Finance Bill signals demise of probate trusts

At the time of writing, the Finance Bill (number two) 2006 was still waiting to wend its way through the House of Commons debate process.

Although there has already been healthy, if ultimately unhelpful, debate on the demise of trusts and the inter-spouse transfer, Clause 157 and Schedule 20 have yet to be deliberated.

As things stand, one of the other casualties of the changes, which some have described as an unwarranted assault, is the homely probate trust.

A probate trust promises no benefit to the investor other than the avoidance of the delay and expense sometimes associated with the formalities necessary to administrate the estate of a deceased.

This is particularly useful, if the deceased has left a will, and a grant of probate is needed or if the person dies intestate and a grant of "letters of administration" is required.

In most cases, expenses will be limited to the out-of-pocket disbursements of the person appointed to administer the estate, for example, the personal representatives. Some people prefer to appoint a solicitor to act in this capacity and this will inevitably increase the cost.

Most product providers whose customers are likely to be affected by this have, historically, made available a suitable probate trust.

In the UK, as in some other jurisdictions, there may be an additional cost, including any inheritance tax (IHT) that may be payable, but as previously mentioned the trust is not designed to avoid IHT.

Before the changes were announced in the recent Budget, the creation of such a trust by a UK-domiciled individual, was neutral for the purposes of IHT.

Unfortunately, the impact of the new rules will make these trusts subject to the discretionary trust IHT regime and the transfer of an asset into even a simple probate trust will now be treated as a chargeable lifetime transfer (CLT).

This could also, depending on the personal circumstances of the investor, result in an immediate liability to IHT at the lifetime rate of 20%.

For example, if Jack Smith, a UK-domiciled investor, was to now create a probate trust to hold his investment bond worth £500,000, he will be making a CLT for IHT purposes and IHT of £43,000 will be payable immediately.

If paid by the trustees it would be calculated as £500,000 minus £285,000 (the IHT threshold) = £215,000 times 20%. If Jack pays the tax himself, £53,750 will be payable.

At the same time, such a trust will also be a gift with reservation (GWR) and so the value of the trust property will be included in Jack's estate.

This could lead to double charging and while there are provisions to avoid a double charge in the event of Jack's death, these would not include a refund of any lifetime IHT paid.

A further sting in the tail caused by the Budget is that existing probate trusts, along with other interest-in-possession trusts, have the propensity to be brought within the new rules.

UK-domiciled investors, whether UK resident or expatriate, will be well-advised to seek guidance on these matters.

key points

Probate trusts to fall under the discretionary trust IHT regime

Probate trusts were previously IHT neutral and used to avoid delays when administering a will

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