appendix and the Zurich International Portfolio Bond (ZIPB) brochure for full details. (vii) How do the Trustees make the capital payments to the Settlor? The Trustees would normally set up a regular withdrawal facility under the Plan to finance these payments to the Settlor. The Trustees could arrange for these payments to be paid direct to the Settlor by including appropriate details in the Bank/Building Society details box on the ZIPB application form. 5. The inheritance tax effects of the DDGT (i) Establishing the Trust The DDGT enables an investor to make an investment in trust under which the gift will be totally free of IHT and there will be no consequences for the Settlor s estate after seven years, as long as the initial discounted gift falls within the Settlor s nil rate band for IHT. For these purposes, CLTs made in the previous seven years need to be taken into account. If the Settlor dies within seven years of establishing the DDGT, the discounted gift will be included in their taxable estate and may result in an IHT liability, depending on the size of the Settlor s estate and their Will provisions. If the discounted gift causes the Settlor s nil rate band to be exceeded (on a seven year cumulative basis), there will be an immediate 20% IHT charge on the excess over the nil rate band. If the Settlor is to pay the IHT, this will mean that the gift needs to be grossed-up so that the actual amount of the loss to the estate on which tax is payable takes account of the tax payment. Example John invests in a DDGT which results in a CLT of 340,000 to the Trust. He has made no CLTs in the previous seven years and his annual exemptions have been used elsewhere. Either the Trustees can pay IHT of 3,000 (i.e. 20% of 340, ,000) or John can pay IHT of 3,750 (i.e. 20% of 343, ,000). A further tax liability (at 20%) on the gift could arise if the Settlor dies within seven years of making the transfer (see point (vii) of this section). 7

8 It is generally not recommended that the Settlor makes a gift in excess of their available nil rate band. This is not only so that no immediate tax liability arises but also to avoid the practical difficulties that this may give rise to. For example, if the Trustees were to pay the tax, they would need to keep some of the cash gift back in order to fund the tax and so the amount of cash available for investment would be reduced. They would also need to open a bank account which the Settlor s gift cheque would have to be paid into first, so it would not be possible for the Settlor to simply make a cheque payable to Zurich. If, on the other hand, the Settlor were to pay the tax, the gift would have to be grossed-up and the grossed-up figure used in all IHT calculations, including the value of the discount, and this is likely to be more complicated. Zurich can only calculate the discount by reference to the amount invested. For the purpose of this guide, we assume that the initial gift is fully covered by the Settlor s available nil rate band. Further details on this are included in the Appendix. (ii) What is a discounted gift? Because the Settlor retains a right to regular capital payments from the Trust via the reversionary interests (known as the Settlor s Fund), this right will have a value for IHT purposes which stays inside the Settlor s estate. For the purposes of calculating the gift at outset, the value of the initial investment can therefore be reduced (or discounted ) for the purposes of IHT by this retained value. This discounted value remains relevant for IHT calculation purposes should the Settlor die within seven years of the gift. (iii) Why is there no value attached to the Settlor s Fund on death? Although the right to future capital payments has a value during the Settlor s lifetime, no value will be included in the Settlor s estate on death in respect of the Settlor s Fund. This is because the Settlor s right to the stream of future capital payments ceases on death and therefore immediately before the Settlor s death this right is worthless, meaning no value needs to be included in the Settlor s taxable estate at that time. (iv) How is the size of the discounted gift determined? The value of the Settlor s right to future regular capital payments (i.e. the Settlor s Fund) is calculated taking into account the Settlor s (or both Settlors if appropriate) age, state of health and the amount and frequency of the capital payments they are entitled to. For new Plans, the difference between the value of the Settlor s Fund and the amount of the initial investment will be treated as a transfer of value for IHT purposes and will be a CLT. It is not recommended that gifts are made if they cause the Settlor s available nil rate band to be exceeded, as an immediate tax charge at 20% will then arise. (v) Underwriting the gift to calculate the discount Zurich will underwrite the Settlor to establish the amount of the discounted gift. Subject to the Settlor being satisfied with this discounted gift valuation, the investment can then proceed. To enable the underwriting to be carried out, Zurich require that the Settlor completes a health questionnaire at outset and, if appropriate, they then obtain medical evidence from the Settlor s GP. The only time a General Practitioner s Report (GPR) won t be collected is where the Settlor s application has to be declined because of information included in the Settlor s health questionnaire. 8

