Reduce inheritance taxes

Introduction

Inheritance tax (IHT) is a concern for many people planning their estate, particularly those with significant assets. Although there are several strategies for reducing inheritance tax, the “Rysaffe Principle” is one of the lesser known but very effective methods.

This strategy helps mitigate the IHT burden through the use of multiple trusts.

Here is a detailed explanation of the Rysaffe Principle and how it can benefit you if you are looking to optimize your estate planning.

What is the Rysaffe principle?

The Rysaffe principle has its origins in a 2003 tax case, Rysaffe Trustee Company (CI) Ltd v Inland Revenue Commissionerswhere the court ruled on the structure of multiple trusts and their tax treatment.

The main takeaway from this case was that setting up multiple trusts on different days could result in more favorable treatment for IHT purposes. The ruling clarifies that each trust would be treated independently and not as a collective group, allowing for a more manageable estate tax situation since each trust is taxed separately.

So how does it work?

The Rysaffe principle is based on the creation of several discretionary trusts, rather than just one.

The Inheritance Tax Act states that when calculating tax liabilities, the value of all assets placed in a trust over a 10-year period can be aggregated. This aggregation can push the value of the trust into a higher tax bracket, thereby increasing IHT charges.

However, by creating multiple trusts on different days, each trust is treated as a separate entity for IHT purposes. This means that each trust benefits from its own nil rate band (NRB) threshold, which currently stands at £325,000 (for tax year 2024/2025). As a result, a significant amount of wealth could be protected from IHT using this method.

Example – Mr. Jones

Mr Jones wishes to place his Family Investment Company (FIC) shares in trust for his children.

Mr. Jones anticipates that the value of the growth stocks he places in trust will increase significantly over his lifetime.

If Mr Jones places £100 of shares in a single trust there will be no IHT on arrival as the £100 would only use £100 of his personal NRB. If, at the time the shares are distributed by the trust, they are worth, say, £1,000,000. Of this amount, only £325,000 would be covered by the NRB Trusts and the remainder would be subject to IHT.

However, if Mr Jones were to place 5 x 20 shares in 5 different trusts set up on different days, there would still be no IHT on arrival as the same £100 is covered by his personal NRB, but at On exit, each trust would have a value of £200,000 and an NRB of plus or minus £325,000 [1]to cover it, leaving no liability to IHT.

Although the process of setting up multiple trusts may involve more complexity and require professional advice, the potential IHT savings can be substantial.

Advantages of the Rysaffe principle

1. Maximize the zero rate band: By dividing assets between multiple trusts, each trust can benefit from its own NRB, reducing or eliminating IHT charges.

2. Avoid aggregation: Because each trust is created on a different date, the assets of each trust are not pooled for tax purposes, allowing for greater flexibility in estate planning.

3. Flexible Gifts: This strategy provides flexibility in how assets are distributed among beneficiaries, allowing different trusts to be tailored to different family members or different purposes.

4. Long-term savings: Over time, the Rysaffe Principle can significantly reduce the periodic IHT charges that apply to discretionary trusts over their lifetime.

Considerations and Potential Pitfalls

Although the Rysaffe principle offers notable tax benefits, it is important to consider certain practical and legal challenges:

1. Complexity of Trusts: Creating multiple trusts increases administrative burden and may result in additional legal and trustee fees.

2. Careful Timing: To benefit from the Rysaffe principle, it is crucial that trusts are created on different days. Failure to do so could result in asset aggregation, thereby negating the tax benefits.

3. Professional Advice: The Rysaffe Principle is a sophisticated tax strategy that requires careful planning. Consulting a tax professional or estate planner is essential to ensure compliance with UK tax laws and optimize the structure.

Won’t HMRC challenge these arrangements?

Due to 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 ‘check’ artificial arrangements which are put in place solely to obtain a tax advantage and have no commercial basis.

However, the use of multiple trusts was reviewed by the GAAR Advisory Committee a few years ago. He commented:

“The practice was challenged 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.”