The Spousal By-Pass Trust (or more commonly known as the Pilot Trust) whilst being clearly relevant for those situations where an approved pension fund will pay benefits on death, it is also a relevant and effective estate and inheritance tax planning device for the owners of private trading businesses or farms.
Shares in a trading company or interest in a trading partnership usually qualify for 100% business property relief. Where 100% business property relief is available this means that there is no limit on the amount that can be transferred to other than the surviving spouse of civil partner inheritance tax free. For example shares could be transferred into a spousal by-pass trust. This is useful where partners or co-share holders have in place arrangements for the purchase of the business interest of a deceased owner. This common arrangement has the effect of ensuring that the surviving business owners receive the shares of the deceased and the family or other beneficiaries of the deceased receive cash. This is usually funded by life assurance held in trust and provided for by virtue of a double option agreement. Without a spousal by-pass trust the terms of a double option agreement would mean that the policy proceeds would buy the deceased’s shares from his personal representatives who would then pass the funds to the widow. As a result, the co shareholders are left in complete ownership of the business and the widow would have a sum of cash. The cash, unlike the business interest, would not qualify for business property relief and thus inheritance tax could become an issue in respect of the cash on the widow’s death.
As an alternative, the deceased could have put in place a spousal by-pass trust, either in his Will or during his lifetime with a view to leaving the business interests subject to it on death. Should such a trust be in place then the shares would pass directly to it on the deceased shareholders death and there would be no inheritance tax to pay regardless of their value provided they qualified for 100% business property relief. Under the double option agreement the policy proceeds would be used to purchase the shares from the trustees of the trust with a result that the proceeds of sale would be held inside the trust and not in the estate of the widow. However under the terms of the trust there would be a wide class of beneficiaries including the widow who should she require funds these could be made available to her by way of advancement or preferably by way of an interest free loan. The making of loans rather than outright capital advancements can be effective from the point of view of inheritance tax planning.
This type of arrangement was often incorporated in wills where husband’s and wife were making use of a nil-rate band discretionary trust on the first death where the Will provided that any shares attracting 100% business property relief would pass also into that trust arrangement, thereby boosting the value of the nil-rate band trust in circumstances where the shares were turned into cash, either as a result of the existence of the double option agreement and the life cover or by the widow simply deciding to use available cash in order to purchase the shares, thereby replacing the shares with cash in the discretionary trust.
As there are tax issues to be considered in any type of trust arrangement or transfer it is important that legal advice is sought and again in relation to the drafting of any trust arrangement to ensure that it meets its objectives.
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