Trusts - are they still relevant?
Current Issues | Tax | 14th November 2018
A trust arises when the legal title of property is transferred to trustees, for them to manage the property for the benefit of those named or specified in the trust deed. Trusts can be created during one’s lifetime, on death in a Will (or deed of variation to a Will) or in accordance with intestacy provisions. Trusts may be UK resident or non-resident for income tax and capital gains tax
Uses for Trusts
Although a number of the benefits of trusts have been eroded over recent years there are still many reasons why a trust may be used.
If the trust is created as a discretionary trust, the beneficiaries have no right to any benefit, so the trustees can decide how much they receive from the trust and when. This is very useful for those who may wish to try and alleviate inheritance tax by passing assets to children or grandchildren, but the beneficiaries are felt to be financially imprudent, so outright gifts are felt inappropriate, or they are concerned about possible ‘fortune hunters’.
Trusts are also a very effective way of managing assets for people who may not be able to manage their finances sufficiently, due to a disability. Personal injury trusts can also be very effective for people that receive compensation for an injury or illness. They can be structured to ensure they do not affect an individual’s right to welfare benefits
Trusts on death (will trusts)
Until 2007, discretionary trusts equal to the unused nil-rate band have been a popular inclusion in wills, to utilise that inheritance tax benefit otherwise wasted in the typical situation where each of a married couple leaves their estate to the surviving spouse and then to their children, However, now any unused nil rate band has become transferable between spouses, this is less common. But they still do have a purpose, particularly if the property thus settled may be expected to increase in value.
However, the most common will trust gives a life interest to the surviving spouse, especially where this is a second marriage and the deceased wants to leave assets to the children of the first marriage on the surviving spouse’s death.
In some very limited circumstances trusts can be used to protect assets from third party claims or on divorce. However, the decision to settle assets to avoid creditors’ claims can be challenged under the Insolvency Act. Divorce courts are notorious in ignoring restraints on trustees. Furthermore, local authorities have power to challenge ‘deliberate deprivation’.
Trusts may be:
Bare trusts, where the trustee holds property for a beneficiary, although the beneficial ownership remains with the beneficiary. For example –
- The clients’ accounts of solicitors, estate agents, etc.
- Nominee companies holding the listed securities of most investors.
- A parent holding in trust property given by grandfather to his infant granddaughter. to hold until she is 18.
- A partnership’s farm is registered in the names of only four partners out of seven, who hold it in trust for the partnership.
- Jack and Jill hold the lease of a flat in trust for themselves as tenants in common in equal shares or as joint tenants.
For income tax, capital gains tax and inheritance tax such trusts are transparent; the beneficial owner(s) are chargeable, not the trustees.
Trusts with interests in possession, that is, where someone has a right to the income for a defined period or until the right is revoked, the capital then going to others either at the trustees’ discretion or as specified.
Discretionary trusts, those without interests in possession, where the trust income and capital is held to be accumulated, or distributed at the trustees’ discretion to one or more of identified beneficiaries.
Tax position of UK trusts [adopting 2018/19 tax rates, but the tax rates proposed for 2019/20 are the same]
Generally, the income of trusts with an interest in possession (that is, where someone has a right to the income as it arises) is chargeable at 7.5% (dividends) or 20% (rent, interest etc.). However, certain receipts (share redemption, accrued income profits, gains on offshore funds, profits from deeply discounted securities, etc.) are chargeable at 45%. The income of discretionary trusts is chargeable at 38.1% (dividends) or 45% other income, save for a first slice of £1,000 (reduced if there are other trusts with the same settlor to a minimum of £200), which is charged at 7.5% (dividends) or 20% (rent, interest etc.). If someone has an interest in possession, unless the trust is ‘settlor-interested’, the income net of the trust management expenses is treated as that person’s, with credit for the tax borne by the trustees.
The income of a settlor-interested trust is treated as the settlor’s for income tax purposes. A trust is ‘settlor-interested’ for income tax purposes if the settlor or the settlor’s spouse or civil partner may benefit from the trust (save in certain exceptional circumstances).
Unless the trust is ‘settlor-interested’, discretionary beneficiaries who receive income payments are treated as receiving them net of 45% income tax. Otherwise they are treated as having suffered non-repayable tax at 45% on the actual amount received.
