HMRC Inheritance Tax: Customer Guide

What are special trusts?

What are 'special trusts'?

Special trusts are types of discretionary trusts, but the settled property held on them is not relevant property. This means that special trusts are not liable to the ten-yearly and proportionate charges, although in some instances the property may be subject to another charge on leaving the trust.

It also means that, subject to any specific exemption, there is a tax charge when an existing discretionary trust is converted to a special trust.

Superannuation schemes

Approved superannuation schemes and approved personal pension arrangements are generally exempt from the charges on settled property. Tax may be payable if

  • a member gives up part of his or her pension in order to provide for someone other than a spouse or civil partner
  • a member has the power to decide who receives a benefit on his or her death
  • a benefit on the member's death is payable to the personal representatives as part of the estate
  • a sum payable under the scheme is made the subject of a further trust.

Accumulation and maintenance trusts

Before 6 April 2008, property in an accumulation and maintenance trust was not relevant property. To come within that definition the trusts must have satisfied the following tests

  • there was no interest in possession in the settled property
  • one or more people (qualifying beneficiaries) would be beneficially entitled to the property, or to an interest in possession in it, by the age of 25, and in the meantime, any income that is not used for the maintenance, education or benefit of a qualifying beneficiary was to be accumulated.

If a trust satisfied these statutory requirements, the settled property was not liable to the ten-yearly or proportionate charge. Unless all the qualifying beneficiaries were grandchildren of a common grandparent, this exclusion from the charge ceased to apply 25 years after the last time the statutory conditions were satisfied. (For this purpose, 'grandchildren' includes the widows, widowers, surviving civil partners or children of such grandchildren, if those grandchildren died before becoming entitled to the property.)

There are, however, transitional arrangements for accumulation and maintenance trusts that existed on 15 April 1976. If you are dealing with one of these please bear in mind the article in the December 2000 issue of Tax Bulletin 50 on these trusts.

Apart from the exemptions described below, inheritance tax is charged when

  • property held on accumulation and maintenance trusts ceases to be held on those trusts
  • the trustees make a disposition.

This charge, like the proportionate charge, is the amount by which the value of the settled property is reduced as a result of the event giving rise to the charge. If the tax payable is paid by the trustees out of any property remaining in the trust it is grossed up at the appropriate rate.

Tax is charged at a flat rate, which tapers over time. The extent of the taper depends on the time (counted in quarters) that has passed since the property, on which the charge falls, became or last became held on accumulation and maintenance trusts.

The rate is

  • 0.25% for the first complete 40 quarters (10 years)
  • 0.2% for each of the next complete 40 quarters, reducing by 0.05% for each succeeding 40 quarters (up to 50 years).

After 10 years the rate is 10%, after 20 years 18%, after 30 years 24%, rising to a maximum of 30% if the property has been in trust for 50 years or more before the chargeable event.

Periods before 13 March 1975 are not counted. In calculating the flat rate tax charge to the time that has passed since the property was put on the special trust, if it has been excluded property at any time it is not counted.

Are there any exemptions for accumulation and maintenance trusts?

Prior to 6 April 2008, there was no tax charge if settled property ceased to be held on accumulation and maintenance trusts because a qualifying beneficiary

  • became beneficially entitled to the property or to an interest in possession in it
  • died before becoming entitled to the property.

In addition, there was no liability to inheritance tax on

  • distributions to charities or other exempt bodies
  • payments that are (or will be) income for income tax purposes in the recipient's hands, and
  • payments of trustees' costs.

In certain circumstances, relief was also available from the charge arising on a reduction in the value of the settled property due to a disposition by the trustees.

New rules for existing accumulation and maintenance trusts from 6 April 2008

Accumulation and maintenance trusts which were already in existence on 22 March 2006 will change from 6 April 2008. From 22 March 2006, no new accumulation and maintenance trust can be created.

For those trusts already in existence, there are three options:

1. The trustees of the trust can amend the terms of the trust, before 6 April 2008, to provide that the beneficiaries of the trust will become absolutely entitled to the property on or before the age of eighteen. If any distributions are made from the trust, they must be made to the beneficiaries. If they do this, the trust can remain as an accumulation and maintenance trust until the eighteenth birthdays of the beneficiaries and the exemptions previously enjoyed will continue.

