Tax Planning & The Rysaffe Principle

The ‘Rysaffe principle’ relates to Rysaffe Trustee Co (CI) v Inland Revenue Commissioners* (2003) where a series of trusts were created on consecutive days. The principle being that by establishing a series of smaller trusts, rather than just one trust, you can reduce the impact of the 10-yearly periodic charge and exit penalty by benefiting from a Nil-Rate Band (NRB) to Inheritance Tax for each individual trust.

Background to the case

HMRC (H M Revenue & Customs) contended :-

‘That the making of all the settlements were associated operations and that therefore the settlor had made one composite settlement by an extended disposition.’

After an initial successful hearing both High Court and a unanimous Court of Appeal Judgement stated that Section 42 Inheritance Tax Act (IHTA) 1984 was to apply on the basis that the word ‘disposition’ had its ordinary meaning and was not to be extended to include a disposition by associated operations.

A key statement from Judge Park J, dealing with the associated operations point was as follows :-

‘All the parcels of shares were properly comprised in settlements for the purposes of Section 64. The associated operations provisions had nothing to do with that analysis. There were 10-yearly charges on all of the parcels of shares. It is (I assume) true that in aggregate the five 10-yearly charges would be lower than the single charge which would have applied if there had only been one settlement. But that is not a valid reason for artificially importing the associated operations provisions into the exercise and using them to impose the false hypothesis that there was only one settlement when in fact and in law there were five.’

Additionally, from a planner’s point of view it is worth considering Section 62 IHTA 1984 relating to ‘related settlements’. In summary for a trust to be a related settlement:

a) the settlor is the same in each case, and
b) the trusts commenced on the same day.

So, trusts created on different days do not fall within this definition.

Therefore, by creating a series of trusts on different days we can reduce the inheritance tax payable.

Example: Let us consider a £340,000 investment into a discretionary trust.

Scenario 1:

If £340,000 is made as a one-off payment into the trust and no previous chargeable lifetime transfers (CLTs) have been made in the last seven years, assuming the full NRB is available (and other exemptions have been used elsewhere) the tax liability at entry would be:

£340,000 gifted into trust
£325,000 (NRB for 2010/11)
£15,000 liable to tax at 20% (half the death IHT rate)
Initial charge = £3,000, assuming trustees pay the tax

Scenario 2:

£340,000 gifted into trust by creating three trusts each for £113,333 on separate days
£325,000 (NRB for 2010/11)
£15,000 liable to tax at 20% (half the death IHT rate)
Initial charge = £3,000, assuming trustees pay the tax

In this example the charge is the same for the one trust route as it is for using three separate trusts. However, by setting up three trusts the 10-yearly periodic charge is likely to be lower as can be seen by the following calculations.

10-yearly periodic charge