9 (vi) Does HM Revenue & Customs (HMRC) need to be informed about the DDGT? For cash gifts into trusts, such as for the DDGT, if the CLT arising on the gift into this Trust, when added to CLTs the Settlor has made in the previous seven years, causes the Settlor to exceed the nil rate band (see above) and so tax is due, the Settlor must report the transfer to HMRC Inheritance Tax on forms IHT100, IHT100a and D34. (vii) What are the IHT implications of the Settlor dying within seven years of establishing the DDGT? If the Settlor does not survive the gift by seven years, the IHT liability on the original CLT needs to be recalculated at death rates. If the discounted gift was within the Settlor s available nil rate band (as is recommended), no IHT will be due on the gift itself. However, an equivalent amount of the nil rate band will no longer be available to the estate of the Settlor. If this passes to someone other than the surviving spouse, an IHT liability at 40% will arise on the amount in excess of the nil rate band. If the nil rate band was exceeded, so that lifetime tax at 20% was paid, the rate of tax charged will increase to 40%. IHT taper relief will be available in which case the IHT liability may start to reduce after the third year because of this taper relief. However, it will never be possible to recover any IHT paid at outset. (viii) What are the IHT implications for the Trust itself? As this is a discretionary trust, this means that special IHT charging rules apply. The Periodic Charge Periodic charges at ten-yearly intervals are, broadly speaking, applied to the value of the assets in the Trust (although special rules apply to determine the value of trust property for Discounted Gift Trusts see below). The effective rate of IHT will be determined based on an assumed transfer by an assumed transferor. This will mean that it will broadly be necessary to take account of: the value of the property in the Trust on the ten-year anniversary and any other trust set up on the same day (the assumed transfer) and, the Settlor s cumulative total of CLTs made immediately before the Trust was established plus any sums paid out of the Trust in the ten years prior to the anniversary (the cumulative total of the assumed transferor). The maximum liability will be 6% of the value of the trust property but frequently it will be much less or nil. In cases where the Settlor has not made any CLTs in the seven years before the Trust is created, no payments have been made out of the Trust in the previous ten years and there has been no added property, there will be no liability provided the value of the Trust does not exceed the nil rate band applicable at the ten-year anniversary. Any excess over the then nil rate band will suffer IHT at 6%. Under these rules there may be IHT charges: on every ten-year anniversary of the Trust the Periodic Charge and/or, whenever property leaves the Trust (e.g. when capital is advanced to a Beneficiary) the Exit Charge. 9

10 Example Kevin creates a DDGT in July 2009 for 300,000. The value of Kevin s retained rights is 150,000 and so the discounted gift is 150,000 based on an annual capital payment to Kevin of 15,000 (5% of the investment in the Plan). Kevin has made no CLTs in the previous seven years. No payments are made out of the Trust in the first ten years (other than the capital payments to Kevin out of the Settlor s Fund, which are ignored for this purpose). In July 2019 the Trust Fund is worth, say, 300,000 and the nil rate band is, say, 400,000. No IHT is payable. For the purposes of calculating the value of the trust fund for the periodic charge, HMRC has confirmed that the present value of the Settlor s right to future capital payments at that time (i.e. at the ten-year anniversary) should be deducted from the value of the trust fund (i.e. the Plan). This means that an amount in respect of the then value of the Settlor s rights would need to be deducted from the value of the Plan. Had the value of the Plan been 475,000 after ten years with the Settlor s rights valued at 25,000, then the value of the relevant property in the settlement would have been 450,000 and IHT of 3,000 would have arisen ( 6%). This equates to a charge at 0.66% on the whole value of the trust property. The Exit Charge Exit charges will be based on the value of property leaving the Trust. HMRC has confirmed that no exit charge will arise on payments made to the Settlor under a trust, such as a DDGT, because this property is already held absolutely on bare trust for the Settlor. There will be no exit charges within the first ten years of the DDGT s existence if the value of the initial CLT going into the Trust (i.e. the discounted gift) plus the cumulative total of the Settlor s CLTs in the seven years prior to creating the Trust is below the nil rate band when the Trust is created, assuming no property has been added to the Trust. If an exit charge does arise, it will increase according to the number of quarters that have expired since the Trust was created. The amount of any exit charge occurring after the first ten years will depend on the rate of tax charged at the previous ten-year anniversary (if any) and the length of time (in quarters) that the property has been in the Trust since the last periodic charge. If there is no periodic charge at the immediately preceding ten-year anniversary then there will be no exit charge in the next ten years. If all the Trust Fund is distributed before the tenth anniversary, no tax charge will arise (see next section). If assets remain in the Trust after a distribution, the Trustees will need to obtain specialist tax advice. 10

