Accumulation Maintenance Trusts - where are we now

Lately, I’ve seen a spike in Accumulation & Maintenance (A&M) trust queries. This is not surprising when you consider that it is now 18 years since the March 2006 Budget introduced significant changes to the tax treatment of lifetime trusts, one of which was to bring A&M trusts – which had historically benefitted from favourable tax treatment – into the relevant property regime unless action was taken, prior to 6 April 2008, to give beneficiaries an entitlement to a share of the trust capital at 18. Many of these trusts are now reaching the stage where beneficiaries are attaining the age of entitlement and trustees will therefore be keen to understand their tax obligations and what, if anything, can be done to mitigate them.

What was an A&M trust?

An A&M was essentially a hybrid between a discretionary trust and an interest in possession trust established primarily by parents or grandparents to make tax-efficient provision for their children or grandchildren. Under the terms of the trust, the beneficiaries would become entitled to at least an interest in possession (i.e. a right to income) by a specified age no greater than 25; however, entitlement to capital could be postponed indefinitely. There were various ways in which this condition could be met, for example: beneficiaries could become entitled to income and capital at 25 with the trustees having power to accumulate trust income in the interim; or the beneficiaries could take an interest in possession at e.g. 18 or 21 and become entitled to a share of the capital on reaching 25 or 30. If a settlor did not want beneficiaries to take an interest in possession at 18, they would need to make specific provision in the trust deed as, in absence of specific provision, beneficiaries would obtain an interest in possession, by default, at the age of 18, by virtue of s31 Trustee Act 1925.

A&M trusts were popular before 22 March 2006 because, provided they satisfied certain conditions, they were treated more favourably than pure discretionary trusts for inheritance tax and, to a more limited extent, capital gains tax purposes.

Tax treatment of pre-2006 A&M trusts

Income tax

During the A&M trust’s ‘discretionary phase’ (i.e. the period prior to the beneficiary taking an interest in possession during which the trustees could accumulate income not used for the beneficiary’s education or maintenance), the trustees would pay tax on trust income at trust rates. Once the beneficiary became entitled to an interest in possession, any income would belong to and be assessed to tax on the beneficiary. The income tax treatment of A&M trusts remains the same post-2006.

Inheritance tax (IHT)

Discretionary powers, such as those conferred on trustees of an A&M trust, would normally bring a trust within the relevant property regime meaning that entry, exit and 10-yearly periodic charges would apply. However, A&M trusts created before 2006 were exempted from these charges. Instead:

• A gift to an A&M trust was a potentially exempt transfer rather than an immediate chargeable transfer;
• There were no 10-yearly periodic charges on the trust assets;
• There were no inheritance tax exit charges when beneficiaries became entitled to trust assets or to an interest in possession, on or before the specified age;
• The death of a beneficiary before the specified age did not give rise to an inheritance tax charge.

Capital gains tax (CGT)

Trustees of A&M trusts were (and still are) subject to CGT on trust gains in excess of their annual exempt amount. The rate(s) of CGT payable by trustees is equivalent to the rate(s) paid by higher rate taxpayers. Where a beneficiary of a pre-2006 A&M trust became absolutely entitled to capital on or before reaching the specified age, the trustees would make a disposal for CGT purposes; however, it was possible for them to ‘hold over’ any gain (i.e. pass it on to the beneficiary thereby avoiding CGT at the trust rate). The exception to this was where the beneficiary became entitled to an interest in possession at an earlier date than capital. Although there was no disposal by the trustees when the beneficiary became entitled to income, there would be a disposal when the capital entitlement vested with no scope for a hold over claim.

What changed on 22 March 2006?

It has not been possible to create new A&M trusts since 22 March 2006. Those already in existence on that date were able to take advantage of transitional provisions to retain their IHT privileges by amending the trust terms, before 6 April 2008, to provide for capital to vest absolutely at an age no later than 18.

These transitional provisions were extended to trusts which were amended to provide for capital to vest no later than age 25. Such trusts were converted into age 18–25 trusts, which are exempt from IHT charges while the beneficiaries are under 18 and are taxed as relevant property trusts only for the subsequent period up to the age of 25.

A&M trusts in existence on 22 March 2006 which did not take advantage of one of these transitional provisions, entered the relevant property regime with effect from 6 April 2008.

A&M trusts post-2006

The post-March 2006 tax position of A&M trusts created prior to the FA 2006 changes depends on the trust terms and, where the original trust terms did not give the beneficiaries entitlement to capital by age 25, what, if any, action was taken to alter the trust terms before 6 April 2008.

It should be noted that where a beneficiary attained an interest in possession in the trust fund prior to 22 March 2006, that interest will be treated like any other pre-2006 interest in possession i.e. no relevant property charges apply periodically or where funds are distributed to the beneficiary. However if the beneficiary dies, the beneficiary’s share is taxed as part of his estate.

