This article was first published in the Law Society’s Private Client Section magazine, PS, in November 2022. Philip Warford is managing director of Renaissance Legal and Scott Clayton is managing director of Renaissance Trust, specialists in helping families and carers of disabled and vulnerable people
A recent Family Resources Survey conducted by the government estimated there were 14.6 million people in the UK with a disability in 2020/21. This represents 22% of the total UK population and means we are all very likely to have clients who have a disabled relative.
How we go about protecting an inheritance for a disabled relative continually changes. In this article on the subject of Trusts for disabled and vulnerable people, we will summarise the more recent changes which reinforce why Disabled Person’s Trusts (DPT) are more favourable to use than Discretionary Trusts (DT).
Why do we need to protect an inheritance for a disabled person?
There are three main reasons why families with disabled relatives might need to consider directing assets to a DPT:
- Capacity – if a beneficiary does not have capacity, then there will usually be a need to apply to the Court of Protection for a Property & Affairs Deputy Order to manage the inheritance
- Vulnerability – by inheriting direct, you could place someone in a position of financial vulnerability
- Means-tested benefits – following the 1967 Gartside case, capital is disregarded where it is held in a trust in which the beneficiary has no legal right to it.
What is a Disabled Person’s Trust (DPT)?
A Disabled Person’s Trust (DPT) is one which qualifies as a disabled person’s interest for Inheritance Tax (IHT) purposes and a trust for a vulnerable person for Income Tax (IT) and Capital Gains Tax (CGT) purposes.
The requirements about how income and capital may be applied during the lifetime of the disabled person is:
1 for IHT purposes, stated in section 89B(1), IHTA 1984 (as amended); and
2 for IT and CGT purposes, stated in sections 23 to 45, FA 2005 (as amended).
It is especially important for a trustee to ensure that once the DPT becomes subject to UK taxation, a Vulnerable Person Election Form (VPE1) is submitted to HMRC to claim the special IT and CGT treatment.
Taxation of DPTs
Tax on entering a DPT
A lifetime gift to a DPT is a Potential Exempt Transfer for IHT purposes. That means it is a chargeable transfer for CGT purposes.
When the IHT Residence Nil Rate Band (RNRB) was introduced in 2017/18 a distinction was made for gifts on death into a DPT and a DT. A gift on death into a DT cannot benefit from the RNRB, whereas a gift on death into a DPT can. For families with disabled relatives who need to be able to claim the RNRB, this becomes an important succession planning point.
Taxation of assets during the lifetime of the Disabled Person
The result of the legislation is the amount of tax charged on income and gains arising to the trustees is no more than it would have been had it arisen directly to the disabled person.
Taxation when the Disabled Person dies
When the disabled person dies, the trust property is treated as being owned by them for IHT purposes. The value of the trust fund is added to the value of the disabled person’s personal assets and any IHT charged is pro-rated on all of the assets.
Taxation on winding up the Trust
In general, DTs are liable to pay IHT every 10 years on the value in excess of the Nil Rate Band and when assets leave the trust. DPTs are not subject to these charges.
Registration of DPTs on the Trust Register Service (TRS)
We are probably all very versed in the TRS now, but just to recap. The anti-money laundering regulations in the UK were updated in 2020 to extend the TRS registration requirement to all UK, and some non-UK, express trust that were in existence on or after 6 October 2020, with the deadline for registration being 1 September 2022.
Trusts are placed into one of two categories:
- Registerable Taxable Trust. These generally active trusts are given a Unique Tax Reference (UTR) number which is used as a reference for both reporting tax and for the TRS
- Registerable Express Trusts (not taxable). These trusts are issued with a Unique Reference Number (URN). Such trusts will include currently dormant pilot trusts.
DPTs have specific exemption from registering on the TRS if they are Registerable Express Trusts, DTs do not.
Once the DPT becomes subject to UK taxation it will fall into the category of a Registered Taxable Trust and be required to register and obtain a UTR.
It is important to note that, in order to obtain the more favourable tax treatment for IT and CGT, both the trustees and the disabled person must make a joint vulnerable person