How is a discretionary trust taxed for Inheritance Tax purposes?

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Discretionary trusts are taxed very differently from simply leaving assets outright to a beneficiary, following a distinct set of rules often called the "relevant property regime", and understanding this ten-year cycle is essential for anyone setting up or administering this type of trust. **What makes a trust "discretionary"** In a discretionary trust, the trustees have discretion over how and when to distribute income and capital among a defined class of potential beneficiaries (for example, "my children and grandchildren"), rather than any individual beneficiary having an automatic, fixed entitlement to a specific share -- this flexibility is valuable for estate planning (allowing trustees to respond to beneficiaries' changing circumstances) but comes with its own distinct tax treatment. **Entry charge -- when assets go into the trust** When assets are first put into a discretionary trust during the settlor's lifetime, this is generally treated as a "chargeable lifetime transfer" -- if the value transferred (combined with any other chargeable transfers in the previous seven years) exceeds the settlor's available nil rate band (£325,000), an immediate lifetime Inheritance Tax charge of 20% (half the standard 40% death rate) applies to the excess, payable at the time of the transfer. Transfers into a discretionary trust made on death (via a will) don't face this lifetime entry charge in the same way, but are assessed as part of the deceased's estate in the normal way. **The ten-year periodic charge** Every ten years from the trust's creation, the trustees must calculate whether a periodic charge is due -- broadly, a charge of up to 6% (technically calculated as 30% of the lifetime rate, itself up to 20%, giving a maximum effective rate of 6%) applies to the value of the trust's "relevant property" (broadly, the assets held in the discretionary trust) above the nil rate band available to the trust at that ten-year point. Many smaller discretionary trusts, with total value comfortably below the nil rate band, will find no periodic charge is actually due, even though the calculation must still technically be considered at each ten-year anniversary. **Exit charges -- when assets leave the trust** Whenever capital leaves the trust (for example, trustees distribute assets outright to a beneficiary) between the ten-year anniversaries, an "exit charge" may apply, calculated as a proportion of the most recent periodic charge rate, pro-rated for how many complete quarters have passed since the last ten-year anniversary (or since the trust was created, for the first ten years) -- broadly, the longer since the last periodic charge calculation, the higher the exit charge rate, up to the same 6% maximum. **Why this regime exists** Before this regime was introduced, trusts could potentially be used to hold assets for very long periods (across multiple generations) without ever facing an Inheritance Tax charge, since no individual beneficiary "owned" the assets outright and therefore no death triggered a charge -- the relevant property regime ensures trusts face a broadly comparable ongoing tax cost to what would apply if the assets had instead passed through a chain of individual estates every generation. **Reporting requirements even when no tax is due** Trustees are generally required to consider and, where relevant, report the periodic and exit charge position to HMRC even where the calculation shows no tax is actually due (because the trust's value remains below the available nil rate band), and separately, most trusts must be registered on HMRC's Trust Registration Service regardless of their tax position. **How this differs from bare and interest in possession trusts** This relevant property regime specifically applies to most discretionary trusts -- other trust types (such as bare trusts, where a beneficiary has an absolute, fixed entitlement) are taxed very differently, generally being treated as though the beneficiary already owns the assets outright, without the ten-year charge cycle applying at all. **Practical tip** If you're a trustee of a discretionary trust, mark each ten-year anniversary clearly in your records and get professional valuation and tax advice in good time before each anniversary, since correctly calculating (and if necessary paying) the periodic charge, and properly calculating any exit charges on distributions made between anniversaries, requires careful record-keeping of the trust's value and the nil rate bands available at each relevant date.

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