Malcolm Finney checks out the current position on the use and implications of pilot trusts for inheritance tax purposes.
The answer to the question posed in the title of this article is perhaps ‘slowly dying but by no means dead’!
What is a pilot trust?
A pilot trust is broadly a discretionary trust with only a nominal sum being settled initially (e.g. £10) and which will often contain a statement that further funds (usually substantial) are to be added to the trust.
Property comprised in a discretionary trust is subject to two key inheritance tax (IHT) charges, namely, anniversary charges (i.e. levied on the value of the trust property every ten years, at up to 6%) and exit charges (i.e. levied on the value of trust property when it ceases to be held in trust).
It is with a view to minimising these charges that the concept of the pilot trust is utilised often in multiple form.
Multiple pilot trusts
When a settlor creates a number of pilot trusts on successive (not the same) days, the trusts are not regarded as ‘related’ when calculating any anniversary and exit IHT charges. As a consequence, the value of property in each of the other trusts is ignored and not aggregated with the value of the trust property under consideration and such IHT charges are significantly reduced.
In addition, when calculating the charges each trust is generally entitled to its own nil rate band of £325,000 (i.e. giving rise to a possible 0% charge, if trust property value is below £325,000).
Classic use of multiple trusts pre-10 December 2014
A grandfather on his death wishes to leave a large sum to his grandchildren. By simply leaving a single large sum on a single trust set up under his will, it causes maximum future anniversary and exit charges; by using pilot trusts such charges can be severely mitigated.
Example: Multiple pilot trusts
Harry Smith is proposing to leave £900,000 to his grandchildren. On advice he sets up three lifetime pilot trusts (each with £10). Two years later on his death he leaves £300,000 to each of the three trusts (on which IHT is payable, to the extent that Harry’s available nil rate band is exceeded).
As each amount falls within the nil rate band of £325,000, future anniversary and exit IHT charges are significantly mitigated (if not nil). Settling the £900,000 on a single will trust precipitates an anniversary charge of £34,500 (only one IHT nil rate band being available).
Unfortunately, HMRC decided that it was not happy with what was perceived as a loophole through which taxpayers were driving many coaches and horses, and so changed the rules introducing a so-called anti-avoidance ‘same-day addition’ rule.
The intended effect of this rule was to kill off the type of planning in the above example, by requiring the value of property added on the same day to different trusts to be aggregated when computing anniversary and exit charges.
Not retrospective
However, the good news is that legislation was not retrospective, and thus it does not apply to pilot trusts created and added to before 10 December 2014. In addition, transitional provisions provide that if death occurred before 6 April 2017 and a will has been executed before 10 December 2014, the ‘old’ rules continue to apply (even though any additions under the will may take place on or after 10 December 2014), enabling IHT savings to still be made.
Not only were the new rules not retrospective but they have not precluded the use of pilot trusts in their entirety. The same day rule can be simply avoided with respect to lifetime additions of substantial monies by making sure any such additions are made on different (e.g. successive) days; which means that each pilot trust retains its own nil rate band and any anniversary and exit charges are mitigated.
Practical uses
Settling life assurance policies on lifetime pilot trusts may be particularly advantageous (e.g. instead of settling a £1 million life insurance policy on one trust, four separate policies each of £250,000 are settled on four separate pilot trusts). Consideration might also be given to pension death benefits out of trust-based pension schemes.
Pilot trusts should also be considered where property subject to IHT business property relief is to be settled.
Practical Tip:
Pilot trusts are not dead and still have a powerful role to play with respect to IHT mitigation. Advice should, therefore, be sought whenever large sums are to be settled as to whether use of multiple pilot trusts could achieve significant IHT savings.
