2012 Number 2 Finance Act 2012: Discretionary Trust Tax 107 Introduction Most practitioners will be familiar with discretionary trusts, which clients often establish in their wills and, less frequently, by a deed of settlement set up during their lifetime. FA 2012 seeks to extend the definition of a discretionary trust and to change the charging provisions, which will lead to greater complexities, particularly in relation to discretionary trusts arising under a will. What is a Discretionary Trust? A discretionary trust arises where the trust property is held by the trustees on trust to apply the income or capital, or both, for the benefit of the members of the class of beneficiaries as (specified in the trust document) in such proportions as the trustees in their absolute discretion think fit. A discretionary trust may be created Finance Act 2012: Discretionary Trust Tax Susan O Connell Partner, O Connell Brennan Solicitors Cormac Brennan Partner, O Connell Brennan Solicitors by an inter vivos deed of trust or settlement or, more commonly, by will. A discretionary will trust provides a flexible structure for parents with young children where it is difficult to ascertain at the time of making a will what their individual circumstances might be in the future or where a person is making provision in his or her will for an individual with special needs who may not have the capacity to hold assets directly in his or her own name or to manage them. In many cases, parents will include a discretionary trust structure in their will to ensure that their children are sufficiently mature at the date when they receive their inheritance, and the trustees of the discretionary trust are entrusted with the role of ascertaining the level of maturity of the children and their ability to manage the assets involved.
108 Finance Act 2012: Discretionary Trust Tax CAT and Discretionary Trust Tax A discretionary trust provides flexibility in the distribution of an estate and, depending on the circumstances, it may be possible to distribute some or all of the assets in a tax-efficient manner. With capital acquisitions tax-free thresholds having been significantly reduced, the rate of CAT having risen steadily over the last three years and many estates suffering from a lack of liquidity, discretionary trusts may provide a solution for clients who wish to facilitate the payment of inheritance tax liabilities in an orderly fashion. As a beneficiary of a discretionary trust is liable to CAT only when the trustees appoint property out of the trust to him or her, in order to combat the loss of CAT where assets were being held for long periods in discretionary trusts, FA 1984 introduced an initial levy on assets comprised in a discretionary trust. An annual levy on the assets comprised in a discretionary trust was subsequently introduced by FA 1986. This article aims to set out the core charging provisions and the effect of the changes introduced by FA 2012. Definition of a Discretionary Trust The definition of a discretionary trust for tax purposes brings within the charge to tax trusts that are not strictly discretionary trusts from a legal perspective. Section 2 CATCA 2003 defines a discretionary trust as follows: Discretionary Trust means any trust whereby, or by virtue or in consequence of which The definition of a discretionary trust for tax purposes brings within the charge to tax trusts that are not strictly discretionary trusts from a legal perspective. The definition includes certain trusts such as maintenance and accumulation trusts, which would not normally be regarded by legal practitioners as discretionary trusts. Section 111 FA 2012 seeks to amend the definition of a discretionary trust by providing that any entity which is similar in its effect to a discretionary trust shall be treated as a discretionary trust irrespective of how it is described in the place where it is established. FA 2012 also provides that any reference to trustees in relation to a discretionary trust shall be deemed to include persons acting in a similar capacity to trustees in relation to such an entity. According to the explanatory memorandum to Finance Bill 2012, the purpose of this amendment is to extend discretionary trust tax to entities known as foundations, and it applies with effect from 8 February 2012. The amendment as contained in FA 2012 is in fact much broader and may have the effect of including other entities that it is not intended to capture. It would appear for the moment, however, that the main purpose of the amendment is to ensure that foundations established in countries such as Liechtenstein, Jersey and Panama will be within the charge to discretionary trust tax if they fall within the territorial limits of CAT (see below). Initial Levy (a) (b) property is held on trust to accumulate the income or part of the income of the property, or property (other than property to which for the time being a person is beneficially entitled for an interest in possession) is held on trust to apply, or with a power to apply, the income or capital or part of the income or capital of the property for the benefit of any person or persons