Trust continuity preserves IHT excluded property status in Court of Appeal

Fri 27 Oct 2017

Recent changes in the domicile rules affecting an individual’s inheritance tax (IHT) non-domicile status can have serious effects on trusts they have set up. Overseas assets settled on trust when the settlor was non-domiciled are excluded property for IHT purposes which means those assets are not liable for IHT charges when they become or cease to be relevant property of the trust, or for the 10-yearly principal charge

IHT and trusts generally- relevant property

The majority of assets held in trusts settled since 22 March 2006 (including will trusts) are subject to IHT as relevant property, although there is an exception for certain narrowly defined types of interest in possession (IIP) trust for:

·         bereaved minors;

·         disabled persons; and

·         certain lifetime beneficiaries who have “Immediate Post-death Interests”.

As regards IIP trusts settled before 22 March 2006, IIP trusts are usually kept out of the relevant property regime as “qualifying interests in possession”. The IHT regime for relevant property trusts can mean IHT is payable when assets are added to the trust (for example at lifetime rates if the settlor is still alive), and also at every ten year interval at a reduced rate (a maximum of 6%) where the assets remain in trust.  There may also be an IHT charge when the assets leave the trust based on the length of time the assets have been in the trust since the previous charge.

Excluded property is not subject to IHT

There is a range of assets that can be excluded property, some defined by the type of asset, such as certain Government securities (“gilts”) but an important class of excluded assetsis the overseas assets of non-UK domiciliaries. The interpretation of the provisions concerning the exclusion of overseas assets settled on trust by a non-UK domiciliary was the subject of a Court of Appeal case in Barclays Wealth Trustees (Jersey) limited and Michael Dreelan v HMRC referred to as “Dreelan” for ease and to avoid confusion, due to the number of cases that have involved Barclays Bank entities over the years.

Ordinarily settled property remains in the trust it was originally settled on until it is appointed out to a beneficiary, by exercise of a power of appointment or when the trust comes to an end. However, in Dreelan things were a bit more complicated.:

·         Mr. Dreelan was non-UK domiciled when he established a Jersey trust in 2001 and settled assets, mainly cash, on trust in February 2003.

·         In April 2003 he became UK-domiciled.

·         The trust property was shares in a UK company, acquired using the cash he had settled, which once within the trust, became held below a UK company.

·         Those UK shares were appointed by the trustees to another trust in 2008.

·         Later in 2008 those shares were sold for cash and an earn-out, and in 2011 the cash (sited in the UK) was appointed back to the original trust.  The cash was transferred by the trustees from the UK to a non-UK bank account shortly before the original trust’s first ten year anniversary.

·         All of the appointments of the property after initial settlement took place after Mr. Dreelan had become UK-domiciled.

The statutory definition of excluded settled property

Inheritance Tax Act 1984 (IHTA) s 48 (3) deals with excluded settled property thus:

“Where property comprised in a settlement is situated outside the United Kingdom –

(a)        the property . . . is excluded property unless the settlor was domiciled in the United Kingdom at the time the settlement was made …”

So if the property is overseas at the time of an occasion of charge, even if it has been in the UK since being settled and only later returned offshore before the occasion of charge, it doesn’t matter if the settlor has become UK-domiciled in the meantime: the property is still excluded.

The complication- property transferred through other settlements

The original settled property changed its form a number of times over the years, from cash to shares, to cash and an earn-out right and finally back completely into cash which was held in the UK until a few days before the original trust’s next ten-year charge was due. It was not disputed that the cash in the trust at the ten-year anniversary, which fell in 2011:

·         was overseas property at that date; and

·         was directly traceable back to the original settlement made when Mr. Dreelan was non-domiciled.

Mr. Dreelan and the trustees’ contention was that although the trust property had left the original trust, moved through other trusts and eventually returned to the original trust, it should be treated as never having left the original trust. The basis for this was IHTA s 81 which requires property that has been held in more than one trust successively must be regarded as remaining in the original trust unless there has ever been a time when it was not only outside any trust but also beneficially owned by any person.

But IHTA s 82 applies a restriction to excluded property that has passed through more than one trust: for the property to be excluded property, the settlor of every trust that the property passes through must have been non-domiciled at the date when property was settled on the trust.

HMRC argued that when in 2011 the property was appointed from the second trust back to the original trust, that was a new settlement as far as the second trust was concerned. The High Court had accepted that argument but the trustees and Mr. Dreelan appealed to the Court of Appeal.

It has long been accepted that as a matter of general trust law once a trust has been set up its effective settlement date is the date when property was first settled onto it and for trust purposes it doesn’t matter what other additional settlements of property take place: there is only one date on which settlement of the trust takes place.

The Court of Appeal unanimously decided that the simple literal meaning of s 48 followed the principles of trust law so that:

·         s 48 should be interpreted as requiring only that the settlor had to be non-domiciled at the time when the trust’s originating settlement was made; and

·         all subsequent additions of property, while they might be settlements of property, could not be regarded as the settlement of the trust.

This was a robust judgment that restored the common understanding of how ss 48, 81 and 82 operated that had applied until the High Court decision.