IPDI or not IPDI?

…That is the question.

You often see Life Interest Trusts and Right to Occupy Trusts discussed together, and for good reason as they do share some similarities. This week we give a basic overview of their differences, specifically when it comes to Inheritance Tax (IHT) treatment.

In brief, Life Interest Trusts grant a person the right to occupy any trust property and a right to receive all the income produced by the trust, for example if the property is rented out or sold. These trusts may also be extended to give the trustees powers to advance capital to the life tenant on a discretionary basis. In contrast, a Right to Occupy Trust simply grants a person a right to occupy any trust property without any of the additional entitlements conferred by a full Life Interest.

So how do they compare IHT wise? This will depend on how the trust is drafted.

A Life Interest Trust that is created by will and that takes effect immediately upon the testator’s death (an ‘Immediate Post Death Interest’ [IPDI]) grants the life tenant an ‘interest in possession’ (IIP).

On the testator’s death the assets pass to the trust free of IHT if the life tenant is their spouse or civil partner. If the life tenant is not a spouse or civil partner there may be IHT to pay when the assets pass to the trust. During the life tenancy there will be no anniversary or exit charges. The pitfall though is that when the life tenant dies the trust fund is revalued and the value of the assets amalgamated with their own assets for calculating IHT. This is because assets held in an IIP trust are treated for IHT purposes as though they belong to the life tenant.

Despite appearing simpler, a Right to Occupy can actually get a bit more complex. If the Right to Occupy is drafted so that the Occupant has an absolute right to occupy the property free of rent, and this right cannot be revoked by the trustees then they will be treated as having an IIP. This will then be taxed following the rules discussed above.

If the trustees are instead given an overriding power to revoke the right to occupy then the trust may not be taxed as an IIP trust and may instead be taxed under the relevant property regime; assuming HMRC are satisfied that the overriding power to revoke is enough to avoid creating an IIP.

This will mean that assets passing to the trust on first death may be subject to IHT, even where the Occupant is a spouse or civil partner. Depending on the value of the assets in the trust it may also be subject to anniversary charges (every 10 years) and exit charges (when assets leave the trust) at a maximum of 6%. On the death of the Occupant the assets in the trust are not treated as part of their estate for IHT purposes. This will also mean that the RNRB will not be available, and in the case of spouses and civil partners the full TNRB of the first to die will not be available on second death.

 

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