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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. At Hart Shaw, we can provide taxation advice to help you utilise trusts as part of an overall tax planning strategy for you and your family.
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.
The Trust Registration Service (‘TRS’) requires all trusts and ‘complex estates’ (broadly those with a value of more than £2.5m or involving a capital sale with proceeds of more than £500,000) to be registered centrally. In addition to this the trust must update the register every year when there has been a taxable event. The most common instance of this will be the submission of annual income tax returns to be completed by 31 January following the relevant tax year; the TRS register must be updated by the same deadline. However, it is not just the imposition of annual income tax liabilities which necessitates an annual TRS update, any liability of any tax (including IHT and SDLT) will require the TRS to be updated. Currently only if the trust has no tax liability at all is a TRS update unnecessary, however a consultation will be underway in 2019 with a view to extending the reporting requirement to all trusts irrespective of any tax liabilities.
The TRS is available via www.gov.uk/trusts-taxes/trustees-tax-responsibilities
There are two basic types of trust in regular use for individual beneficiaries:
A life interest trust has the following features:
A typical example is where a widow is left the income for life and on her death the capital passes to the children.
A discretionary trust has the following features:
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.
Trusts which fall in the relevant property regime are:
If a relevant property trust is set up in the settlor's lifetime, this gives rise to an immediate charge to inheritance tax but at the lifetime rate of 20%. If the value of the gift (and certain earlier gifts) is below £325,000 no tax is payable. Discretionary trusts set up under a will attract the normal inheritance tax charge at the death rate of 40%.
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’.
Whilst the inheritance tax charges do 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.
Within this group are:
In these circumstances a lifetime transfer into a life interest trust will be a potentially exempt transfer (PET) and no inheritance tax would be payable if the settlor survived for 7 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.
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 are chargeable at 20%. There is an exception for residential property gains are charged at 28%.
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.
Life interest trusts are taxed on their income at 7.5% on dividends and 20% on other income. Discretionary trusts pay tax at 38.1% (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.
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:
This factsheet briefly covers some aspects of trusts. If you are interested in providing for your family through the use of trusts please contact us at Hart Shaw.
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