HM Revenue and Customs Brief 22/13
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Issued 6 August 2013
Discounted Gift Schemes: Ten Year Anniversary values for
Inheritance Tax and updated guidance on the calculation of transfer
values when Discounted Gift Schemes are effected
This brief sets out HM Revenue & Customs' (HMRC's)
view on how to calculate the value that will be subject to Inheritance
Tax for a Discounted Gift Scheme held in a relevant property trust when
the ten year anniversary charge arises for the trust. It also provides
updated guidance on how the transfer value is to be calculated when a
Discounted Gift Scheme is effected including providing clarification
and revisions to the assumptions underlying the valuation.
This brief is aimed at the trustees of a relevant property
trust which holds a Discounted Gift Scheme and who are responsible for
delivering an Inheritance Tax account for the ten year anniversary. It
is also aimed at the providers of Discounted Gift Schemes who may wish
to provide relevant values to their customers both when a Discounted
Gift Scheme is effected and at subsequent Ten Year Anniversaries.
The intention of this brief is to provide certainty for
taxpayers and Discounted Gift Scheme providers in that a valuation
prepared in accordance with this brief will be acceptable to HMRC.
All statutory references are to Inheritance Tax Act 1984
unless otherwise stated.
1. The Ten Year Anniversary Charge
Following changes to the taxation of trusts for Inheritance
Tax purposes in the Finance Act 2006, most types of trust used for
Discounted Gift Schemes created on or after 22 March 2006 are relevant
property trusts and subject to Inheritance Tax under Part III, Chapter
III Inheritance Tax Act 1984. Under s.64 a charge to Inheritance Tax
arises on the value of the relevant property held in the trust every
ten years at which time the trustees are required to report the value
of the relevant property to HMRC.
Under a Discounted Gift Scheme the settlor will typically
have settled a bond or a series of policies from which they have
retained the right to either pre-determined regular withdrawals or to a
succession of maturing reversions. The bond or policies are relevant
property. However, the settlor's retained rights are normally held on
bare trust for the settlor and as such, these rights are not relevant
property for Inheritance Tax purposes. At the ten year anniversary, the
value of the relevant property needs to be established for the purpose
of calculating the charge that arises under s.64. The value of the
relevant property is its open market value as required by s.160, but it
does not include the value of the rights retained by the settlor.
The open market purchaser of the relevant property would be
purchasing the right to receive the whole value of the underlying bond
following the death of the settlor. The open market purchaser will take
account of the fund value at the valuation date and will have to allow
- the expected withdrawals to be received by the settlor
between the valuation date and the settlor's date of death, and
- the expected delay between the valuation date and the
eventual death of the settlor.
The closest equivalent asset which is sold in the open market
is considered to be an interest in reversion. In the case of the
purchase of an interest in reversion, analysis of sales indicates that
open market purchasers take a prudent approach and they do not factor
in any growth in the capital value of the asset. In addition, analysis
indicates that an open market purchaser of a reversion takes no account
of the interim income payable to the life tenant.
However, under a Discounted Gift Scheme the rights retained
by the settlor are not precisely identical to the rights of a life
tenant entitled to income. The retained benefits are not limited to any
income produced by, or growth on, the fund. It is possible for the
settlor's retained rights to exceed the growth generated by the fund
itself so that the fund is depleted over time. Equally the growth on
the fund may exceed the sums due to the settlor under the retained
rights, so that the fund value increases over time. HMRC takes the view
that an open market purchaser would take a prudent approach when taking
these possibilities into account in the price he or she is prepared to
1.2 Valuation methodology
The asset to be valued is the total fund, less the value of
the rights retained by the settlor, payable on the death of the
settlor. The actual valuation will be slightly different depending on
whether the retained rights are structured as a series of withdrawals
of pre-determined amounts or are based on the value of a series of
funds payable on fixed future dates. In either case it is considered
that the open market purchaser would not allow for any growth in the
fund value, but would discount the current value to account for the
delay until the fund will be available, being on the death of the
Where the retained rights are of pre-determined regular
withdrawals, the total fund value is discounted to the expected date of
death of the settlor. From this value is to be deducted the present
value of the expected future withdrawals to be taken by the settlor
based on their life expectancy and discounting those payments to the
date that each payment is to be made.
