NOTE: This article was published in December 2018 and reflects the law as it stands on the date of publication and not at any later date. 

The paper can be downloaded as a PDF here.

8B.1. Advantages of 2-year discretionary trust

A gift of a QRI and/or of the downsizing addition to a discretionary trust will not qualify for the RNRB, since it will not be closely inherited. However, in circumstances where a RNRB gift might be advisable, advantage could be taken of IHTA 1984, s. 144 so as to obtain the benefit of the RNRB if, within 2 years of death, it is appropriate for the whole or part of the QRI and/or downsizing addition to be appointed to direct descendants absolutely, or on trusts which attract the RNRB.

The use of a discretionary trust be particularly appropriate in the case of a married couple following the first death. The predeceasing spouse could make a gift to the discretionary trust of such a share in his or her QRI, and any downsizing addition, sufficient to claim the maximum RNRB on their death. Alternatively, the whole estate could pass into such a discretionary trust. The beneficiaries would include the surviving spouse and direct descendants.

The Will could provide that any appointment must be made within a period ending on the day before the second anniversary of the testator’s death. The trustees would then have the option, within 2 years of the death of the testator, of appointing the whole or part of the trust assets:

(a) to children absolutely or on IPDI trusts, thereby taking advantage of the RNRB;
(b) to the surviving spouse absolutely or on IPDI trusts, taking advantage of the spouse exemption; or
(c) upon long-term discretionary trusts out of which appointments can be made after the expiry of the 2-year period, e.g. to the surviving spouse for life.

An appointment to the surviving spouse might be appropriate if, say, the testator’s estate is above the taper threshold, or because the trustees determine that the IHT benefits of the RNRB are less important than the survivor having full control and ownership of the house. The testator could give guidance to the trustees in a letter of wishes.

The Will would contain a default provision if and to the extent that an appointment is not made within the discretionary period, such as:

(a) a trust for the children in equal shares absolutely; or
(b) a trust for the surviving spouse absolutely, if she is then living, and in default to the children in equal shares absolutely.
8B.2. Risk of IPDI for surviving spouse

If the RNRB gift to a discretionary trust is of the testator’s residence or of a share therein (as opposed to a cash legacy of the downsizing addition) there is a risk that the surviving spouse will be deemed to have an IPDI therein, by virtue of her exclusive occupation of the residence without paying an occupation rent to the trustees. Her occupation may be deemed to be pursuant to the trustees’ express, or implied, grant of permission (see Statement of Practice 10/79).

An interest in possession which arises within 2 years of death will be backdated to death by reason of IHTA 1984, s. 144 and would, therefore, qualify as an IPDI subject to IHT at full death rates in the survivor’s estate. This may not be of great concern where the TNRB and the brought-forward allowance can be claimed on the survivor’s death. However, it would be unfortunate where the aim is to avoid wasting the brought-forward allowance and/or TNRB (see 8.11.5 above). It would also not be possible to make an appointment to direct descendants within 2 years of death, thereby making use of the RNRB, since it is a requirement of IHTA 1984, s. 144 that an IPDI has not arisen before the appointment.

8B.3. Arguments against an IPDI

The risk of an IPDI is not so great where the surviving spouse owned a share in the residence in her own right before the first death. The surviving spouse will, no doubt, have a right of occupation under TLATA 1996, s. 12 by virtue of her own share. The same reasoning should apply if the predeceasing spouse owned the whole beneficial interest, but devised a share equal to the RNRB to the discretionary trust, and the remaining share to the surviving spouse absolutely, or on IPDI trusts. The surviving spouse occupies by virtue of her entitlement to, or in, the remaining share.
In any event, an interest in possession cannot arise unless the trustees consciously determine, expressly or tacitly, to confer a right of occupation (Judge v HMRC [2005] STC (SCD) 874). Indeed, HMRC have confirmed, at least in a case where a discretionary trust is funded by a share in property, that an IPDI should not arise if the surviving spouse merely continues in occupation on the same terms as before the testator’s death without the trustees doing anything positive to affect the survivor’s occupation.

It is, therefore, strongly arguable that the surviving spouse would not acquire an interest in possession in the trust’s interest, pending a decision by the trustees whether to appoint to the surviving spouse, or for the benefit of the children. Indeed, that argument would be even stronger if the default trust is in favour of the children.

The risk of an IPDI is, however, more acute where the testator owned the whole beneficial interest in the residence, and the whole interest is settled on discretionary trusts. If the surviving spouse continues to reside, it may be an irresistible inference that she does so pursuant to the trustees’ permission.

Furthermore, even where the surviving spouse owns a share in her own right, an IPDI might be inferred if the residence is sold, and the trustees reinvest the trust’s share of the sale proceeds within 2 years of death in the purchase of another property, occupied by the surviving spouse. The trustees would then have taken positive steps within the 2-year period to confer a right of occupation on the surviving spouse, with regard to the trustees’ share, thereby conferring an IPDI therein.

It may be considered, however, that the flexibility of appointing to the surviving spouse, or to children so as to take advantage of the RNRB, outweighs the relatively remote risk of conferring an IPDI on the surviving spouse.

8B.4. CGT

An appointment out of the discretionary trust within 2 years of death to the children, or to the surviving spouse, absolutely, may give rise to a deemed disposal at mar.ket value by the trustees for CGT purposes, on a beneficiary becoming absolutely entitled (TCGA 1992, s. 71). Holdover relief will not be available under TCGA 1992, s. 260(2)(a). However, this will not matter if the appointment is made before the administration is complete. In that event, the appointee will take as a “legatee”. The appointee will be deemed to acquire the appointed property at probate value, so that there is no chargeable gain (TCGA 1992, s. 62(4); CGT Manual, para. 31430).

If the appointment is made within the 2-year period, to the children absolutely or upon IPDI trusts, so as to take advantage of the RNRB, the question arises whether principal private residence relief would be available in respect of the children’s share on the subsequent sale of the property, assuming that the property is not the children’s only or main residence. Relief should apply if there is an appointment of part of the testa.tor’s QRI upon IPDI trusts for the children, and of the remainder of the QRI upon IPDI trusts for the surviving spouse, who occupies the property as her only or main residence. Under TCGA 1992, s. 225 relief is available so long as a beneficiary (but not necessarily all of the beneficiaries) of a trust of an interest in a dwelling-house reside in the dwelling-house. The testator’s share of the dwelling-house will be comprised in one trust, following an appointment for the benefit of the children and the spouse. Indeed, the whole of the testator’s share should be regarded as settled in one trust even if the trustees appoint part to the children absolutely, so long as the remaining part is settled on IPDI trusts for the surviving spouse (see Crowe v Appleby (1975) 51 TC 457).