11 Example In 2025, six years since the first ten-year anniversary, and after Kevin s death, the Trustees of Kevin s Trust pay 50,000 to a Beneficiary. Assuming the rate of IHT paid at the last ten-year anniversary was 0.66%, the IHT charge will be 50,000 x 0.66% x = 198. No IHT charge will arise on property paid out of the Trust if there was no IHT charge at the last ten-year anniversary. An exit charge will not arise on loans made by the Trustees to the Beneficiaries. The occasion of a periodic charge and transactions that can give rise to an exit charge, such as capital payments to the Beneficiaries, may also need to be reported to HMRC on forms 100c and 100d (and form D34 where a life insurance bond is involved) if they exceed a certain amount. (ix) What are the IHT implications of the Settlor surviving to the selected reversionary dates? Each time the Settlor survives to the appropriate anniversary date of the Trust and becomes entitled to a capital payment, the Trustees will make a capital payment to the Settlor. The exit charge can arise, generally speaking, where property or part of the property comprised in the settlement ceases to be relevant property see previous page. Under a DDGT the question arises as to whether the Settlor s capital payments, being payments from property that is not relevant property (i.e. property held on bare trust for the Settlor), would give rise to an exit charge. As stated above, HMRC has confirmed that the capital payments paid to the Settlor do not give rise to exit charges. This means that no returns will be needed to HMRC in respect of the capital payments made to the Settlor. (x) How is the amount of the discounted gift arrived at when there are joint Settlors who are spouses or civil partners? Where spouses or civil partners invest as joint Settlors, the cheque establishing the arrangement must be drawn on a joint bank account (or two individual cheques each for half of the total investment). Each Settlor will then be treated as making an investment equal to 50% of the total investment. However, the discounted gift made by each will vary because of the different mortality factors that will apply due to age and state of health. 11

12 Example Let s assume that Paul and Sue (who are both UK domiciled) invest 100,000 as joint Settlors into a DDGT under which they are entitled to a total payment of 5,000 each year throughout their joint lives and the life of the survivor. Each is treated as making an investment of 50,000 which will provide each of them with a capital payment of 2,500 each year throughout each lifetime. Sue is younger than Paul. The joint discounted gift is calculated as 46,300 on the 100,000 joint investment and it will be apportioned according to Paul and Sue s income rights on their individual investments of 50,000 each. Because of differing mortality factors, the discounted gift elements will differ. For example, Paul s discounted gift might be 26,400 and Sue s 19,900. This will reflect the likelihood of Sue living longer than Paul (because she s younger), which means her Settlor s Fund will have a greater value. However, the amount retained by each of them will also include an allowance for the income right that person may receive as survivor if he/she outlives the first to die. HMRC has issued guidance notes on how this calculation should be made. In broad terms, the joint discount will be apportioned between Paul and Sue according to the respective value of their income rights. If there are joint Settlors who have contributed equally, the Trust is effectively treated as two separate Trusts, each settled by one Settlor, for all IHT purposes. Where the Trust is to be created by a husband and wife and one (or both) are non-uk domiciled, separate professional advice should be taken. 6. The DDGT and tax avoidance rules Two potential pieces of tax avoidance legislation could apply to the DDGT the IHT gift with reservation rules and the income tax pre-owned assets tax rules. (i) The gift with reservation (GWR) rules These rules apply in cases where a donor makes a gift of assets and continues to enjoy a free benefit from those assets be it the enjoyment of income or access to capital under a trust. On the face of it, as under the DDGT an individual makes an investment in a trust and enjoys a regular flow of capital payments from it, the GWR rules would appear to be capable of application. In fact they do not apply, but to understand why these provisions do not apply, it is necessary to first consider the precise nature of the Settlor s entitlements under the Trust. These are known as reversionary interests which means that the Settlor is only entitled to the payments on survival to the appropriate payment date. In principle, the GWR rules could apply by virtue of one of two provisions: a) Section 102 Finance Act 1986 Under this provision, if a donor enjoys a benefit from property they have gifted, it will be a GWR. However, as was established in the House of Lords decision in the Ingram case, the GWR rules will not apply where the donor makes a gift of identifiable property from which they cannot benefit and keeps back separate identifiable property from which they can benefit and which remains in their estate. In the case of the DDGT, the property retained is the Settlor s Fund (the right to the reversionary interests) and the property gifted is the Beneficiaries Fund. As the Settlor cannot benefit from the Beneficiaries Fund, section 102 will not apply. 12

