Tax planning with trusts
I have had many calls over the years from individuals asking if they should set up a trust. Typically, this is in response to a feature they’ve read in a Sunday newspaper or a conversation with a friend or colleague.
Trusts have received a bad press over the years and have been seen as a tool of tax evasion or avoidance. While there is no doubt that trusts have been used by some as part of an aggressive scheme to reduce exposure to tax, there’s a lot of misunderstanding about the use of trusts and their role in protecting assets.
Before considering the use of trusts in tax planning, it’s important to have a basic understanding as to what a trust is. In simple terms, a trust is a legal arrangement that involves the transfer by an individual of assets to another individual (or individuals) who then manages those assets on their behalf.
The ‘settlor’ transfers the assets. The ‘beneficiary’ enjoys the benefit of those assets. The ‘trustee’ manages the trust. A trust may have more than one settlor, beneficiary or trustee.
The attraction of a trust is that it allows an individual to transfer assets out of their own name, while retaining some control over the use and ultimate destination of those assets. The terms of the trust are set out in the ‘Trust Deed’.
The circumstances in which a trust might be useful would include the following:
To transfer assets to children or grandchildren where there is concern that they are not mature enough to manage those assets themselves.
To hold business or agricultural assets.
To reduce exposure to Inheritance Tax (IHT).
To ensure that the executors of a Will have the powers to deal with an estate in the most tax efficient manner.
Trusts are often used in conjunction with life assurance products or pensions.
There will be IHT and capital gains tax (CGT) issues to consider when a trust is established, sells chargeable assets, and comes to an end.
Income tax is payable on income generated within a trust. The rate of income tax payable in discretionary trusts is higher than the rate payable in interest in possession trusts. Income tax paid by a trust may be recovered by the trust beneficiaries.
The services of a solicitor will be required to draw up a Trust Deed and the cost will depend on the complexity of the trust. The trustees will need to notify HM Revenue & Customs (HMRC) of the existence of the trust and register online with the Trust Registration Service.
There will be ongoing costs associated with the running of a trust and these could include investment managers’ fees and solicitors’ fees. Trusts that hold income generating assets will need to submit annual tax returns to HMRC and there may also be annual tax returns to complete for trust beneficiaries.
So when I receive a call asking if it is a good idea to set up a trust, the answer is that it depends. Each case is different – there will be certain circumstances where a trust will be useful and others where a trust will result in unnecessary complication. If you have any queries regarding trusts, please get in touch.
Photo by Jeff Sheldon on Unsplash.