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Trusts

Trusts are sep­a­rate per­sons for UK tax pur­pos­es and have spe­cif­ic rules for all the main tax­es. There are also a range of anti-avoid­ance mea­sures aimed at pre­vent­ing exploita­tion of poten­tial tax ben­e­fits. If you live in the Lanark­shire area we, at Rus­sell & Rus­sell, can pro­vide tax­a­tion advice to help you utilise trusts as part of an over­all tax plan­ning strat­e­gy for you and your fam­i­ly.

What are trusts?

Trusts are a long estab­lished mech­a­nism which allow indi­vid­u­als to ben­e­fit from the assets whilst oth­ers (the trustees) have the legal own­er­ship and day to day con­trol over the assets. A trust can be extreme­ly flex­i­ble and have an exis­tence total­ly inde­pen­dent of the per­son who estab­lished it and those who ben­e­fit from it.

A per­son who trans­fers prop­er­ty into a trust is called a set­t­lor (or truster in Scot­land). Per­sons who enjoy income or cap­i­tal from a trust are called ben­e­fi­cia­ries. Though not very com­mon with Eng­lish trusts, it is pos­si­ble for the set­t­lor to appoint a pro­tec­tor, an inde­pen­dent per­son who over­sees the admin­is­tra­tion of the trust.

Trusts are sep­a­rate per­sons for UK tax pur­pos­es and have spe­cif­ic rules for all the main tax­es. There are also a range of anti-avoid­ance mea­sures aimed at pre­vent­ing exploita­tion of poten­tial tax ben­e­fits.

Types of trusts

There are two basic types of trust in reg­u­lar use for indi­vid­ual ben­e­fi­cia­ries:

  • life inter­est trusts (often referred to as inter­est in pos­ses­sion trusts and in Scot­land known as life renter trusts)
  • dis­cre­tionary trusts.

Life interest trusts

A life inter­est trust has the fol­low­ing fea­tures:

  • a nom­i­nat­ed ben­e­fi­cia­ry (the life ten­ant or life renter in Scot­land) has an inter­est in the income from the assets in the trust or has the use of trust assets. This right may be for life or some short­er peri­od (per­haps to a cer­tain age)
  • the cap­i­tal may pass onto anoth­er ben­e­fi­cia­ry or ben­e­fi­cia­ries.

A typ­i­cal exam­ple is where a wid­ow is left the income for life and on her death the cap­i­tal pass­es to the chil­dren.

Discretionary trusts

A dis­cre­tionary trust has the fol­low­ing fea­tures:

  • no ben­e­fi­cia­ry is enti­tled to the income as of right
  • the set­t­lor gives the trustees dis­cre­tion to pay the income to one, some or all of a nom­i­nat­ed class of pos­si­ble ben­e­fi­cia­ries
  • income can be retained by the trustees
  • cap­i­tal can be gift­ed to nom­i­nat­ed indi­vid­u­als or to a class of ben­e­fi­cia­ries at the dis­cre­tion of the trustees.

Inheritance tax consequences

Importance of 22 March 2006

Major changes were made in the IHT regime for trusts with effect from 22 March 2006. The old dis­tinc­tion between the tax treat­ment of dis­cre­tionary and life inter­est trusts was swept away. The approach now is to iden­ti­fy trusts which fall in the so-called ‘rel­e­vant prop­er­ty’ regime and those which do not.

Relevant property trusts

Trusts which fall in the rel­e­vant prop­er­ty regime are:

  • all dis­cre­tionary trusts when­ev­er cre­at­ed
  • all life inter­est trusts cre­at­ed in the set­t­lor’s life­time after 22 March 2006
  • any life inter­est trust cre­at­ed before 22 March 2006 where a ben­e­fi­cia­ry changes after 6 Octo­ber 2008. A key excep­tion exists where a change occurs after 6 Octo­ber 2008 on the death of a life ten­ant but the new life ten­ant is their spouse.

If a rel­e­vant prop­er­ty trust is set up in the set­t­lor’s life­time, this may give rise to an imme­di­ate charge to inher­i­tance tax at the life­time rate of 20%. If the val­ue of the gift (and cer­tain ear­li­er gifts) is below £325,000 or is cov­ered by an IHT relief then no tax is payable. Trusts set up under a will attract the nor­mal inher­i­tance tax charge at the death rate of 40% (after reliefs and the nil rate band where avail­able).

Rel­e­vant prop­er­ty trusts are charged to tax every ten years (known as the peri­od­ic charge) at a max­i­mum rate of 6% of the val­ue of the assets on each tenth anniver­sary of the set­ting up of the trust. A fair pro­rate charge of less than 6% (and often much low­er) is also made if assets are appoint­ed out of the trust known as an ‘exit charge’.

Benefits of a relevant property trust

Whilst the inher­i­tance tax charges may not look attrac­tive, the rel­e­vant prop­er­ty trust has a sig­nif­i­cant ben­e­fit in that no tax charge will arise when a ben­e­fi­cia­ry dies because the assets in the trust do not form part of a ben­e­fi­cia­ry’s estate for IHT pur­pos­es. There can be sig­nif­i­cant long-term IHT advan­tages in using such trusts.

Trusts which are not relevant property

With­in this group are:

  • life inter­est trusts cre­at­ed before 22 March 2006 where the pre-2006 ben­e­fi­cia­ries remain in place or were changed before 6 Octo­ber 2008 or where a sec­ond spouse has tak­en over the life inter­est on the death of the first spouse
  • the trust was cre­at­ed after 22 March 2006 under the terms of a will and gives an imme­di­ate inter­est (can­not be replaced by anoth­er) in the income to a ben­e­fi­cia­ry and the trust is nei­ther a bereaved minor’s nor a dis­abled person’s trust; or
  • the trust is cre­at­ed in the set­t­lor’s life­time or on death for a dis­abled per­son.