13 b) Para 7 Schedule 20 Finance Act 1986 This provision means that where a person makes a gift of a life insurance policy effected on his life or the life of his spouse (which would include a registered civil partner) and the rights under that policy vary between the donor and the donee of the gift, then the gift of that policy will be a GWR. With the DDGT, para 7 Schedule 20 will not apply because the Plan will not be effected on the life of either the Settlor or their spouse. Furthermore, any variation of rights occurs under the Trust and not the policy. This is only relevant if the life insurance version is chosen, as there are no lives insured under the capital redemption version of the Plan. (ii) The pre-owned assets tax rules Schedule 15 Finance Act 2004 introduced the pre-owned assets tax (POAT) rules. These rules apply where the donor of an asset continues to enjoy a free benefit from the asset they have gifted and that gift is not caught by the IHT GWR rules. In those circumstances if, using special valuation rules, the value of the benefit together with other POAT benefits of the same donor exceeds 5,000 in a tax year, the whole of that benefit is charged to income tax on the donor. For the POAT rules to apply on a gift of investments, two conditions need to be satisfied: a) The property must be held on a settlement. b) The donor must be able to benefit from the property in the settlement. (The test for this is whether section 624 ITTOIA 2005 would apply to the settlement.) For these purposes, property held on a bare trust is not held on a settlement. Moreover, under the legislation if a trust consists of a number of separate sub-trusts, each of those sub-trusts must be tested separately. This means that when different property in a settlement is subject to different trusts only the particular property which is caught is subject to the charge imposed by Schedule 15, and not (where greater) the whole property of the settlement. Where such sub-trusts exist, it is therefore necessary to test each of those sub-trusts independently to see if the POAT rules apply. Under the DDGT certain interests are held for the benefit of the Settlor (the Settlor s Fund) and some for the Beneficiaries (the Beneficiaries Fund). This means that the Trust Fund is comprised of two sub-funds, one is the Settlor s Fund and the other the Beneficiaries Fund. Both funds therefore need to be tested against the two conditions to see if they are subject to the POAT rules. In this respect, the Settlor s Fund is held on bare trust for the Settlor and so this part of the Trust is not held subject to a settlement a pre-condition for the POAT rules to apply. Whilst the Beneficiaries Fund is held on a settlement, the Settlor cannot benefit from this part and so, again, the POAT rules do not apply because the second condition is not satisfied. HMRC has also confirmed in their Guidance Notes on the POAT issued in May 2007 that the more commonly understood forms of Discounted Gift Trust are not subject to the POAT legislation. 13

