1. Key Principle
Inheritance Tax (IHT) on a Chargeable Lifetime Transfer is based on the loss to your estate, not on what the trust receives. Because your estate can reduce by different amounts depending on who pays the tax, HMRC applies two different calculation methods.
2. When the Trustees Pay the Tax (20% Net Rate)
If the trust pays the tax out of the assets you’ve transferred:
- The tax is deducted from the trust fund itself.
- Your estate only reduces by the amount you gifted.
- HMRC applies the standard 20% lifetime rate to the value above your available nil‑rate band (NRB).
Example: You transfer £100,000 above your NRB.
- Tax = £100,000 × 20% = £20,000
- Trust receives £80,000
- Your estate reduces by £100,000
3. When You (the Settlor) Pay the Tax Personally (25% Grossed‑Up Rate)
If you choose to pay the tax from your own bank account:
- You are effectively making two gifts:
- The amount going into the trust
- The tax you pay on behalf of the trust
- Because your estate loses more than the trust receives, HMRC requires the gift to be grossed up.
- This increases the effective tax rate to 25% of the net amount.
Why 25%? A 20% tax on a grossed‑up amount is mathematically equal to 25% of the net amount.
Example: You transfer £100,000 above your NRB and pay the tax yourself.
- Tax = £100,000 × 25% = £25,000
- Trust receives the full £100,000
- Your estate reduces by £125,000
- 20% of £125,000 = £25,000, matching the tax paid