Where the retained rights are based on the value of a series
of funds payable on fixed future dates the value of the funds that are
expected to mature after the death of the settlor are discounted to the
expected date of death of the settlor.
There are a number of approaches that can be taken to these
calculations that will produce virtually the same values, provided the
same mortality and interest rate assumptions are used.
1.3 Health of the Settlor at the Ten Year Anniversary
The open market purchaser of an interest payable only on the
death of an individual, such as a reversion, will assume normal life
expectancy for the life of that individual unless there is clear
evidence that they are terminally ill, for example in the viatical
market for life policies. The risk to the open market purchaser is that
if the individual survives longer than expected the purchaser has to
wait longer to realise his or her investment. This open market practice
leads to the view that the age to be used in the valuation is the age
next birthday of the settlor with no adjustment for their state of
This approach would, however, understate the value, possibly
substantially, in cases where the settlor was terminally ill at the
date of the ten year anniversary. The rate of tax payable at the ten
year anniversary, which is dependent on the value of the relevant
property at that date, determines the tax payable under s.65 on
property in the settlement which ceases to be relevant property, for
example on the distribution of the funds following the death of the
settlor. There is therefore a risk that tax will be lost if the
valuation at the ten year anniversary is based on the actual age next
birthday of the settlor where, in fact, the settlor was terminally ill.
Three options to overcome this risk are:
- To obtain evidence of the settlor's state of health at the
ten year anniversary in all cases. This would add both an
administrative and a financial burden on the trustees and would require
an assessment of the medical evidence obtained, presumably by the
provider preparing the valuation, adding to their costs. In most cases
the outcome would be that the settlor was not terminally ill and
therefore that the valuation should be based on the actual age next
birthday of the settlor. The advantage of this approach, however, is
that there would be certainty for the trustees that the value at the
ten year anniversary was finalised and it would remove the risk to HMRC
of loss of tax on any distributions in the following ten years.
- To complete the valuation at the ten year anniversary on
the basis of the settlor's actual age next birthday but, where the
settlor dies within two years of the ten year anniversary, for HMRC to
review the position at the ten year anniversary to satisfy itself as to
whether the value needs revision. This would reduce the administrative
burden at the ten year anniversary, but would not provide certainty for
the trustees that the tax position was settled. There would also be
practical difficulties in some cases in obtaining the relevant evidence
of the settlor's state of health at the ten year anniversary
- To complete the valuation at the ten year anniversary on
the basis of the settlor's rated age next birthday when the Discounted
Gift Scheme was effected, plus an addition of 10 years for each ten
year anniversary. This has the advantage of simplicity. The settlor's
life will, in almost all cases, have been fully underwritten at the
outset and no further medical evidence will be required. It would also
provide certainty to the trustees that the tax position at the ten year
anniversary was finalised and that HMRC would not review that position
in the event that the settlor died within the next two years.
HMRC consider that the third option provides a practical
approach to the valuation. It places the minimum administrative burden
on trustees or product providers whilst at the same time protecting
HMRC from potential loss of tax. The majority of settlors effecting
Discounted Gift Schemes have no rating added to their age based on
medical underwriting when the Discounted Gift Scheme is set up and
therefore they would continue to have no rating applied at each ten
Where no underwriting was completed on the original transfer
it may be necessary for HMRC to review the original transfer value if
this has not previously been reported. Alternatively it may be
necessary to obtain evidence of the settlor's state of health at the
ten year anniversary to complete the valuation.
1.4 Valuation Basis
The valuation is required to be carried out on an open market
basis in accordance with s.160 and it is not possible to predict what
open market practice will be by the time these valuations are required,
with the first valuations expected to be required in March 2016. The
open market valuation would need to reflect current market practice on
the mortality assumptions being applied to reversionary interests as
well as the rates of return then required by purchasers.
