Question:

Where a Deed of Variation redirects an inheritance into a Discretionary Trust, when is the trust treated as having commenced? Is it from the date of the testator’s death, or from the date the Deed of Variation is executed?

Introduction

We are frequently asked to advise beneficiaries who are due to inherit assets or wealth from a parent or other relative. While an outright inheritance increases the beneficiary’s personal estate, many clients prefer to preserve those assets within a trust to provide long-term protection for themselves and future generations.

Provided it is completed within two years of the deceased’s death, a Deed of Variation can redirect all or part of an inheritance into a discretionary trust. This enables the beneficiary to benefit from the inherited assets without increasing the value of their own estate for inheritance tax purposes.

A discretionary trust established in this way can provide a number of important advantages, including:

  • preserving assets for future generations and maintaining the intended line of succession;
  • reducing potential exposure to Inheritance Tax within the beneficiary’s own estate; and
  • protecting assets from risks such as divorce, insolvency or bankruptcy, and the assessment of care fees.

The cost of establishing a Deed of Variation and discretionary trust is typically in the region of £2,000–£3,000 plus VAT, yet the long-term asset protection benefits can be significant.

Once the trust has been established, however, an important technical question arises:

When does the trust actually commence?

The answer depends upon the particular tax regime being considered.

The Legal Position

1. Inheritance Tax – Commencement is backdated to the date of death

Where a valid Deed of Variation satisfies the requirements of section 142 of the Inheritance Tax Act 1984, and the appropriate election is included within the deed, the variation is treated for Inheritance Tax purposes as though it had been made by the deceased immediately before death.

Accordingly:

  • the discretionary trust is treated as having commenced on the date of the deceased’s death;
  • the deceased is regarded as the settlor for Inheritance Tax purposes; and
  • the trust enters the relevant property regime from that date.

This means that:

  • the first ten-year anniversary is measured from the date of death;
  • exit charges are calculated by reference to that commencement date; and
  • where multiple trusts arise under variations, they may all be treated as commencing on the same day for relevant nil-rate band purposes.

The trust’s commencement date is treated as the date of the testator’s death.

2. Income Tax, Capital Gains Tax and General Trust Law

The position differs for Income Tax, Capital Gains Tax and the general law of trusts.

Unlike the Inheritance Tax provisions, a Deed of Variation does not generally operate retrospectively for Income Tax purposes. Instead:

  • the person giving up the inheritance is treated as the settlor;
  • the trust is regarded as coming into existence only when the Deed of Variation is executed; and
  • the settlement begins on the date of the deed itself.

Although a Capital Gains Tax election may allow certain tax consequences to be treated favourably, it does not alter the fact that, in legal terms, the trust is created on execution of the Deed.

The trust comes into existence on the date the Deed of Variation is executed.

Practical Application

In practice, the following commencement dates should be applied, depending upon the context:

Context Commencement Date
Inheritance Tax (relevant property regime, ten-year charges, exit charges) Date of death
Income Tax Date of the Deed of Variation
Capital Gains Tax Date of the Deed of Variation (subject to any applicable elections)
General trust law Date of the Deed of Variation
Trust Registration Service (TRS) administration Generally the date of the Deed of Variation, or when assets are settled into the trust

At ProTrust Consulting, we understand that dealing with these matters can feel overwhelming, particularly during what is already a difficult time. Our experienced team is here to guide you through the process, explain your options in plain English, and help ensure everything is handled as smoothly and efficiently as possible.

If you have any questions or would like advice tailored to your circumstances, please don’t hesitate to get in touch.  We’re always happy to help.