A trust can have a wide range of uses. From Inheritance Tax planning to controlling how your assets pass to the next generations now or after your death, they are a useful tool which are commonly misunderstood.
If you are considering establishing a trust, it is important to understand some of the basics about how they operate and the role of a Trustee.
This article aims to give a brief overview and we would always recommend seeking professional advice before taking any action.
What is a trust?
A trust is a separate entity operated by a small group of people (at least two or three), known as the ‘Trustees’. The Trustees are the legal owners of whatever assets are transferred to them by the person giving them away, the ‘Settlor’. The Trustees are normally individuals, but can include a professional Trustee or Trust Company.
The Trustees are required to look after those assets on behalf of those who will benefit from the Trust, the ‘beneficiaries’.
The details of who the Trustees, Settlor, Beneficiaries are and assets being placed into Trust are normally set out in the ‘Trust Deed’, along with the ‘terms’ of the trust, i.e. how the Trust will operate.
There are a broad range of Trusts, however the two main types are ‘Discretionary’ and ‘Interest in Possession’.
Broadly, in a Discretionary Trust, the Trustees have the power to distribute income and/or capital to the beneficiaries at their discretion i.e. they have absolute control.
In an Income in Possession Trust, the beneficiary, known as the ‘Life Tenant’ of the Trust, is entitled to all of the income arising in the Trust. The Capital of the Trust i.e. the assets, are normally reserved for another beneficiary(ies), the ‘remaindermen’. This type of trust is commonly used where a spouse passes away and under the terms of their Will, assets pass into a Life Interest Trust for the surviving spouse, to provide for them in their lifetime, with the assets then passing to their children upon the surviving spouse’s death.
Why are Trusts used?
People establish Trusts for a variety of reasons, depending on their goals. Some benefits include;
- Inheritance Tax planning. In some circumstances, gifting an asset into Trust will remove the value of it from your own Inheritance Tax Estate. If the Settlor is also a Trustee, they still can continue to have a say over how the asset is managed.
- Succession Planning. Ensuring that assets pass from your estate to the desired beneficiaries, or providing for the future of other generations, such as future grandchildren.
- Safeguarding assets. Trusts can help to offer an extra layer of protection against events such as insolvency proceedings and divorce.
- Providing protection for vulnerable or disabled beneficiaries and minor or bereaved children.
- A level of confidentially. Trusts are not the secret tax avoidance structures they were once perceived to be. Most trusts are required to report a certain level of information to HMRC. However, they do offer a level of confidentially from the general public as to the legal ownership of assets and potentially, confidentiality as to how assets will pass. Beneficiaries of Trust’s may not even know they are such, until it becomes necessary.
- Tax planning for non-UK domiciled individuals.
How is a Trust established?
A trust can be established during the lifetime of the Settlor, or upon death, through their Will.
In both circumstances, a suitably experienced solicitor will be required to draft the Trust Deed, or Will, to ensure that it is suitably worded and the assets correctly transferred into the Trust.
The Trustees role
Trustees have a legal responsibility to carry out certain duties as part of their role. These include, but are not limited to;
- Acting in the best interest of the Beneficiaries at all times;
- Avoiding conflicts of interest;
- Acting impartially;
- Maintaining complete and proper accounting records;
- Investing Trust assets prudently.
Tax and Trusts
Income Tax
Gifting assets into Trust means that the income is no longer that of the Settlor.
If income producing assets are settled into Trust, or the Trust makes distributions of income to Beneficiaries, the Trustees may need to complete a Self-Assessment tax return.
The type of trust determines the Income Tax rate.
Capital Gains Tax
Settling assets into Trust during lifetime is normally a chargeable disposal by the Settlor, for Capital Gains Tax purposes.
Depending on the type of Trust, there are some Capital Gains Tax reliefs for the Settlor, when gifting assets into Trust.
Trustees are also required to report chargeable disposals on a Self-Assessment tax return. This can include not only the sale of assets, but also distributions of assets to beneficiaries in certain circumstances.
Inheritance Tax
Settling assets into Trust is normally a ‘Chargeable Lifetime Transfer’ for Inheritance Tax purposes and may result in a tax charge.
Depending on the type of trust, there may also be an Inheritance Tax charge on the distribution of assets from a trust, and on the value held in the trust on the tenth anniversary of its establishment and every ten years thereafter.
Trust Registration Service
Most trusts are now required to register for HMRCs ‘Trust Registration Service’, even if they are already in Self-Assessment. A certain level of information needs to be provided to HMRC, including Trustee, Beneficiary and Settlor details, and information about what assets were originally settled into Trust.
Non-resident Trusts
The taxation of non-UK resident trusts is complex and is not covered in the basic details set out in this article.
If you require advice concerning the residency of a Trust and the subsequent tax consequences, specialist advice should be sought.
Summary
While Trusts are not as popular as they once were, they still present a useful tool for tax planning and the safeguarding of assets.
We find that the majority of issues tend to arise where Trusts are established without a full understanding of the implications, or how the Trust should operate. Suitable professional advice should always be sought before deciding to establish a Trust and potentially on an ongoing basis, as to how the Trust should be administered.
Advice clinics are available to book one hour free of charge with the relevant expert – contact the Tax team on 01242 776000 or email tax@randall-payne.co.uk.