A non-domiciled settlor of a settlor-interested trust who is UK resident is exposed to a possible ‘pre-owned asset’ income tax charge if the trust assets include interests in UK open-ended investment companies (OEICs) or authorised unit trusts, unless the trust is only settlor-interested because the settlor’s spouse or civil partner is a beneficiary. This applies even though such assets are excluded property for inheritance tax purposes.
Capital gains tax
Trustees are subject to capital gains tax on the trust’s chargeable gains at the same rates as individuals, with an annual exemption of up to £5,850 (reduced to a minimum of £1,170 if there are other trusts with the same settlor).
For 2019/20 the annual exemption proposed is £6,000, or if reduced because of other trusts with the same settlor, a minimum of £1,200.
In some cases, where someone has an interest in possession, the trust property is treated as part of the estate of that person for inheritance tax purposes. This applies in particular to trusts established before 22 March 2006, trusts established on the settlor’s death under a Will and trusts for disabled persons.
Otherwise, inheritance tax at 20% is payable on a lifetime gift into trust, to the extent the sum of the amount settled and any earlier gifts within the 7 years then ending exceeds £325,000. If the settlor dies within 7 years of the gift further tax is payable, of a maximum of another 20%.
Inheritance tax is payable by the trustees on capital distributions and at each ten-year anniversary at a maximum rate of 6%.
Tax position of trusts not UK resident
Trustees are subject to UK income tax at the rates applicable to UK resident trusts on UK property income and if any of the beneficiaries is UK resident also on other income.
Capital gains tax
Trustees are only subject to UK capital gains tax in 2018/19 on gains realised on disposal of UK residential property. From 6 April 2019 this is to apply to gains realised on disposals of UK land and buildings, generally, and also of interests in property-rich companies. Trust gains not subject to UK tax may be attributed to UK resident beneficiaries who receive capital payments.
UK inheritance tax applies to non-resident trusts in the same way as for UK trusts.
Although some of the inheritance tax benefits have been removed, especially in 2006, some remain.
Capital gains tax on the disposal of assets to a lifetime trust may generally be deferred by ‘holdover relief’ until the trustees’ subsequent disposal.
Although the creation of a trust is usually a chargeable event for inheritance tax, if the assets settled qualify for business property relief (BPR) or agricultural property relief, (APR) this avoids an immediate inheritance tax charge. This can be particularly useful if the assets may not qualify for BPR or APR in the future.
Otherwise, a lifetime gift of property within the nil rate band (currently £325,000) settled in a trust from which the settlor may not benefit will escape inheritance tax if the settlor survives 7 years.
It is still good tax planning for a non-domiciled individual (unless they are, or become, a ‘formerly domiciled resident’) to settle assets in trust before becoming UK domiciled. A ‘formerly domiciled resident’ is someone born in the UK with a domicile of origin in the UK who is resident in the UK and was so resident in at least one of the two preceding tax years
Assets in the trust that are ‘excluded property’ will be exempt from UK inheritance tax, even if the settlor later becomes UK domiciled. Assets situated outside the UK (except those mentioned below involving UK residential property) and interests in UK open-ended investment companies (OEICs) and authorised unit trusts are excluded property. Also excluded are FOTRA (free of tax to residents abroad) gilts if the beneficiaries fulfil certain conditions.
Although they are situated outside the UK, the following are not excluded property: interests in offshore partnerships and offshore ‘close’ companies to the extent their value is attributable to UK residential property, and loans financing such interests. Proceeds realised from disposal of such property remain exposed to UK inheritance tax for two years afterwards.
Trust registration service
HMRC requires that all ‘taxable express trusts’ (trusts that are liable to pay income tax, capital gains tax, inheritance tax, stamp duty land tax, land and buildings transaction tax or stamp duty reserve tax) should register online with the Trust Registration Service. Regulations also requires other ‘express trusts’ to maintain the information (of settlors, trustees, beneficiaries, etc.) that the Register would require if the trustees become liable to pay any of the six taxes.
The Fifth Anti-Money Laundering Directive will mean that all trusts, not just those taxable, may have to register, possibly with effect from 10 January 2020. HMRC are understood to be considering ways to alleviate the burden this would impose.
Please note that this is just a brief outline. No action should be taken without specific professional advice. Please speak to your usual Shipleys contact if you would like to discuss anything further.