or of any one or more of a number or of a class of persons whether at the discretion of trustees or any other person and notwithstanding that there may be a power to accumulate all or any part of the income. FA 1984 introduced a levy on the value of the assets comprised in a discretionary trust. These provisions are now contained in ss14 18 CATCA 2003 (as amended). The levy as introduced was 3%, and it was increased in 1994 to 6%. However, since 1994, the legislation provides for a refund of one-half of the initial levy if the trust is wound up and all of the trust assets are appointed absolutely to beneficiaries within five years. The initial levy applies to any trust in relation to which property was subject to a discretionary trust on 25 January 1984 and to any trust where property becomes subject to a discretionary trust on or after that date. The objective of the 1984 legislation was to tax certain discretionary trusts where amounts of capital are tied up
2012 Number 2 Finance Act 2012: Discretionary Trust Tax 109 and withheld for the purposes of postponing immediate liability to CAT. Where property is subject to a discretionary trust, the initial levy arises on the later of: law, the assets did not become subject to the discretionary trust until the residue of the estate was ascertained. Details of the effect of this amendment are set out below. the date on which the property becomes subject to the discretionary trust, the date of death of the disponer or the date on which all of the principal objects of the trust have reached the age of 21 years. The term principal objects includes the spouse or civil partner of the disponer, the children of the disponer, the children of the civil partner of the disponer, the children of a predeceased child of the disponer, the children of a predeceased child of the civil partner of the disponer, the children of the civil partner of a predeceased child of the disponer, or the children of the civil partner of a predeceased child of the civil partner of the disponer ( civil partner above refers to "spouse or civil partner ). Predeceased in all instances means predeceased the disponer. The amendment introduced by FA 2012 provides that, where a discretionary trust is created by a will or codicil of a deceased person, the property is deemed to become subject to the discretionary trust on the date of death of that person. This effectively reverses the judgment of the High Court in Revenue Commissioners v Christie and Others (as executors of the Jeannie Hammett Irvine Will Trust) (unreported, 3 February 2006). In that case, the High Court considered a discretionary trust established by the will of the deceased. Approximately four years after the date of death, the executors assented to the vesting of the trust fund (being the residue of the estate) in themselves as trustees. Revenue argued that the property became subject to the discretionary trust on the date of death of the disponer, while the trustees argued that, as the fund consisted of the residue of an estate, it could not have been subject to the discretionary trust until the residue of the estate was ascertained and appointed to the trustees. Laffoy J ruled that, as a matter of Annual Levy FA 1986 introduced a 1% annual levy on the value of undistributed assets comprised in a discretionary trust. These provisions are now contained in ss19 24 CATCA 2003 (as amended). The annual levy is charged on the value of the assets comprised in a chargeable discretionary trust on 31 December in each year. A chargeable discretionary trust is a discretionary trust where: the disponer is dead and The amendment introduced by FA 2012 provides that, where a discretionary trust is created by a will or codicil of a deceased person, the property is deemed to become subject to the discretionary trust on the date of death of that person. This effectively reverses the judgment of the High Court in Revenue Commissioners v Christie and Others. none of the principal objects (as defined above) is under the age of 21 years. However, the 1% annual levy will not arise within the same 12-month period as the initial levy. There are anti-avoidance provisions to counter short-term appointments out of discretionary trusts for the purposes of ensuring that on the valuation date (31 December) there are no assets or there are diminished assets in the trust for the purpose of the 1% annual levy. Scope of Discretionary Trust Tax The rules of CAT apply in determining the territorial limits of discretionary trust tax. Accordingly, for trusts created before 1 December 1999, the entire property subject to the discretionary trust is chargeable to discretionary trust tax if the settlor was domiciled in the State at the date of the disposition. Otherwise, only the Irish property comprised in the trust is taxable. For trusts created on or after 1 December 1999, all trust assets are within the charge to discretionary trust tax where the disponer was resident or ordinarily resident in the State at the date of the disposition. Otherwise, only property situate in the State at the date of the initial levy and annually (on 31 December in each year) is taxable.