In order to provide some certainty as to the valuations that
will be acceptable, HMRC will accept valuations that are calculated
using the same mortality basis as is then in use in valuing the
transfer when a Discounted Gift Scheme is effected, replacing select
with ultimate mortality. This does not preclude the use of alternative
valuation approaches to establish open market values, but is intended
to provide certainty for valuations provided in accordance with this
approach. HMRC will publish any changes to its valuation basis at least
three months before the changes are to take effect to give providers
time to update their systems.
The examples below show how the value of the relevant
property is calculated. The mortality and interest rate basis used is
that set out in paragraph 2.2 below.
1.5.1 Example 1
The first example assumes that the settlor was a woman aged
75 next birthday when the Discounted Gift Scheme was effected with no
addition to age based on medical underwriting. At the ten year
anniversary the underlying value of the bond is £1,000,000. The
withdrawals retained by the settlor are equal to 5% of the original
£500,000 investment, payable monthly in arrears.
The open market value equals
The fund value at the ten year anniversary x , less
The annual rate of withdrawals x , where
is an immediate assurance
factor, payable immediately on the death of a life aged x next
is an annuity factor for an
annuity payable in arrears at a frequency of p times per year for the
term of a life aged x next birthday.
||= £1,000,000 x 0.70301
||= £703,010, less
||= £25,000 x 6.710
Which gives a value of £535,260.
From this value a deduction of approximately £1,000 is made
in respect of the purchaser's costs, to give a net value of £534,260.
1.5.2 Example 2
The facts are as in example 1, except that an age addition of
4 years was made based on medical underwriting when the Discounted Gift
Scheme was effected
|| = £1,000,000 x 0.76160
||= £761,600, less
||= £25,000 x 5.379
Which gives a value of £627,125.
From this value a deduction of approximately £1,000 is made in
respect of the purchaser's costs, to give a net value of £626,125.
1.5.3 Example 3
The facts are as example 1, except that the settlor was a man
aged 83 when the Discounted Gift Scheme was effected. No age addition
was made as a result of medical underwriting.
||= £1,000,000 x 0.81385
||= £813,850, less
||= £25,000 x 4.192
Which gives a value of £709,050.
From this value a deduction of approximately £1,000 is made
in respect of the purchaser's costs, to give a net value of £708,050.
1.6 Jointly effected Discounted Gift Schemes
Many Discounted Gift Schemes are effected jointly by two
settlors with the retained rights payable until the death of the
survivor of both settlors. Section 44(2) provides that where more than
one person is the settlor in relation to a settlement then, for
purposes including a ten year anniversary charge, the property is
treated as being comprised in separate settlements. The value of the
fund will be divided between the separate settlements in the proportion
that the original funds were provided by each settlor, usually equally.
The valuation of the fund needs to take into account that the fund will
not be available to the open market purchaser until after the death of
both settlors. The valuation of the expected withdrawals will need to
take into account whether or not the full payments continue until the
death of the survivor of both settlors.
A husband age 78 and his wife aged 75 each put £500,000 into
a Discounted Gift Scheme from which withdrawals of £50,000 per year,
paid monthly in arrears, are to be made until the death of the
survivor. At the ten year anniversary the fund is worth £2,000,000.
||= £1,000,000 x 0.63642
||= £636,420, less
||= £25,000 x 8.223
Which gives a value of £430,845.
From this value a deduction of approximately £1,000 is made
in respect of the purchaser's costs, to give a net value of £429,845.
1.7 Ten Year Anniversary reporting requirements
An account is required to be submitted to HMRC by the
trustees of a relevant property settlement where a charge to tax arises
under Part III, Chapter III of the Inheritance Tax Act 1984. The
reporting requirements are relaxed in connection with Excepted
Settlements, the definition of which are set out in the Inheritance Tax
(Delivery of Accounts) (Excepted Settlements) Regulations 2008
SI2008/606. For the purpose of establishing whether the transfer
exceeds the 80% limit specified in Regulation 4(4), it is the value of
the relevant property calculated in accordance with this brief that
should be used.
