Non-Qualifying Interests in Possession: IHT After Finance Act 2006
Finance Act 2006 split interest in possession trusts into qualifying (IPDI, TSI, disabled person) and non-qualifying categories. Only qualifying interests are treated as owned by the life tenant for IHT. Non-qualifying interests — most post-2006 lifetime IIPs — are relevant property trusts: subject to entry CLT, 10-year charges, and exit charges. The life tenant's death triggers no IHT on the trust fund.
Qualifying vs Non-Qualifying: The Four Categories
Immediate Post-Death Interest (IPDI)
Qualifying IIPAn interest in possession that arises on the death of the settlor — i.e. created by a will or intestacy, and the beneficiary's interest begins immediately on the death. The IPDI beneficiary is treated as owning the underlying trust assets for IHT: assets are in the beneficiary's estate; the transfer into the trust on death qualifies for the spousal exemption if the life tenant is the surviving spouse; on the life tenant's death, the assets pass as if the life tenant owned them (subject to the life tenant's own NRB and spousal exemption).
Example: A will trust that gives a surviving spouse the right to income from the estate for life, with the capital passing to children on the spouse's death. Created by the will of the first to die — it is an IPDI. Spousal exemption applies on first death; IHT assessed on the spouse's death on the trust assets (plus their own estate) above the combined NRBs.
Transitional Serial Interest (TSI)
Qualifying IIPAn interest in possession that arose before 22 March 2006 (the pre-FA 2006 interest) was a qualifying interest in possession. Where a beneficiary held such an interest before 22 March 2006 and it subsequently terminated (e.g. because the beneficiary died or surrendered the interest) and a new interest arose after that date, the new interest may be a Transitional Serial Interest (TSI) — treated as qualifying provided the new interest arose within a limited transitional window. TSI rules are complex and fact-specific.
Example: A trust created in 2000 gave a life interest to the settlor's spouse. The spouse died in 2009. The trust deed then gave the next life interest to the settlor's child. That child's interest arose after 22 March 2006 but is a TSI — the original interest pre-dated FA 2006 and the next-in-line interest was contemplated by the pre-2006 trust.
Disabled Person's Interest
Qualifying IIPA trust created for the benefit of a disabled person (within the meaning of s89 or s89A IHTA 1984) is treated as a qualifying interest in possession — the disabled person's interest is treated as owned by the disabled beneficiary. Specific conditions apply: the trust must be established for the benefit of a person who is incapable of managing their property or affairs by reason of mental disorder, or who is in receipt of certain disability-related benefits. These trusts receive favourable IHT treatment: no relevant property charges, and the assets are treated as part of the disabled beneficiary's estate.
Example: A trust created by a parent for an adult child with severe mental illness, giving that child all the income and capital in their lifetime. This is a disabled person's trust under s89 IHTA 1984 — qualifying interest in possession, not relevant property.
Non-Qualifying Interest in Possession (post-22 March 2006)
Non-Qualifying — Relevant PropertyAny interest in possession trust created on or after 22 March 2006 that is NOT an IPDI, TSI, or disabled person's interest is a non-qualifying interest in possession. The life tenant is NOT treated as owning the underlying assets for IHT. Instead, the trust is treated as a relevant property trust — subject to the entry CLT charge, the 10-year periodic charge (up to 6%), and exit charges on distributions. The life tenant's death does not trigger an IHT charge on the trust assets (because the assets are not in the life tenant's estate).
Example: A lifetime discretionary trust created in 2010 that gives one beneficiary the right to income for 5 years, then becomes fully discretionary. The initial income interest is NOT an IPDI (not created on death) and NOT a TSI (no pre-2006 qualifying interest). It is a non-qualifying IIP — the trust is relevant property from day one, with a CLT entry charge and ongoing periodic charges.
Frequently Asked Questions
What changed for interest in possession trusts after Finance Act 2006?
Before 22 March 2006, all interests in possession trusts were treated as if the life tenant owned the underlying assets for IHT purposes (s49(1) IHTA 1984). The trust assets formed part of the life tenant's estate; the life tenant's death triggered IHT on the trust assets at the death rate (40% above the NRB); transfers into the trust were potentially exempt transfers (PETs) not CLTs. Finance Act 2006 fundamentally changed this. From 22 March 2006, only 'qualifying' interests in possession (IPDIs, TSIs, and disabled person interests) retain the old treatment. All other new interests in possession — including lifetime IIPs created after that date — are treated as relevant property trusts, not as owned by the life tenant. The FA 2006 change was announced on Budget day and took effect immediately, giving no time to restructure pre-existing plans.
Why does it matter whether an interest in possession is qualifying or non-qualifying?
The IHT consequences are fundamentally different: (1) Qualifying IIP (IPDI/TSI): the trust assets are in the life tenant's estate. Death of the life tenant triggers IHT on the trust fund above the NRB. But the spousal exemption applies if the trust was created by the first spouse's will for the surviving spouse — meaning the trust fund passes IHT-free on first death and only becomes taxable on the second death. (2) Non-qualifying IIP (post-2006 lifetime IIP): the trust is a relevant property trust. The settlor pays an entry CLT (20% above NRB) on creation. The trust fund is subject to 10-year charges (up to 6%) on each anniversary. Distributions to the life tenant are subject to exit charges. The life tenant's death does NOT trigger an IHT charge on the trust assets — the trust continues. The two regimes produce entirely different IHT outcomes, and which applies is determined by the date of creation and the qualifying category.
Is an IPDI available for will trusts created in favour of children rather than a spouse?
Yes — the IPDI definition requires only that the interest arises on the death of the settlor (the will-maker) and that it begins immediately on that death. It does not require the life tenant to be a spouse. A will trust that gives an adult child the right to income for life (with the capital then passing to grandchildren) can be an IPDI if it arises on the testator's death. However, the IHT treatment of an IPDI in favour of a child is less favourable than one in favour of a spouse: the transfer of the trust assets on the testator's death into the IPDI for the child is NOT covered by the spousal exemption — it is part of the taxable estate. The IPDI trust assets will then be treated as part of the child's estate for IHT on the child's death. IPDIs for children are used primarily for blended-family estate planning (protecting children from a first marriage), not primarily for IHT reduction.
What happens on the death of the life tenant of a non-qualifying IIP?
Where the life tenant holds a non-qualifying interest in possession (a post-2006 lifetime IIP), their death does not trigger an IHT charge on the trust fund — because the trust assets are not in the life tenant's estate. The trust continues as a relevant property trust after the life tenant's death. The trustees may then exercise their discretion to distribute capital to other beneficiaries (subject to exit charges) or the trust continues to accumulate and will be subject to 10-year charges on future anniversaries. This contrasts with the death of the life tenant of a qualifying IIP (IPDI) — where the death triggers full IHT on the trust assets as part of the life tenant's estate.
Can a post-2006 interest in possession trust ever be restructured to become qualifying?
In limited circumstances. Converting a post-2006 non-qualifying IIP into a qualifying structure generally requires: (1) winding up the existing trust and re-creating a qualifying structure — but this triggers exit charges (relevant property distributions) and potentially CGT on the disposal of trust assets; (2) using a court variation or deed of appointment to alter the trust terms — but the new arrangement must independently satisfy the IPDI/TSI/disabled person conditions; (3) on the death of the settlor, assets can pass into an IPDI via the will — but this requires the trust to be wound up and the assets to pass through the estate. Restructuring non-qualifying IIP trusts is complex and typically requires specialist tax and trust law advice. The exit charges and CGT costs of restructuring may outweigh the IHT benefit of converting to a qualifying structure.
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