Those A&M settlements created before 22 March 2006 where the beneficiary did not take an interest in possession before 22 March 2006 now fall into three categories:

 

Beneficiaries become entitled to capital by age 18

Where the beneficiaries become entitled to their share of the trust assets on or before attaining the age of 18 (either by virtue of the original trust terms or because advantage was taken of the transitional provisions to amend the trust terms before 6 April 2008), the IHT treatment previously enjoyed will continue to apply. This is despite the fact that the trustees can accumulate trust income at their discretion during the beneficiary’s minority.

Beneficiaries become entitled to capital between 18–25

Where the beneficiaries become absolutely entitled to their share of the trust assets after attaining the age of 18 but before the age of 25 (again, whether under the original trust terms or because the trust has been amended between 22 March 2006 and 6 April 2008 to secure this position), the trust will be taxed as an age 18–25 trust. This means that no IHT exit or periodic charges apply while the beneficiary is under the age of 18 but an exit charge will be levied when the beneficiary becomes entitled to the trust property. The exit charge is apportioned with reference to the number of quarter years that have passed between the beneficiary reaching the age of 18 and becoming absolutely entitled. This is a maximum period of 28 quarters (seven years) and the charge will therefore never exceed 4.2% (i.e. 6% x 28/40) of the value of the assets distributed.

Beneficiaries become entitled to trust assets after the age of 25

Where the trust terms do not, or have not been amended prior to 6 April 2008 to, give the beneficiaries an absolute entitlement to capital by the age of 25, the trust will now be taxed as a relevant property trust and so will be subject to IHT periodic charges every 10 years and to IHT exit charges where beneficiaries become absolutely entitled to all or part of the trust property. In this scenario, exit charges will apply to payments of capital to beneficiaries of any age, and not just in cases where the beneficiary is older than 18.

The commencement date of the trust for the purposes of determining the anniversary date will be the date that the A&M trust originally commenced. All pre-2006 A&M trusts will have now passed the first anniversary where a periodic charge could have arisen and calculation of the periodic charge will therefore now follow the usual rules (note that on the first occasion of charge, an apportionment would have been made to account for the fact that the trust assets would not have been relevant property for a full 10 years).

Exit charges levied on distributions made after the occasion of the first periodic charge will also be calculated in the usual way i.e. as a proportion of the rate that was charged at the previous ten-year anniversary.

Capital Gains Tax

The occasion of a beneficiary becoming absolutely entitled to the capital (whether on reaching the specified age or as a result of an earlier advancement) will always be a disposal for CGT purposes; however, if the asset is transferred to the beneficiary in specie, the trustees and beneficiary will be able to elect to hold over the gain (i.e. pass it on to the beneficiary to avoid a CGT charge for the trustees) in certain circumstances (s260 TCGA 1992).

Although s260 (gift) holdover relief is usually only available where the transfer is also an occasion of charge for IHT, special provision is made in cases where the trust is either a pre-2006 A&M trust that gives the beneficiaries an entitlement on or before 18; or an A&M that has been converted into an 18-25 trust where the trustees have decided to advance the beneficiary’s share to the beneficiary before or on them reaching 18 (i.e. in those cases where the distribution would not usually give rise to an IHT exit charge due to the IHT privileges described above).

The upshot of this is that s260 gift hold over relief is available in all pre-2006 A&M trust cases, regardless of whether the trust was altered to bring it into the 18-25 regime before 6 April 2008 or not, and regardless of the age of the beneficiary on becoming absolutely entitled. The only situation where gift holdover would not be available on the beneficiary becoming absolutely entitled would be if the beneficiary already had an interest in possession under the trust pre-22 March 2006.

Conclusions

A&M trusts have always been perceived as complicated and the FA 2006 rule changes have done little to simplify the position!

One practical point to watch with A&Ms is that due to beneficiaries reaching the specified age at different times, a pre-2006 A&M may now be subject to a number of different IHT regimes, with each beneficiary’s share of the trust fund treated as a separate sub-trust subject to its own set of rules.

It is also important to remember that any additions made to the A&M since 2006 will constitute chargeable lifetime transfers and the element of the trust fund attributable to the addition, will, going forward, be subject to IHT periodic and exit charges within the trust (although the addition will not taint the rest of the trust fund which will continue to be taxed in accordance with the above rules).

Trustees of existing A&Ms that are now subject to the relevant property regime should be encouraged to consider their options in advance of impending anniversary dates – especially if the value of the trust fund has increased in value to above the nil rate band since the previous anniversary so that a periodic charge is likely to arise for the first time. Depending on the ages and circumstances of the beneficiaries (and the objectives of the settlor and trustees) there may, if action is taken early enough, be an opportunity to distribute before the anniversary, thereby avoiding IHT charges altogether.