Ask Gill – Question 1

Which trust should you use when a client wishes to provide a house for his son and the son’s girlfriend and unborn child?

It is always useful to start with the basics – why is the client seeking to use a trust as opposed to making an outright gift to the son or making a loan to the son to purchase the property?

An outright gift of a sum of money obviously is the easiest approach and would enable the son to save SDLT as a first-time buyer (assuming he has not owned a property before). After seven years the gift would be outside the client’s estate for IHT purposes.

However, an outright gift puts the investment at risk should the relationship with the girlfriend not work out. If the property was purchased in the son’s sole name this might protect it a little.

Better still, rather than make a gift of the money the client could simply lend the money to his son to buy the property and could call back the loan on demand (so no transfer of value for IHT) or charge him interest on the loan.

It may be that the client does not trust his son and may have other children too so a trust may be a sensible idea. What are the options? The proposal is for a lifetime gift so we could use a bare trust, an interest in possession trust or a discretionary trust. A bare trust is like making an outright gift and would not provide sufficient protection for the investment as the son could demand the transfer of the legal title to him.

This leaves an interest in possession trust or a discretionary trust. Under the current IHT regime, whichever choice is made the transfer of value will be a chargeable transfer unless we are talking about a disabled person’s interest. Assuming we are not, then the choice of trust makes no difference from an IHT point of view as both will be in the relevant property regime and any amount gifted over the client’s available Nil Rate Band will be immediately chargeable to IHT at 20%.

Any gift will need to provide sufficient funds to meet the 10 yearly anniversary charges and exit charges which means that enough money should be placed in the hands of the trustees to cover maintenance of any property and fund at least one 10 year anniversary as a contingency as well as cover the purchase price and on-costs.

An interest in possession trust can grant the son a life interest but then what is to happen to the trust fund should he die, or the life interest is terminated or attacked by a trustee in bankruptcy?

First of all, it will be important to prevent the trust falling back into the father’s estate if the son died and so it needs to have remainder beneficiaries which could be any grandchildren of the client, for example, or a charity. It is possible for interest in possession trusts to be partitioned and particular interests sold which may not suit the client. Whilst the capital will be protected from a trustee in bankruptcy of the son the income from the fund would be at risk from such a trustee in bankruptcy. You could make the interest in possession trust a protective trust under s.33 Trustee Act 1925 so that should the son try to partition the trust or sell his interest or if he became bankrupt, the trust would convert to a discretionary trust.

Overall, the most flexible option would be to make a transfer of value to a discretionary trust from the outset where the beneficial class can include not just the particular son but other children of the client and where a power to add and remove beneficiaries can be included in case the relationship with the girlfriend works and the client wants to include her or at least provide for their grandchild.

The downside of using a discretionary trust to fund the purchase of a property is that the higher rate of SDLT will have to be paid; whereas, if the interest in possession trust was used then providing the son did not have another property then the acquisition is made as though the son was the purchaser for SDLT purposes so the trust benefits from the son’s position and will not pay the higher rate.

All in all, careful questioning and a process of elimination should assist the client in making the right choice for them.

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