IHTM42223 | The settlement: powers of appointment

Before reaching the income provisions of a settlement deed, it is usual to find powers of appointment of capital and income.

A power of appointment may allow

• the trustees to appoint the capital by deed or deeds - or the capital and income - at their discretion;

• appointment of capital to be made by someone authorised by the trustees in their discretion.

It will usually extend to the whole or part of the capital as the trustees in their absolute discretion decide, and the persons to benefit will be some members of the class of objects as the trustees in their discretion decide.

These powers alone do not tell us whether the trust is discretionary. ‘Income’ is within the powers above, but this does not mean that the income is subject to discretion as it arises. An exercise of the power in the prescribed form (deed) is required to dispose of the income.

• The status of the trust, discretionary or interest in possession (IIP), is determined by the trusts that apply until the power of appointment is exercised (trusts in default of appointment). Many years might pass before any appointment is made.

• In this case, after the income powers, the next clause might say, ‘Subject to and in default of appointment to William Jones for life.’ That is an IIP.

• Or it could say, ‘Subject to and in default of appointment my trustees shall pay the income as it arises to such members of the discretionary class (defined at clause…) as my trustees in their absolute discretion think fit.’ That is not an IIP.

The power of appointment hangs over any existing vested IIPs but has effect only when exercised. In deciding whether a trust is IIP or discretionary, the trust in default of appointment prevails.

If a person has an IIP they can demand their benefit, whatever it might be. But if the trustees have an existing power of accumulation the interest is not ‘vested’ and the trusts are discretionary.

Every settlement yields benefit, even if the benefit is not in the form of income. Whether it yields income, or a right to reside, or to enjoy a chattel, the benefit is produced day by day.

It is important to note that from 22 March 2006 there is a distinction between qualifying and non-qualifying IIPs. Non-qualifying IIPs are charged to tax in the same way as discretionary trusts, i.e. as relevant property.

Example

The trustees can exercise their power and take a beneficial interest away from William, the default beneficiary, and in doing so they bring William’s interest to an end. If the settlement is a qualifying IIP this gives rise to a claim under IHTA84/S52 (1) against William personally as the deemed transferor, on the full value of the underlying assets. (IHTM16091)

His interest in this example is said to be vested subject to divesting. It is an IIP for so long as he is allowed to enjoy it.

If the trustees revoke William’s interest and appoint to his brother James on similar terms, the trusts are still IIP. The important point is that the trustees’ power of appointment cannot be used retrospectively to deprive William or James of the benefit that was due to them up to the date on which the deed or resolution exercising the power says it is to go elsewhere.

In contrast, because a power of accumulation takes effect ‘at source’ before any interest can vest, its existence is enough to prevent William or James from taking any vested interest from the beginning.

If the settlement were a non-qualifying interest then, in the scenarios above, the settled property remains relevant property and no exit charges arises under IHTA/S65.