2. The trustees of the trust can rewrite the rules of the trust, before 6 April 2008, to provide that the beneficiaries will become absolutely entitled to the trust assets on or before their 25th birthdays. If they do this, the trust will become a new age 18 to 25 trust and age 18 to 25 exit charges will apply to distributions to the beneficiaries and when the beneficiary becomes absolutely entitled to the trust property at the age of 25.

3. The trustees of the trust can do nothing. The accumulation and maintenance trust will then become a relevant property trust and will be subject to the mainstream proportionate charges and ten-yearly anniversary charges which apply to relevant property trusts. Examples of these charges can be found in the section called ‘How is inheritance tax charged on relevant property trusts’?

Employee trusts

Relief from the ten-yearly and proportionate charges is available on employee trusts.

Tax is charged when property ceases to be held on employee trusts or when the trustees make a disposition, which reduces the value of the property that is held. Distributions to the employees or their relatives or dependants are normally exempt.

No tax charge arises on an interest in possession in the settled property if the interest extends to less than 5% of the property.

The rate of tax is the same as property leaving accumulation and maintenance trusts. In calculating the period over which the charge applies, different rules apply when an existing discretionary trust was converted to an employee trust after 9 December 1981 and before 9 March 1982.

Charitable trusts

Inheritance tax is not charged on settled property that is held indefinitely for charitable purposes only.

The treatment of 'temporary charitable trusts' is different. Settled property that is held for a limited period for charitable purposes only is also excluded from the ten-yearly and proportionate charges. Instead, tax is charged when

  • property ceases to be held for charitable purposes, or
  • the trustees make a disposition, which reduces the value of the property that is held.

Any application of the property for charitable purposes does not give rise to a charge.

The rules governing the tax charge on property leaving temporary charitable trusts and the rate of the charge are similar to those that apply to other special trusts, such as employee trusts.

Compensation funds

Property that is held in a compensation fund and maintained by a trade or professional association is exempt. The exemption applies only if the purpose of the fund is solely or mainly to compensate for or relieve loss or hardship which, through the default of members, is incurred by others.

Newspaper trusts

The settled property charges do not normally apply to trusts for newspaper publishing companies or newspaper holding companies.

Instead, they are treated like employee trusts.

Protective trusts

If a beneficiary (the principal beneficiary) has an interest in possession that is subject to protective trusts and he or she tries to dispose of the interest (or do anything to deprive him or her of it), the interest in possession comes to an end.

The settled property becomes subject to discretionary trusts under which the income may be used for the benefit of the beneficiary or his or her spouse or the beneficiary’s spouse, civil partner or issue.

The property is not relevant property, and the ten-yearly and proportionate charges do not apply if the principal beneficiary's interest in possession

  • was subject to protective trusts
  • came to an end before 12 April 1978, and
  • on that event, the settled property became subject to discretionary trusts.

Tax is charged when

  • property ceases to be held on those trusts
  • the trustees make a disposition, which reduces the value of the property, on the same basis as applies to property leaving employee trusts.

Distributions for the benefit of the beneficiary who had the protected interest are exempt.

After 11 April 1978 the failure or determination of a beneficiary's interest in possession, which is subject to protective trusts, is ignored. The beneficiary is treated as having an interest in possession in the property which, under the general law, is then held on statutory (or similar) discretionary trusts. Tax is not charged on the failure or determination of the interest.

Distributions from the property to people other than the principal beneficiary are dealt with on the same basis as for interest in possession settlements (see above).

Trusts for disabled people

When the property ceases to be held on the discretionary trusts (whether during the lifetime of the disabled person or at death) it is dealt with on the same basis as interest in possession trusts.

The rules do not apply when the property held on the discretionary trusts was transferred into trust before 10 March 1981. Relief from the ten-yearly and proportionate charges is available for this property because it is not regarded as relevant property.

Inheritance tax is charged when the property ceases to be held on the discretionary trusts on the same basis as the charge on property leaving employee trusts. A similar charge arises when the trustees make a disposition, which reduces the value of the trust property.

There is no tax charge on payments for the benefit of the disabled person.

Maintenance funds for historic land and buildings

Relief from the full discretionary trust charges is available for trust funds set up for the maintenance of designated land and buildings.

But, a tax charge may arise

  • if any property ceases to be held on the relevant trusts, or
  • when the trustees make a disposition, which reduces the value of the trust property.