The Dreelan case confirms that transfers of property between excluded property settlements after the settlor becomes deemed domiciled will not cause the property to become subject to UK inheritance tax. However, settlors should not add personally held property to a settlement after they become deemed domiciled as this is likely to be subject to UK inheritance tax.
Reminder of the inheritance tax principles
The UK inheritance tax treatment of settlements depends on whether the settlor was domiciled or deemed domiciled in the UK at the time the settlement was made.
Most settlements created by UK domiciliaries fall into the “relevant property regime”. Under the relevant property regime, there is an inheritance tax charge on property in the settlement when the trust is created, and then on every tenth anniversary of the commencement of the settlement (anniversary charges) and on the distribution of property out of trust. If the settlor retains an interest in the settlement, then there will also be an inheritance tax charge on the settlor’s death under the “gifts with reservation of benefit” regime. Certain property is exempt from these inheritance tax charges, such as agricultural or business property.
However, if the settlor of a trust was not UK domiciled at the time the settlement was made, the trust is an “excluded property trust”. There is no inheritance tax on non-UK property in an excluded property settlement.
The analysis is slightly more complex when property is transferred from one settlement (the original settlement) to another (the second settlement).
- The transferred property is treated as remaining in the original settlement for the purposes of the relevant property regime. It will only be excluded property if the settlor of the original settlement was non-UK domiciled (and it is non-UK property).
- But there is an additional requirement for excluded property status: the settlor of the second settlement must also have been non-UK domiciled when the second settlement was made.
Summary of the Case
The case concerned transfers between two trusts, both settled by Michael Dreelan. Mr Dreelan was domiciled in Ireland but subsequently became deemed domiciled in the UK. Before he became a UK domiciliary:
- In 2001, he settled a trust (the 2001 Settlement) which was an excluded property settlement.
- In 2003, he transferred shares in a UK company Qserv Limited (Qserv) to the trustees of the 2001 Settlement.
After Mr Dreelan became a UK domiciliary:
- In 2008, Mr Dreelan and his brothers settled a new trust, the Dreelan Brothers Joint Trust (the DBJT). Each brother had a life interest in a quarter of the DBJT. This was a relevant property trust as Mr Dreelan was deemed domiciled when it was made.
- The trustees of the 2001 Settlement transferred the Qserv shares to the DBJT. The Qserv shares were deemed to remain in the 2001 Settlement for the purpose of the relevant property regime but were not excluded property; that would have required the DBJT to have been made by a non-domiciled settlor.
- The trustees of the DBJT sold the Qserv shares and retained the cash proceeds.
- In 2011, the trustees of the DBJT transferred Mr Dreelan’s shares of the cash proceeds of the Qserv shares (the Qserv Proceeds) back to the 2001 Settlement. The trustees of the 2001 Settlement transferred the Qserv Proceeds into a Jersey bank account, so they were holding foreign property.
At the first anniversary date of the 2001 Settlement, the trustees were holding the Qserv Proceeds as foreign property. To determine whether the Qserv Proceeds were excluded property for inheritance tax purposes, the question was whether the settlor was UK domiciled “at the time the settlement was made”. It was agreed that Mr Dreelan was the settlor of the Qserv Proceeds since the shares derived from him originally.
HMRC argued that for the purposes of determining excluded property status, every transfer of funds is a new settlement and the domicile of the settlor must be investigated at the date of the transfer. If HMRC were right, then when a settlor establishes a trust with £10 and then adds further sums the next day, he would actually have made two settlements – one on the date of the settlement and one the next day.
On that basis HMRC argued that a new settlement had been made when the trustees of the DBJT transferred the Qserv Proceeds back to the 2001 Settlement in 2011. As Mr Dreelan was then deemed domiciled in the UK, HMRC’s view was that the Qserv Proceeds were not excluded property but were subject to the anniversary charge.
By contrast Mr Dreelan argued that “settlement” should be interpreted in accordance with the general understanding of trust practitioners and that a settlement is made when it is first established and not every time there is a transfer into the settlement.
The Court of Appeal agreed with Mr Dreelan and held that in accordance with the usual principles of trust law, a settlement is a single settlement even if a number of transfers are made into the settlement. The settlement is made when the settlor first executes the trust instrument and provides the initial trust property.
As Mr Dreelan was not domiciled when he first made the 2001 Settlement, it remained an excluded property trust. The foreign assets in the 2001 Settlement were therefore not subject to the anniversary charge, and it made no difference that they had been transferred into a relevant property trust and back again.
It is unlikely that many trustees will face the scenario of trust property which has been transferred from an excluded property trust to a relevant property trust and then back again. Nonetheless, it is useful to note that such funds can regain their excluded property status if they are transferred back to the original trust (or, presumably, to a different excluded property trust).
The key message to take from this case is that it is not necessary to test the domicile of the settlor every time funds are transferred between excluded property trusts. This should make it easier for trustees where the settlor of a series of trusts is now deemed domiciled in the UK and the trustees wish to make transfers between the settlements or contract between the settlements on non-commercial terms.
This reasoning would not allow trustees to declare a new trust after the settlor has become deemed domiciled, while retaining excluded property status. The new trust would be made when it is declared (after the settlor is deemed domiciled), so would be a relevant property trust. However, it is usually possible for trustees to amend the terms of an excluded property trust significantly without actually declaring a new trust.
Taken to its logical conclusion, the Court of Appeal’s reasoning would mean that deemed domiciled settlors could add property to a settlement which they set up while non-domiciled in the UK. As the settlement was made while the settlor was non-UK domiciled, any foreign property (whenever added) would be excluded property. However, the Court of Appeal expressly refused to rule on that point, noting that wider policy considerations may then be engaged.
Until a court confirms the point, it should be assumed that when a domiciled settlor transfers property into an excluded property trust, the added property will be within the relevant property regime and subject to inheritance tax.