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HMRC internal manual

Inheritance Tax Manual

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HM Revenue & Customs
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Special trusts: protective trusts

Charging provisions: IHTM04101

Most protective trusts go through their entire existence in reality as an interest in possession, with no divesting act ever occurring. These are interest in possession trusts and they give rise to no special problems or questions.

Protective trusts are designed to protect the beneficiary, not the settlement nor its assets. If a settlor wishes to put property on protective trusts they simply have to say so in the deed, or refer in the deed to Trustee Act 1925/ S33, which is the governing section.

Briefly, in accordance with general law the settlor uses a protective trust to give the beneficiary an interest in possession in the fund until he or she commits any divesting act, (such as trying to sell it or going bankrupt), when the fund automatically converts into a discretionary trust under Trustee Act 1925/ S33(1)(ii) for that beneficiary and his/her family.

If the trustees make an advance to the beneficiary, that is not a chargeable distribution.

It is a rather old-fashioned type of trust nowadays, but this form of trust ensures that the beneficiary(ies) will not go short, even if they are unlucky or irresponsible.

Special rules provide that

  • If the divesting act occurred before 12 April 1978 then a claim arises under IHTA84/S73

    • when the property ceases to be subject of the discretionary trust under Trustee Act 1925 S33(1)(ii), otherwise than by a payment for the benefit of the principal beneficiary, and
    • where the trustees make a disposition that reduces the value of the fund, otherwise than a payment as above.
    • In such cases the property is taxed at the flat rate charge. (IHTM42802)
  • If the divesting act occurs on or after 12 April 1978 then IHTA84/S88 applies. This provides that for inheritance tax purposes the divesting act is simply ignored. The beneficiary is treated as beneficially entitled to an interest in possession in the property.

Following the changes to the IHT rules for trusts in Finance Act 2006:

  • Where a protective trust is created before 22 March 2006 and a beneficiary is treated as beneficially entitled to an interest in possession as a result of a divesting act on or after that date, the interest is treated as if the beneficiary had become entitled to it before 22 March 2006 and so continues to form part of their estate for IHT purposes, S88 (3);
  • Where a protective trust is created on or after 22 March 2006 and

    • The beneficiary’s underlying interest is an immediate post-death interest (IHTM16060), a disabled person’s interest within S89B (1)(c) or (d) (IHTM42805) or a transitional serial interest (IHTM16060), and
    • The beneficiary is treated as beneficially entitled to an interest in possession as a result of a divesting act

the interest is treated as a continuation of the immediate post-death interest, disabled person’s interest or transitional serial interest, and as if that interest had not come to an end, S88(5);

  • Where the protective trust is created on or after 22 March 2006 and the beneficiary’s underlying interest is not an immediate post-death interest, a disabled person’s interest within S89B(1)(c) or (d) or a transitional serial interest, S88 does not apply, S88(6).