Taxation Readers’ Forum: At your discretion – offshore bonds and IHT

‘My client died in September 2018. She was UK resident and was the settlor and beneficiary of a discretionary trust. A vulnerable person’s election was in place.

In March 2019, the trustees cashed in an offshore bond because funds were required to pay an inheritance tax liability. A six figure chargeable event gain arose on encashment.

My questions to readers are as follows:

• Who is liable to pay the tax?
• Should the gain be reported in the trust tax return, the personal return to date of death or the administration return from date of death to 5 April 2019?

I am aware that the position is rather more complicated when an encashment applies after death, but before the end of the tax year. Unfortunately, I have no practical experience of this; perhaps it is an unusual occurrence.

Leading on from who is taxed, I have the following additional questions.

• How will top slicing relief operate (12 years in this case) bearing in mind that if the gain was liable on the trustees this would not be available whereas if it applies to the settlor it will give a significant reduction to tax due.
• If the income tax liability on the gain was chargeable on the settlor but the trust reimbursed them, would that have any unintended consequences?

Taxation readers’ views will be very much appreciated.’ Query 19,460 – Sliced and Diced.

Terry Jordan’s reply

‘Generally, the settlor will be liable to tax on the chargeable gain.

Where, as here, a policy is held on trust, the settlor of the trust will normally be chargeable if still available to charge (ITTOIA 2005, s 465). A settlor who dies may in some cases be chargeable on an event occurring after death, for example if the policy held by trustees is on the life of someone other than the settlor and continues after the settlor’s death.

When a chargeable event occurs after a UK resident settlor’s death, but before the end of the tax year, the gain will be chargeable as part of the total income of the deceased settlor for that tax year and should be shown on their tax return.

If the gain arises on an event after the end of the tax year in which the settlor died, the trustees will be taxed on the gain, subject to transitional provisions for policies in existence before 17 March 1998.

If the trust and the policy were in existence before 17 March 1998 and at least one of its creators was an individual and one of the creators died before 17 March 1998 then, as long as the policy has not been varied on or after 17 March 1998 to increase benefits or extend its term, there is no charge on the trustees and no charge on the settlor if the chargeable event occurs in a tax year later than that of the settlor’s death (ITTOIA 2005, Sch 2 para 112).

Sliced and Diced asks about top slicing relief. In Marina Silver (TC7103) it was held that the taxpayer was entitled to her personal allowance in the hypothetical calculation undertaken to calculate the relief even though the gain meant that her total income was well in excess of £100,000 for the relevant tax year.

Sliced and Diced also raises a question on the reimbursement of the tax payable. Section 538 gives a right of reimbursement and the consequence will be that the liability will not be deductible for inheritance tax purposes in the settlor’s estate. That may not make any practical difference if the value of the discretionary trust is subject to inheritance tax under the gifts with reservation of benefit provisions.’