Trusts

What Is a Trust?

A trust (sometimes called a ‘settlement’) involves a 'truster' transferring assets to ‘trustees’ (who may include the settlor) who then hold and manage those trust-assets for the benefit of certain named ‘beneficiaries’. This may be done for various reasons, for example to avoid or reduce a tax liability upon death, to enable assets to be managed while the beneficiaries are subject to a disability (eg due to age or mental incapacity), to avoid legal rights claims or having to contribute towards residential home fees, or even to maximise flexibility in providing for certain beneficiaries in the future.

A trust may be created during your lifetime or upon your death under your Will. Trusts are regulated by statute law, case law and by the specific powers and duties of the trustees set out in the trust deed itself. It is fundamental that a truster has full confidence in (ie ‘trusts’) his chosen trustees, given the necessarily extensive powers that a trustee has, notwithstanding their specific duties to the beneficiaries.

It is usually necessary to advise the Inland Revenue when a trust is created by registering it and filing various forms along with a copy of the trust-deed (declaration of trust), and in most cases the filing of annual trust income tax returns will also be necessary. It may also be necessary to report to HMRC certain events apart from the creation of a trust.

Trustees must also meet regularly to consider whether any action needs to be taken by them in connection with the trust, and these meetings must be recorded in minutes.

What Types of Trust Are Available?

Since the Finance Act 2006 most trusts are now categorised according to the way in which they are taxed, the main ones being known as Immediate Post Death Interest Settlements and Relevant Property Settlements, although it is more useful to explain trusts with regard to the purposes for which they are created, and the four basic types are as follows:

1) Bare Trusts

A Bare Trust is usually created where a trustee holds an asset for a beneficiary who is unable to hold that asset for themselves merely because of their age (e.g. if they are a minor) but otherwise there are no conditions that must be fulfilled before the beneficiary is entitled to ownership. In such cases it is the beneficiary, not the trustee, who pays tax on any income or capital gains arising.

2) Liferent Trusts

Liferent trusts are very useful for enabling a person having children by a former marriage or relationship to ensure by their Will that their assets (e.g. a share in the family home) passes to those children whilst allowing their current spouse or partner to enjoy those assets during their lifetime. These trusts may also be set up by elderly parents who give their house in their lifetime to their children, usually to avoid liability for future residential home fees, and the parents will typically reserve a liferent interest for themselves so that they have a legally enforceable right to remain living in their home. However such lifetime gifts involve risks as well as benefits, all of which must be carefully considered, and the avoidance of liability for residential home fees cannot be guaranteed.

3) Discretionary Trusts

A Discretionary Trust is a flexible mechanism whereby the trustees can control the way in which income and capital is paid out to some or all of the potential beneficiaries in the future, by exercising their discretion. They are particularly useful in that the ultimate beneficiaries and the provision made for them can be made by reference to their individual circumstances and other factors existing at the date of the testator's death (or within two years thereafter). Discretionary trusts can also be created in one’s lifetime.

In view of the broad discretion conferred upon the trustees, and although they will be guided by a non-legally binding 'letter of wishes', it is most important that the truster has full confidence in them. In most cases it is inadvisable for a beneficiary to be a one of the trustees in view of their interest in the outcome of the exercise of their discretion. The potential beneficiaries are usually defined in the trust deed or Will by reference to a broad class, and the exercise of the trustees' discretion is usually recorded in a Deed of Appointment.

4) Trusts favoured for tax-purposes

Discretionary and liferent trusts have great practical advantages, although are sometimes taxed quite harshly since the passing of the Finance Act 2006, depending upon the value of the trust assets and other factors. However a few trusts are still favoured to a certain extent for tax purposes, including a Bereaved Minor's Trust, an 18-25 Year Trust, and a Disabled Person's Trust.

The Tax Treatment of Trusts

The tax treatment of trusts is very complex since the rules were changed under the Finance Act 2006, potentially involving liability to Inheritance Tax, Capital Gains Tax and Income Tax, and it is important that this aspect is carefully considered before a trust is established.

However, with careful planning by both the truster and the trustees, they can be a very flexible means of providing for and protecting beneficiaries, as well as being a useful tax-mitigation tool, particularly where the trusts assets are valued at less than the truster's inheritance tax exemption when the trust is created.

For example, a truster can use various Inheritance Tax (IHT) exemptions to ‘drip-feed’ surplus income (or even capital assets, provided that he survives the date of the gift for at least seven years) into a life-time trust, the value of which will grow outside of their estate for IHT purposes, thereby mitigating the potential IHT liability upon their death.

At Macleod & MacCallum we can advise you whether a trust is suitable to your requirements and as to the most appropriate type of trust for your circumstances.  Please feel free to email us for further information.

Disclaimer: The information in this publication is based on our current understanding of the law. It has been produced for information purposes only. Professional advice should always be sought before taking any action.

Macleod & MacCallum cannot take any responsibility for loss incurred through acting or failing to act on the basis of anything contained in this publication.