Missing money...?!?

John_Pierpoint

Frankland v IRC [1996] STC 735 came as a shock to some, although the Inheritance Tax trap involved has been widely discussed. In essence, if property is left on discretionary trusts and those trusts are then ended within two years of death - for instance, by conversion to life interest trusts or by outright appointments being made - in circumstances where an ‘exit’ charge would normally arise then IHTA 1984 s144 affords a measure of relief. First, the exit charge that normally arises is not levied and, second, the will is treated as ‘altered’ for IHT purposes to take account of the situation that then prevails. In Frankland the discretionary will trust was ended on 22 December 1987 by an appointment in favour of the Testator’s surviving spouse, the Testator himself having died on 26 September. Unfortunately (an understatement!) because an exit charge does not apply to discretionary trusts which come to an end within three months of their creation, the conditions for the s144 relief were not satisfied so that reading back the appointment in favour of the spouse was not permissible and some £2 million in Inheritance Tax was payable. If only the appointment had been made some four days later!

Can we picture the scene, as the widow and the executors dispute what the fool of a late husband had tried to do, realising he had only a short time to live.

Ah Ha the tax man had thought of that sort of behaviour.

I wonder why the widow felt she needed control over the extra five million during her life time; given that she should have found it difficult to dream up a need to spend it ?
[Don't forget 5 million was a lot more money 20 years ago, back when the nil rate band for IHT was only £150k and the £150k house was a big detached job]

Still not sure I understand the situation though, there must be lots of pre October 2007 wills tucked away in deed boxes, where the nil rate band is put into a discretionary trust and the widow gets the rest tax free as she is the spouse.
The executors take one look at the discretionary trust and say, "No point in implementing that any more, now that the widow inherits and preserves the nil rate band anyway for her death".

Is Franklin trying to say that the discretionary trust is still in place as far as the tax man is concerned upon the second death ?

purple_haze

I don't suppose the widow did feel the need to control £5m. If the money was left in the trust, £2m IHT was payable: if appointed to her, the £5m would have been spouse exempt (if the appointment had been after three months but within two years of the testator's death). She could then have made PETs of the £5m in the hope of surviving 7 years and removing them from her estate for IHT purposes.


There are indeed many pre 2007 NRB discretionary trust wills in existence. They don't normally cause a problem, as the trustees can appoint the trust fund to the surviving spouse either absolutely or on a lfe interest trust, which preserves the transferable nil rate band for IHT. However, the trustees do need to make the appointment – it's not the case that


The executors take one look at the discretionary trust and say, "No point in implementing that any more, now that the widow inherits and preserves the nil rate band anyway for her death".


The executors do not have a choice whether to implement the trust as such - the trustees have a legal right of action against the executors for the nil rate sum just as any legatee has a right against the executors for his legacy. If the executors do nothing about satisfying the legacy to the NRB trust on first death and the trustees make no appointment, then HMRC will (quite correctly) disallow a claim for the the transferable nil rate band on second death on the grounds that the NRB sum went to a discretionary trust on first death, albeit that by the time of the second death the executors of the first to die had still not paid the NRB legacy to the trustees.


(All that has nothing to do with the Frankland case, by the way.)

John_Pierpoint

Ah - thanks I think I am beginning to understand.

There must be two bits of legislation that don't line up with each other?

The will says "I create a discretionary trust that could last more than 100 years but my trustees can "appoint" funds at any time as they see fit". So in effect the trustees can bring the trust to an end by promptly "appointing" all the funds (in the Frankland case to the widow).

If the trustees do this within two years of the death it will count as an instrument of variation and re-write the will in effect to say "forget the trust the widow gets the lot" a sort of post dated codicil.

However in the tax legislation, someone put in a clause that says that should capital come out of a trust within two years of its creation by a will then as a concession, it will be exempt from the IHT normally payable by the trustees as an exit charge.

However in legal/tax terms there is already a concession applying to trusts in general that in effect says the trust does not exist for taxation for the first 3 months, thus allowing a living settler to correct/change his ideas during those three months. However this concession means the trust does not match up with the s144 concession for will changes in the first 24 months so the concession allowing capital out of the trust does not apply and IHT is payable as it goes back into the estate ?

Have I sort of understood the situation?
Has this "tax trap" any logical justification?
Is the message to executors "If you find a trust in a will beware of doing anything in the first 3 months?"

purple_haze

Yes, I think you're broadly correct.You might say that the Frankland case highlights a lacuna in the tax legislation but in the real world it would be very rare for trustees of a discretionary will trust to be thinking about making appointments within 3 months of the testator's death in any case.

And post the 2006 Finance Act an appointment to the spouse on a life interest within 3 months won't fall foul of the legislation anyway.