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10/12/19

In this blog, partner Jill Springbett outlines some ways in which trusts can be used as part of financial and tax planning for wealthy individuals. 

Trusts can be beneficial for tax and financial planning for wealthy individuals in one or more of the following circumstances:

1. There is more than one generation of the family

Trusts are most commonly used to distribute wealth generated by the older generation to children, grandchildren and/or future descendants usually with a view to saving tax, without giving too many assets too soon.

2. The individual wants to keep control of assets

Often linked with 1. above, to keep family assets together, or to gradually accustom descendants to family wealth.

Trustees need to look after the assets for the beneficiaries as if they were their own, so there are limits to the control that can be exercised.

3. The individual must have no future need of the assets or any income that they may produce and wants to benefit others

If there is any way in which the individual may benefit from the trust fund or income generated by it in the future, this will have adverse effects for both income tax and inheritance tax.

4. The family includes vulnerable individuals

Use of a special purpose trust may be helpful in these circumstances.

Usually, the non-tax reasons for establishing a trust govern the type of trust that is best. However, it is then important to be aware of the differing tax treatment of the different types of trusts. This aspect is not covered in this post.

What is a trust?

A trust exists where a person or persons (trustees) hold property for the benefit of another or others (beneficiaries). A trust is generally created by a person, (known as a settlor), who transfers funds or other property to trustees stipulating in a trust deed or other written instrument (such as a will) the manner in which the property should be held. (Tax legislation generally refers to ‘settlements’ rather than ‘trusts’ but either term may be used.) A trust is usually a taxpayer in its own right.

Types of trust

There are three main types of trust:

1. An interest in possession trust is commonly used to confer a benefit on adult children or adult grandchildren. The beneficiaries are entitled to income either for life or for a specified period as of right (and the trustees may have the power to ‘appoint’ (give) capital to a beneficiary out of the fund from which he or she is receiving income). On the death of the beneficiary or when the specified period comes to an end, the trust property may then be held on trust for another beneficiary or, more commonly, a person or persons named in the trust deed will become absolutely entitled to the trust property, so it ceases to be held in trust.
2. A discretionary trust is a trust in which no beneficiary has any right to income or capital and instead merely has a right to be considered by the trustees as a potential object of their discretionary powers. The trustees, therefore, have considerable flexibility to decide who, among the class of beneficiaries, should receive any income or capital from the trust. Often, a discretionary trust will be accompanied by a letter of wishes to the trustees in which the settlor indicates how he or she would like the trustees to exercise their discretion. If the letter of wishes is binding, the trust will no longer be discretionary.
3. A bare trust is a trust where the trustees hold the capital and income of the trust fund absolutely for the beneficiary in question, and no other beneficiary can have any entitlement to trust assets. Income of the trust is taxed on the beneficiary, not the trustees, and the beneficiary is also treated as owning the assets for capital gains tax purposes. A bare trust does not fall within the inheritance tax (IHT) definition of ‘settlement’, so the trust property is treated as belonging to the beneficiary.

Reasons for establishing a trust

Non-tax reasons

Trusts may be used for a number of different purposes, for example to:

• Put assets into the hands of trustees who are better able to administer the assets than the intended beneficiaries
• Separate the ownership of income and capital so that for the present income is employed for one person but the capital is held long term for another. This often requires the use of an interest in possession trust
• Avoid the ownership of a particular asset having to be determined at a given time – a discretionary trust would be most appropriate for these purposes
• Protect assets, for example, where the settlor wishes to benefit family members but is not confident that they have the ability to make sensible financial decisions. Either an interest in possession or discretionary trust may be used, depending on whether the settlor wishes to protect capital (interest in possession can be used) or both capital and income (discretionary)
• Protect vulnerable people who, because of age or disability, are unable to make their own decisions – a special purpose trust may be best here.

Tax reasons

Trusts are often thought of chiefly as tools for reducing tax liabilities. The tax rules are generally now designed to ensure that trusts cannot be used to reduce overall tax liabilities over a long period. However, it is still possible to reduce overall tax rates in many situations, for example when trust income can be paid to beneficiaries who have no other income, so the income becomes tax free, or if assets are given to trust when their value is low, thereby keeping the growth in their value outside the estate of the settlor on their death.

There are also situations in which a trust may be used to achieve specific tax objectives. Two of the more common ones are:

1. To avoid crystallising a substantial gain on the gift of assets (because a non-arm’s length transaction is treated as taking place at market value).

Where a transfer is made to a trust subject to the IHT relevant property regime, capital gains tax holdover relief is available, even if the asset gifted is not a business asset.

2. To obtain capital gains tax main residence relief for a property occupied by a family member/ dependant but which they do not own – perhaps a child/grandchild at university, or an elderly relative. 

Property owned by an individual but owned by someone else does not qualify for main residence relief as it would not be their only or main home, but using a trust that gives the beneficiary a right to occupy the property will normally mean that main residence relief is available to the trustees on sale of the property.

NOTE:

There are limits on the value of most types of assets that can be put into trust without an inheritance or other tax charge, so careful planning is needed.

There are also complexities in running a trust which lead to fees, so it is generally most cost-effective if substantial amounts can be put into a trust (while still low enough not to trigger a tax liability).

If you would like to discuss the use of trusts as part of your tax or financial planning, please contact Jill Springbett.

Warning: The above is merely general guidance and should not be relied upon as formal advice. The advice we give to each client will depend on their specific circumstances. We suggest you take professional advice before taking any action in relation to the issues discussed above.