14 7. The Trustees and Beneficiaries (i) Who can be Trustees of the DDGT? The Settlor will automatically be a Trustee. Additional Trustees must be appointed and this is contemplated in the Trust Deed at outset. Anyone over 18 years old and of sound mind may be appointed. It may be appropriate to appoint a professional adviser, such as a solicitor or accountant, as a Trustee, although such a person is likely to charge a fee for acting as Trustee. It is essential that at least one additional Trustee survives the Settlor if probate is to be avoided following the Settlor s death. (ii) Who are the Beneficiaries under the Trust? The Settlor is entitled to a stream of cash payments specified at outset each time they survive to a payment date. This is known as the Settlor s Fund. The balance of the benefits is held as the Beneficiaries Fund. The Beneficiaries Fund is held on discretionary trust for the Beneficiaries. As the Trust is discretionary, no Beneficiary is entitled to anything until the Appointor makes an appointment in their favour. If any income arises to the Trustees from the trust investments (not relevant while the sole trust asset is the Zurich International Portfolio Bond), they can either accumulate it during the Trust Period or distribute it (or some of it) to whichever Beneficiary they decide. However, no Beneficiary will have the right to any income distributions will be at the discretion of the Trustees. The Trustees have powers to deal with the trust property, including wide powers to invest, as well as the power to advance capital to any Beneficiary. Discretionary Beneficiaries are the people to whom the Appointor can appoint benefits and include the following persons: The Settlor s spouse/civil partner (if he/she is not also a Settlor). Children and remoter issue of the Settlor. Any spouse, widow or widower of the Settlor s children and remoter issue. For this purpose spouse includes a registered civil partner. Any other person (other than a Settlor) whom the Settlor may appoint to the class of potential Beneficiaries. An appointment should not be made to the Settlor s spouse during the Settlor s lifetime as this could give rise to a reservation of benefit if the Settlor enjoys an indirect benefit. The Settlor names (as Default Beneficiaries ) the individual or individuals who the Settlor would like to benefit from the Trust Fund if no other appointment is made. However, in order for these people to become entitled to benefits, the Appointor at that time (the Settlor or the Trustees see below) must appoint benefits in their favour. If no appointment is made during the Trust Period, they will become entitled to the Trust Fund at the end of the Trust Period. (iii) Who is the Appointor under the DDGT? The Appointor is the Settlor(s) whilst alive and then the Trustees. However, if the appointment is in favour of the Settlor s spouse or civil partner, it must always be made by the Trustees. 14

15 8. The investments of the DDGT (i) What investments can be held in the DDGT? The Trustees must invest in a Zurich International Portfolio Bond. This can be based on a life insurance or capital redemption version. (ii) What are the income tax implications of the DDGT? An income tax chargeable event gain can arise in the event of the Plan being encashed or a part surrender of more than the cumulative 5% tax deferred annual allowances being taken. Chargeable event gains will be taxed on the Settlor if alive and UK resident in the tax year in which they arise. Liability to tax will be at the Settlor s marginal rate(s). For the purposes of the liability to higher rate or additional rate tax only, top-slicing relief will apply so, in general, the gain will be divided by the number of whole years the Plan has been in force. As the Plan is an offshore investment plan, there is no UK tax deemed to have been paid on any gain, with the result that the full amount of the gain is subject to UK income tax. This is different from the income tax treatment of gains within a UK-based plan, where basic rate tax is deemed to have been paid within the plan, and gains are only taxed when they take the taxpayer into the higher rate or additional rate of tax. If the Settlor is not alive in the tax year in which the chargeable event occurs, or is not resident in the UK for tax purposes, the Trustees, if they are UK resident, will be liable for any tax on the gain. The gain will be taxed at the trust rate currently 45% except for the gains falling within the 1,000 standard rate tax band available to the Trustees, where the tax charge will be at the rate of 20% only. If the Trustees are not UK resident, the chargeable event gains will be assessed on any UK ordinarily resident Beneficiaries when, and to the extent that, they receive any benefits from the Trust. The above rules apply regardless of whether the Plan is based on the life insurance or capital redemption version. The Trustees should think very carefully before encashing the Plan while the Settlor is still alive and entitled to a regular flow of capital payments. Under the terms of the Trust, the Trustees are responsible for continuing to make these payments and a Plan which benefits from the 5% tax-deferred annual allowances is an ideal vehicle for investment by the Trustees. For more detail on income tax in connection with the Plan see part B of the Appendix. 9. Joint investors and the DDGT (i) Should spouses each set up their own individual DDGT? This is not recommended because under the trust underlying each individual DDGT, the Settlor s spouse is a potential Beneficiary and these could then be regarded as reciprocal arrangements and so invoke the GWR provisions. It would be better for spouses to effect one joint Settlor DDGT. (ii) Can income be paid to the Settlor s spouse after the Settlor s death? Only if both spouses are making the gift as joint Settlors. The Trust will then provide reversionary capital payments to both Settlors throughout both of their lives. They will then enjoy income throughout both of their lives. Of course, if the spouse isn t also a Settlor, they will be a Discretionary Beneficiary and able to benefit from the Trust Fund following the Settlor s death at the Trustees discretion. 15