For pre-22 March 2006, life­time trans­fers into a life inter­est trust, the gift would have been a poten­tial­ly exempt trans­fer (PET) and no inher­i­tance tax would have been payable if the set­t­lor sur­vived for sev­en years. Trans­fers into a trust on death would be charge­able unless the life ten­ant was the spouse of the set­t­lor. There is no peri­od­ic charge on such trusts. There will be a charge when the life ten­ant dies because the val­ue of the assets in the trust in which they have an inter­est has to be includ­ed in the val­ue of their own ‘set­tled estate’ for IHT pur­pos­es.

Capital gains tax consequences

If assets are trans­ferred to trustees, this is con­sid­ered a dis­pos­al for cap­i­tal gains tax pur­pos­es at mar­ket val­ue but in many sit­u­a­tions any cap­i­tal gain aris­ing can be deferred and passed on to the trustees.

Gains made by trustees on the dis­pos­al of trust assets are charge­able at 24%.

Where assets leave the trust on trans­fer to a ben­e­fi­cia­ry who becomes legal­ly enti­tled to them, there will be a CGT charge by ref­er­ence to the then mar­ket val­ue. Again it may be pos­si­ble to defer that charge.

Income tax consequences

Life inter­est trusts are taxed on their income at 10.75% on div­i­dends and 20% on oth­er income. Dis­cre­tionary trusts pay tax at 39.35% (div­i­dends) and 45% (oth­er income).

Income paid to life inter­est ben­e­fi­cia­ries has an appro­pri­ate tax cred­it avail­able with the effect that the ben­e­fi­cia­ries are treat­ed as if they receive the income as the own­ers of the assets.

If income is dis­trib­uted at trustee dis­cre­tion from dis­cre­tionary trusts, the ben­e­fi­cia­ries will receive the income net of 45% tax. They are gen­er­al­ly able to obtain refunds of any over­paid tax and if they pay tax at 45%, they will get cred­it for the tax paid. Refund excep­tions may apply in cer­tain set­t­lor trust sit­u­a­tions.

Could I use a trust?

Trusts can be used in a vari­ety of sit­u­a­tions both to save tax and also to achieve oth­er ben­e­fits for the fam­i­ly. Par­tic­u­lar ben­e­fits are as fol­lows:

  • If you trans­fer assets into a trust in your life­time you can remove the assets from your estate but could act as trustee so that you retain con­trol over the assets (always remem­ber­ing that they must be used for the ben­e­fi­cia­ries).
  • A trans­fer of fam­i­ly com­pa­ny shares into a trust in life­time (or on death) can be a way of ensur­ing that the valu­able busi­ness prop­er­ty relief is utilised.
  • By putting assets into a trust you can give the ben­e­fi­cia­ry the income from the asset with­out actu­al­ly giv­ing them the asset which could be impor­tant if the ben­e­fi­cia­ry is like­ly to spend the cap­i­tal or the cap­i­tal could be at risk from preda­tors such as a divorced spouse.
  • Trusts (par­tic­u­lar­ly dis­cre­tionary trusts) can give great flex­i­bil­i­ty in direct­ing ben­e­fit for dif­fer­ent mem­bers of the fam­i­ly with­out incur­ring sig­nif­i­cant tax charges.
  • If you want to make some IHT trans­fers in your life­time but are not sure who you would like to ben­e­fit from them, a trans­fer to a dis­cre­tionary trust can enable you to reduce your estate and leave the trustees to decide how to make the trans­fers in lat­er years. It also means that the assets trans­ferred do not now hit the estates of the ben­e­fi­cia­ries.

Trust Registration Service

This is an impor­tant recent dig­i­tal admin­is­tra­tion devel­op­ment, which came about due to Mon­ey Laun­der­ing Reg­u­la­tions which require coun­tries to have a nation­al reg­is­ter of cer­tain infor­ma­tion to fight against mon­ey laun­der­ing and ter­ror­ist financ­ing.

Since 2020, The Trust Reg­is­tra­tion Ser­vice (‘TRS’) requires all UK non — tax­able ‘express’ trusts (and cer­tain addi­tion­al non-UK trusts — not con­sid­ered fur­ther here) to reg­is­ter. An express trust is one which is cre­at­ed delib­er­ate­ly by an indi­vid­ual in writ­ing for spe­cif­ic pur­pos­es rather than being cre­at­ed by an act of law which is a non express trust. Com­mon exam­ples include but are not restrict­ed to inter­est in pos­ses­sion and dis­cre­tionary trusts. Non express trusts include trusts estab­lished by a Court or by leg­is­la­tion and pro­vid­ed there is no tax lia­bil­i­ty are not required to reg­is­ter.

The dead­line for reg­is­tra­tion of new trusts or where changes deter­mine that a trust needs to reg­is­ter is 90 days from creation.Trusts on the reg­is­ter have to be updat­ed when­ev­er there are cer­tain changes, such as a change in the lead trustee. These changes will also have a 90 day action dead­line.

HMRC have pub­lished a man­u­al to assist tax­pay­ers — the Trust Reg­is­tra­tion Ser­vice Man­u­al — HMRC inter­nal man­u­al — GOV.UK

How we can help

This fact­sheet briefly cov­ers some aspects of trusts. If you live in the Lanark­shire area and are inter­est­ed in pro­vid­ing for your fam­i­ly through the use of trusts please con­tact us at Rus­sell & Rus­sell.