Introduction
Inheritance Tax (IHT) is a concern for many individuals planning their estates, especially those with significant wealth. While several strategies are available to reduce inheritance tax liability, the ‘Rysaffe principle’ is one of the lesser-known but highly effective methods.
This strategy helps mitigate the IHT burden through the use of multiple trusts.
Here’s a detailed explanation of the Rysaffe principle and how it can benefit you if you’re looking to optimise your estate planning.
What is the Rysaffe Principle?
The Rysaffe principle originates from a 2003 tax case, Rysaffe Trustee Company (CI) Ltd v Inland Revenue Commissioners, where the court ruled on the structure of multiple trusts and their tax treatment.
The key takeaway from this case was that setting up multiple trusts on different days could result in more favourable treatment for IHT purposes. The ruling clarified that each trust would be treated independently and not as a collective group allowing for a more manageable inheritance tax position as each trust is taxed separately.
So how does it work?
At the basis of the Rysaffe principle is the creation of multiple discretionary trusts, rather than a single one.
Inheritance tax law stipulates that when calculating tax charges, the value of all property settled in a trust within a 10-year period may be aggregated. This aggregation can push the value of the trust into a higher tax bracket, increasing the IHT charge.
However, by setting up multiple trusts on different days, each trust is viewed as a separate entity for IHT purposes. This means that each trust benefits from its own nil-rate band (NRB) threshold, which is currently £325,000 (for the 2024/2025 tax year). As a result, a significant amount of wealth could be sheltered from IHT using this method.
Example – Mr Jones
Mr Jones wishes to place shares in his Family Investment Company (FIC) into trust for his children.
Mr Jones anticipates the value of the growth shares he will be placing intro trust will grow significantly during his lifetime.
If Mr Jones places £100 worth of shares into a single trust, there will be no IHT on the way in, as the £100 would only use up £100 of his personal NRB. If by the time the shares are distributed from the trust the shares are worth say £1,000,000. Only £325,000 of that would be covered by the Trusts NRB and the rest will be subject to IHT.
If however Mr Jones were to place 5 x 20 shares into 5 different trusts set up on different days, there would still be no IHT on the way in as the same £100 is covered by his personal NRB, however on exit each trust would have £200,000 of value and a NRB of more or less £325,000 [1]to cover it, leaving no IHT liability at all.
While the process of setting up multiple trusts may involve more complexity and professional advice, the potential IHT savings can be substantial.
Advantages of the Rysaffe Principle
1. Maximising the Nil-Rate Band: By dividing assets across multiple trusts, each trust can benefit from its own NRB, reducing or eliminating the IHT charge.
2. Avoiding Aggregation: As each trust is created on a different day, the assets in each trust are not aggregated for tax purposes, allowing more flexibility in estate planning.
3. Flexible Gifting: This strategy provides flexibility in how assets are distributed among beneficiaries, allowing different trusts to be tailored to different family members or purposes.
4. Long-Term Savings: Over time, the Rysaffe principle can significantly reduce the periodic IHT charges that apply to discretionary trusts during their lifetime.
Considerations and Potential Pitfalls
While the Rysaffe principle offers notable tax advantages, it’s important to consider some of the practical and legal challenges:
1. Trust Complexity: Setting up multiple trusts increases the administrative burden and may incur additional legal and trustee fees.
2. Careful Timing: To benefit from the Rysaffe principle, it’s crucial that the trusts are set up on different days. Failure to do so could result in the aggregation of assets, nullifying the tax benefits.
3. Professional Guidance: The Rysaffe principle is a sophisticated tax strategy that requires careful planning. Consulting with a tax professional or estate planner is essential to ensure compliance with UK tax laws and to optimise the structure.
Won’t HMRC challenge the arrangements?
Because of the potentially significant IHT savings, it would be natural to be wary of a challenge from HMRC.
There is a General Anti-Abuse Rule (GAAR) which allows HMRC to “look through” artificial arrangements which are only put in place to achieve a tax advantage and have no commercial basis.
However, the use of multiple trusts was reviewed by the GAAR Advisory Panel some years ago. It commented:
“The practice was litigated in the case of Rysaffe Trustee v IRC [2003] STC 536. HMRC lost the case and having chosen not to change the legislation, must be taken to have accepted the practice”.
Conclusion
The Rysaffe principle is a valuable tool for individuals seeking to reduce their inheritance tax liability using multiple discretionary trusts. When applied correctly, it can help maximise the nil-rate band and avoid the aggregation of assets, leading to significant IHT savings.
However, due to its complexity, it’s crucial to seek professional advice to ensure the trusts are structured correctly and in line with current tax regulations.
With careful planning, the Rysaffe principle can be an integral part of a comprehensive estate planning strategy, ensuring more wealth is passed on to beneficiaries rather than the taxman.
Next Steps
If you are looking for specialist, expert IHT advice then ETC Tax is the right place to be. Our team has a vast amount of experience in planning for IHT including the use of the Rysaffe principle should that be the best option for you as part of your wider IHT plan.
Get in touch today!
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