I understand that a ‘discounted gift trust’ is a fund of investments (some bonds, some not) that pays a regular carve-out in excess of the ‘natural’ income, with the ‘discount’ based on the age and health of the settlor. My understanding is also that HMRC regards this as a return of capital. After seven years, the remaining contents of the trust can be passed on to the beneficiaries without incurring inheritance tax. The fundamental question is whether a person who is gifting out of an excess income stream is also permitted to consume the capital returns via regular bond payments. 

Arthur Weller replies: 

If I understand you correctly, you are referring to the inheritance tax 'normal expenditure out of income' rules (outlined in HMRC’s Inheritance Tax Manual at IHTM14231), which broadly state that a person can gift excess income to someone else, and it will not be classed as a potentially exempt transfer (PET), so it is unaffected by the IHT seven-year rule. Since you say that HMRC regards what you receive from the discounted gift trust (DGT) as capital, your receipts and use of what you receive from the DGT will not impact what you give away under the 'normal expenditure out of income' rules. See HMRC’s guidance at IHTM14255, where it states: ‘Although the normal expenditure gifts must have left the transferor with ‘sufficient income’ to maintain their usual standard of living, they do not need to have actually used this for living expenses. The transferor may, in fact, choose to use capital to meet their living expenses and use the income remaining, after making the gifts, for some other purpose. It is enough, for the exemption to apply, that the income was enough to meet both the normal expenditure gifts and the usual living expenses.’