16 (iii) What happens on the death of the Settlor(s)? The Settlor s entitlement to regular capital payments will then cease (unless there is a surviving joint Settlor). No value will be included in the Settlor s estate in respect of the right to future capital payments as that entitlement relies on the Settlor then being alive. Similarly, in joint Settlor cases where the right to capital payments continues to the Settlor s surviving spouse, no value will be included in the estate of the first Settlor to die in respect of the interest passing to the surviving spouse as it is not property in their estate that they can give away. Any value of this right passing to the surviving spouse is taken into account in calculating the discounted gift at outset. Following the Settlor s death (or the death of the surviving Settlor) the Trustees can then either retain the Plan as a long-term tax-efficient investment for the Beneficiaries or encash the Plan and distribute the proceeds. There may be tax deferral advantages in continuing with the Trust. 10. Other important questions (i) What are the capital gains tax implications of the DDGT? A life insurance or capital redemption bond, such as the Zurich International Portfolio Bond, does not produce gains that are subject to capital gains tax. (ii) Is stamp duty payable? With effect from 1 December 2003, stamp duty on documents was abolished which means that a declaration of trust no longer needs stamping. (iii) Can the Plan be added to at a future date? Further investments in the Plan are not permitted. If the Settlor wishes to make further gifts they should make a fresh investment into a new Plan subject to a new Trust. (iv) Can the Trustees take withdrawals which exceed the Settlor s capital entitlement? It needs to be borne in mind that it is the Trustees prime responsibility to pay the Settlor any capital payments they are entitled to as and when they survive to the appropriate dates. The Trustees cannot pay them more than their entitlement on the specified date and it would be unwise to pay benefits to Beneficiaries other than the Settlor during the Settlor s lifetime. (v) Can the Trustees encash segments of the Plan and pay the proceeds to the Beneficiaries? The Trustees could, in extreme cases, take this action but, because of the reasons given in the previous answer, it is not thought that this would be a prudent course of action whilst the Settlor is alive. After the Settlor s death, there would be no reason why the Trustees could not make an absolute appointment and advancement of capital to an adult Beneficiary. If the Trustees wish to make such an advancement they can encash part or the whole of the Plan and advance cash to the Beneficiary. Alternatively, the Trustees could make an absolute appointment of capital to an adult Beneficiary and assign segments to that Beneficiary in satisfaction of their interest. The Beneficiary must then encash the segments themselves and, in such a case, chargeable event gains will be taxed on that Beneficiary which may produce a lower tax liability than if the Trustees had encashed. 16

17 (vi) What if the Plan loses value so the Settlor cannot be paid their capital entitlements? The Settlor s entitlement is subject to the Trust Fund being sufficient to meet that entitlement. The Trustees have no personal liability to the Settlor in cases where the investment reduces in value. (vii) Can an investor get their money back after making the investment? Yes, they can. When we issue the Plan documents, we ll include information on how to cancel the Plan. They (the Settlor(s) and all additional Trustees) will have 30 days from receiving these documents to do this. If they decide to cancel, we ll give them their money back. However, what they get back may not be the amount they invested they may get back less. The amount they will get back will be the lower of the amount they invested and the value of their transaction account after we have sold the assets that they have already invested in. If they invest in assets that are not priced daily, there may be a delay in paying the cancellation value until all trades have been completed. Please refer to the Plan s Terms and Conditions for full details. (viii) Is there any income tax on final encashment of the Plan? Chargeable event gains arising on full encashment of the Plan can be taxable. The full implications were described in the answer to the above question What are the income tax implications of the DDGT? and in the Appendix. (ix) What are the charges associated with an investment in the DDGT? You should look at Zurich s literature on the International Portfolio Bond in order to determine the charges made on such an investment. 17

