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Trusts and Wealth PreservationInheritance TaxCapital Gains TaxDiscretionary TrustsBusiness Property Relief

ACCA · Question 02 · Trusts and Wealth Preservation

SECTION B - ADVISORY REPORT

You are a tax advisor. Your client, Julian, is a high-net-worth individual who wishes to transfer wealth to his grandchildren. He is considering setting up a Discretionary Trust on 1 November 2024.

Julian is considering transferring one of two assets into the trust:

Asset 1: A portfolio of commercial properties currently valued at £1.5 million. Julian purchased these properties in 2015 for £900,000. They generate an annual rental income of £80,000.

Asset 2: His 100% shareholding in Eco-Wind Ltd, valued at £1.5 million. Julian incorporated Eco-Wind Ltd in 2018. The company owns and operates a network of wind turbines. The company's income is derived entirely from the sale of electricity generated by the turbines to the National Grid, and from government renewable energy subsidies. The original cost of the shares was £100,000.

Julian has not made any previous lifetime transfers. He has his full annual exemptions available. He wants to understand the immediate tax consequences of transferring either asset, and the ongoing tax implications for the trust.

REQUIREMENT:
Prepare a memorandum for Julian that:
(a) Evaluates the immediate Capital Gains Tax (CGT) and Inheritance Tax (IHT) implications of transferring Asset 1 (Commercial Properties) versus Asset 2 (Eco-Wind Ltd shares) into the Discretionary Trust. (15 marks)
(b) Explains the ongoing Income Tax and Inheritance Tax implications for the Discretionary Trust once established, assuming Asset 2 is chosen. (10 marks)

How to approach this question

Structure the answer clearly comparing Asset 1 and Asset 2 for both IHT and CGT. For Asset 1, calculate the CLT and note the lack of BPR, then explain s.260 hold-over relief. For Asset 2, critically evaluate whether a wind farm is a trading or investment business to justify BPR, then explain the resulting zero IHT and the availability of hold-over relief. Finally, detail the trust income tax rates and the 10-year/exit IHT charges, specifically noting how BPR interacts with these ongoing charges.

Full Answer

This question tests the interaction of IHT and CGT on the creation of trusts, specifically focusing on the definition of a trading company for BPR. Wind farms are a classic edge case; HMRC accepts them as trading (generating electricity) rather than investment (exploiting land), meaning 100% BPR applies. This makes Asset 2 highly efficient to transfer. Furthermore, any transfer into a discretionary trust is a CLT, which allows for s.260 CGT hold-over relief, even if the actual IHT payable is reduced to zero by BPR.

Common mistakes

Students often assume that because BPR reduces the IHT to zero, the transfer is no longer a CLT, and therefore s.260 hold-over relief is unavailable. This is incorrect; it remains a CLT, so s.260 applies. Another mistake is applying the standard 45% trust income tax rate to dividends, rather than the specific 39.35% dividend trust rate.
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