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  • Katherine Bullock

Practical Magic – Estate Planning – On settlements and calling a spade a spade

Prior to the enactment of Finance Act 2020 (FA 2020) a trust was an excluded property trust if the settlor was non-domiciled when the trust was made, regardless of the domicile of the settlor thereafter. The result was no IHT charge on the trust provided no UK situs property (and post April 2017 no indirect UK residential property) was held by the trustees at the time the charge arose.

This was not HMRC’s view but HMRC’s view was held to be wrong by the Court of Appeal in Barclays Wealth Trustees Limited & Michael Dreelan v HMRC [2017] EWCA 1512 which concerned the movement of assets from one settlement, made when Mr Dreelan, the settlor, was non-domiciled, to another and then back at times when Mr Dreelan had become UK domiciled.

"...HMRC’s view was held to be wrong by the Court of Appeal..."

The Court of Appeal held that as section 81 IHTA 1984 deemed assets transferred between settlements to remain within the original settlement, where no-one had obtained an absolute interest in them in the interim, the status of the assets as excluded property never changed. This was even though, as HMRC argued, in reality transfers were made after the settlor had become UK-domiciled.

FA 2020 restores HMRC’s world view, clarifies Parliament’s intention and affects IHT charges (including those on the settlor’s death) after 22 July 2020, regardless of when the transaction took place.

Accordingly where a settlor adds to an excluded property trust once UK domiciled, the settlor's domicile is tested when the 'property became comprised in the settlement' rather than when the 'settlement was made’. Example: A non-domiciled individual sets up a trust on 1 January 2010 while non-dom with $1m. He becomes deemed domiciled in the UK and adds $500k before 22 July 2020. On the occasion of the 10 year charge on 1 January 2030, $500,000 is not excluded property. The original property is unaffected.

The rules are different for transfers between trusts. Where there is a transfer between relevant property trusts after the settlor becomes deemed domiciled, transfers made after 22 July 2020 are not excluded property. It does not matter if the settlor was not involved or did not know. The settlor, for these purposes, may not necessarily be the person that might normally be identified as such. Where the trust interest is assigned by a beneficiary, the beneficiary is the settlor for these purposes. Where a general power of appointment is exercised, the person exercising the power is the settlor. This means that careful records will need to be maintained not only of the history of trust additions but the domicile of settlors, beneficiaries and others.

A gift with reservation of benefit (GROB) may now arise in respect of non-UK situs property added to an excluded property trust after the settlor becomes UK domiciled and where the settlor retains an interest in the trust. Particular care is therefore needed not to overlook these occasions. For example, if two trusts are set up when the settlor is non domiciled and the transfer takes place after settlor is deemed domiciled and before 22 July 2020, the transfer to the second trust may be excluded property (under HMRC’s stated practice) but the GROB rules will apply if the settlor is a beneficiary of the second trust and the assets transferred will be included in settlor’s estate under GROB, if he dies after 22 July 2020.

Despite FA 2020’s preference for recognising the ‘reality’ of the situation, accumulations from capital that is excluded property within a settlement are treated as being part of the original capital, and so will benefit from the same excluded status as the original capital, even where added later. This avoids the awkward situation where an excluded asset would continue to generate non-excluded value.

Going forward therefore there are a number of traps to guard against. First, there is no guidance on tracing property that is mixed so it may be sensible to segregate assets added after the settlor becomes UK domiciled from those added before that event. Second, trustees should retest the domicile of the settlor whenever there is an addition to or transfer between trust, taking care to identify the settlor for these purposes. Third, take great care with variations of trust and avoid a resettlement, particularly when reducing the class of beneficiaries. Finally watch out for the unexpected GROB on pre 2020 transfers.


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