18 11. How do you set up a DDGT? Your client will have had a full discussion with you (and other professional advisers where appropriate) about the operation of the DDGT and its suitability for them given their objectives and tax position see all the issues covered in this guide. Having decided that the DDGT is suitable in principle, the potential investor will receive a personal Discount Illustration from you (available online) and a Zurich International Portfolio Bond illustration showing estimated future values for the Plan. After this, completing the following steps will lead to implementation. Step 1 A health questionnaire must be completed by your client(s) and at this stage, only this form must be submitted to Zurich. Step 2 Zurich will underwrite your client(s) and if they are accepted, we will issue a Discount Certificate to confirm the discount. If your client(s) fails the underwriting process, a decline letter will be sent. Step 3 If your client(s) then wishes to proceed, the DDGT Deed must be completed and the Trustees must complete the right application form for the Plan. This application form must not be dated before the date of the DDGT Deed. The clearly labelled application form is subtitled Application form for use with a Discretionary Discounted Gift Trust. The Trustees cannot use any other application form, as the wording is not appropriate. The forms (completed Trust Deed and Plan application form), along with your client s cheque (or telegraphic transfer) for the full amount to be invested and the anti-money laundering information (ID & address verification for the Settlor(s) and all additional Trustees) should be sent to Zurich. Step 4 The Plan will be issued in the name of the Trustees and the Plan documents will be sent out soon after this. 18

19 Appendix This Appendix to the Adviser Guide provides more detailed information and examples on the potential inheritance tax (IHT) and income tax liabilities that could arise in connection with the DDGT. It is, however, emphasised that in most cases it is expected that Plans will not give rise to IHT or income tax at least during the lifetime of the Settlor. Of course, this will all depend on the facts of each case. A. Inheritance tax First example trust creation with immediate IHT liability The DDGT is a discretionary trust (relevant property trust). Transfers into this type of trust are treated as chargeable lifetime transfers (CLTs) for IHT purposes. The value for IHT is calculated by adding together any CLTs made in the seven years before the current gift (potentially exempt transfers [PETs] are ignored) with the current gift. The question is whether the total exceeds the current IHT nil rate band (NRB). If the answer is yes, then only the amount above the NRB will be subject to IHT. The rate of tax applicable in this instance is 20%. Example Mr Smith made a CLT of 100,000 in October 2003 and a PET of the same amount in October In July 2009 he wishes to set up a DDGT for 750,000 that results in a CLT of 325,000 into a relevant property trust. The IHT position at entry would be as shown in the table below. In this example, the IHT bill is 20,000, with the tax payable by the Trustees. If the Trustees have to pay the tax, they will have less funds available for investment in the Plan. If Mr Smith wishes to pay the tax there would be a gift of the tax as well. Under these circumstances, the gift would need to be grossed up. The easiest way of calculating the revised amount of tax payable is to replace the 20% tax rate with one of 25%, so the tax payable on the gift will be 25,000. PETs CLTs IHT payable October ,000 October ,000 July ,000 Total of CLTs in last seven years 425,000 NRB 2009/10 ( 325,000) CLT in taxing zone 100,000 Tax rate x 20% Tax payable 20,000 19

20 Second example periodic charge In determining whether the value of the Trust Fund exceeds the NRB at the ten-year anniversary, you also need to take account of any CLTs made in the seven years before establishing the Trust and the amount of any payments out of the Trust in the previous ten years. Example Let us assume the value of the DDGT in our example has grown to 800,000 by July 2019 and the value of the Settlor s right has fallen to 250,000. This means that the gifted part of the Trust is valued at 550,000. The NRB at that time is 450,000. The calculation of the IHT ten-yearly charge is: (CLTs in the seven years before the Trust commenced + capital distributions from the Trust in the ten years preceding the anniversary + the value of the Trust (less the current value of the projected withdrawals the Settlor s Fund) NRB) x 6% = tax payable. NB After the Settlor s death, the ten-yearly charge would be based on the actual value of the Trust Fund as the Settlor s rights would no longer exist see next example. CLTs in seven years before Trust started IHT payable October ,000 Value of gifted part of Trust Fund 550,000 Cumulative total 650,000 NRB 2019/20 ( 450,000) CLT in taxing zone 200,000 Tax rate x 6% Tax payable 12,000 20