110 Finance Act 2012: Discretionary Trust Tax The date of disposition is: in the case of a discretionary trust created by will, the date of death, in the case of a discretionary trust created by inter vivos deed, the date on which the act (or, where more than one act is involved, the last act) of the disponer was done by which the disponer provided the property comprised in the disposition. It is possible to have a number of different dates of disposition where a disponer transfers different assets to a discretionary trust on different dates. The domicile or residence, as the case may be, needs to be clarified for each such date. Relief/Exemptions Exemptions from discretionary trust tax apply to discretionary trusts that are created exclusively: for public or charitable purposes in the State or Northern Ireland, for approved pension schemes, for registered unit trust schemes, for the benefit of a named individual or named individuals who is or are, because of age or improvidence, or physical or mental or legal incapacity, incapable of managing his, her or their affairs, for the upkeep of a house or garden of historical importance or in respect of property that on the date of the determination of the settlement is taken by the State. Accountability The primary liability to account for the payment of discretionary trust tax rests with the trustees, but there is provision to ensure that the beneficiaries remain accountable. Effect of Finance Act 2012 Amendments Opportunity to obtain a refund of one-half of initial levy In the case of a discretionary trust created by will where the principal objects are over 21 years of age, the property is deemed to be subject to the discretionary trust on the date of death of the disponer. As a result of this and other amendments introduced by FA 2012, the five-year period during which the trustees must appoint out all assets to beneficiaries in order to obtain a refund of one-half of the initial levy runs from the date of death. In practice, where the residue of the estate is passing to the discretionary trust, the trustees will not receive the trust fund until the administration of the estate is virtually complete, which can take several years in a complex estate. Payment of initial levy FA 2012 amends the charging provisions to provide that the property is deemed to become subject to a discretionary trust on the date of death in the case of a discretionary trust created by will. This amendment applies for the purposes of both the initial levy and the annual levy. However, FA 2012 states that returns shall be delivered and tax shall be paid within four months of the valuation date. In the case of a discretionary trust created by will where the principal objects are over 21 years of age, the valuation date for the initial levy to discretionary trust tax is the later of the date of death or the date as determined in accordance with s30 CATCA 2003 (as amended). In the case of a discretionary trust established under the will of a deceased person, in accordance with s30 the valuation date will be the earliest date of the following: (a) the earliest date on which a personal representative or trustee or the successor or any other person is entitled to retain the subject matter of the inheritance for the benefit of the successor or of any person in the right of the successor or on that successor s behalf; (b) the date on which the subject matter of the inheritance is so retained; or (c) the date of delivery, payment or other satisfaction or discharge of the subject matter of the inheritance to the successor or for that successor s benefit or to or for the benefit of any person in right of the successor or on that successor s behalf. In accordance with s30, where specific assets are left to a discretionary will trust, if all principal objects are over 21 years of age, the valuation date for the initial charge to discretionary trust tax will normally be the date of the grant of probate, being the date when the personal representative is entitled to retain the subject matter
2012 Number 2 Finance Act 2012: Discretionary Trust Tax 111 of the inheritance for the benefit of the trustees of the discretionary trust, who would be regarded as the successor for the purposes of s30. This means that, although the property becomes subject to the discretionary trust on the date of death, the valuation date will normally be the date of the grant of probate, and the tax will be payable within four months of that date. Where the residue of an estate is left to a discretionary will trust, it will take some time after the grant of probate for the executors to administer the estate, collect in the assets, realise assets if required, discharge all debts and liabilities and satisfy any other legacies. Accordingly, it is generally accepted in practice that the valuation date of inheritance of the residue of an estate pursuant to s30 is the date of ascertainment of the residue. Accordingly, in that case, the initial levy will be payable by the trustees four months after the date of ascertainment of the residue. Payment of annual levy If all principal objects are over 21 years of age, the chargeable date and the valuation date for the annual levy is 31 December in each year, and the returns must be filed and payment of the annual levy made within four months of this date. However, FA 2012 provides that, where an annual levy (called the second taxable inheritance ) arises after the initial levy (called the first taxable inheritance ), and the valuation date for the first taxable inheritance is a date after the chargeable date of the second taxable inheritance, the valuation date for the second taxable inheritance is the same date as the valuation date for the first taxable inheritance. It is assumed that this will apply in respect of all annual levies that arise before the valuation date for the initial levy. However, the use of the terms first taxable inheritance and second taxable inheritance in the legislation is confusing. The best way to illustrate the effect of the changes is by way of an example. Example A testator dies on 30 July 2012, leaving his residuary estate to a discretionary trust created under his will. All of the principal objects are over 21 years of age. The grant of probate issues on 30 July 2013, and after a complex administration the residue of the estate is ascertained on 30 July 2015 and is transferred to the trustees of the discretionary will trust. The relevant dates/events for discretionary trust tax arise as follows: Date Event Date of death, and initial levy arises 30 July 2012 (valuation date date of ascertainment of residue) No annual levy arises (within 12 31 December 2012 months of initial levy arising) 30 July 2013 Grant of probate issues First annual levy arises (valuation date 31 December 2013 date of ascertainment of residue) Second annual levy arises (valuation 31 December 2014 date date of ascertainment of residue) Residue ascertained and transferred to 30 July 2015 trustees Valuation date for initial levy (30 July 2012), for first annual levy (31 30 July 2015 December 2013) and for second annual levy (31 December 2014) Payment date for initial levy, first annual levy and second annual levy; 30 November 2015 returns to be filed and payments made for each In this example, the initial levy, the first annual levy and the second annual levy are payable within four months of the date of ascertainment of the residue of the estate. Depending on the nature and liquidity of the assets comprised in the residue, it may be difficult for trustees to access funds to discharge these levies within such a short period. Conclusion The amendments to the discretionary trust regime will create additional complexities and will cause headaches for practitioners and trustees in terms of working out the dates when the levies arise, the valuation dates for these and the ability to discharge the levies. In reality, the effect of the provision appears to be that it will give rise to additional charges to the annual levy that will accrue from the date of death rather than from the grant of probate or the date of ascertainment of the residue.