2. Updated guidance on the calculation of transfer values
when a Discounted Gift Scheme is effected
In May 2007 HMRC issued a Technical Note setting out the
inheritance tax treatment of Discounted
Gift Schemes (PDF 45K). That note dealt with the transfer of
value that arises when a Discounted Gift Scheme is effected. It also
set out the valuation basis that HMRC considered appropriate in
establishing the value transferred. Subsequent to that note amendments
to the valuation rate of interest have been made which are summarised
in the inheritance tax manual at IHTM
Following a European Court of Justice decision in March 2011
(the 'Test-Achats' case) the use of gender as a factor in setting
insurance premiums is no longer permissible from 21 December 2012. As
one of the main factors used to establish the value transferred when a
Discounted Gift Scheme is effected is the cost of insuring the life of
the individual who has effected the Scheme, the valuation basis needs
to be changed to reflect this significant change in how life assurance
premiums are calculated.
The position at the date of a Ten Year Anniversary is
somewhat different. At a Ten Year Anniversary the open market purchaser
would not be concerned to insure the life of the settlor. Rather the
purchaser's concern would be in establishing the settlor's life
expectancy. This would be affected by the settlor's age, gender and
state of health at that time and would use a different valuation basis
from that used for valuing the retained rights when a Discounted Gift
Scheme is effected.
In order to try to minimise the administrative burden around
providing Discounted Gift Scheme valuations, HMRC will accept Ten Year
Anniversary valuations which are calculated using the same mortality
and interest rate basis as is then in force for calculating the
transfer value when a Discounted Gift Scheme is effected. This is set
out in paragraph 2.2 below. This does not preclude valuations being
submitted using alternative methods or valuation assumptions, but is
intended to provide assurance that valuations calculated in accordance
with this brief will be accepted by HMRC.
2.1 Valuation basis of the retained rights
As set out in the 2007 Technical Note, the value transferred
is calculated as the difference between the total amount invested in
the Discounted Gift Scheme and the open market value of the retained
rights. The formula used to calculate the open market value of the
retained rights is
(1 - p) ÷ (p + i) where
p is an annual whole life premium per £1 sum assured,
expressed as a decimal, and
i is the open market purchaser's required rate of return on
2.2 Mortality and interest rate basis
Following the removal of gender as a factor in setting life
assurance premiums the mortality basis used by HMRC needs to be altered
to reflect this change in open market premium rates. At the same time
it is an appropriate time to reconsider the current interest rate
assumption within the calculation. The revised mortality and interest
rate basis is
Mortality: 80% of AFC00 select mortality (Permanent assurances for
females, combined rates from Continuous Mortality Investigation table
'00' series published in the CMI Working Papers number 21 on 1 August
Interest rate of 4.5% p.a.
This revised basis will be applied to all transfers or Ten
Year Anniversaries which occur on or after 1 December 2013.
2.3 Further clarification – withdrawals in excess of 5% per
HMRC has been asked to clarify the valuation approach it
takes when withdrawals under a Discounted Gift Scheme exceed 5% per
Where the retained rights under a Discounted Gift Scheme
derived from regular partial withdrawals from an investment bond do not
exceed 5% per year, no personal income tax liabilities are taken into
account in the valuation of those retained rights. Where the
withdrawals in such circumstances exceed 5% per year, or where the
cumulative 5% allowances are exhausted, the personal income tax
liabilities of the open market purchaser need to be factored in to the
valuation of the retained rights. In HMRC's view the open market
purchaser of the retained rights will account for income tax at 40% on
the excess over 5% per year. Where the bonds are onshore the assumption
is that a 20% non-refundable tax credit will be taken into account so
that the excess over 5% per year is reduced by 20% net rather than by
40% for offshore bonds.
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Article Published/Sorted/Amended on Scopulus 2013-08-09 09:11:18 in Tax Articles