Many people avoid trusts, including some professional advisers. There is a misconception that they are only for the very wealthy, or they are unnecessarily complicated and difficult to understand.
My experience is that people often like the idea of a trust and their perceived benefits, but do not know where to start to set one up or get the relevant advice.
Trusts can be tricky to understand and there may well be a lot of terminology you may not have heard before, but with the right advice, they can be a very handy tax planning tool.
The starting point is to understand what a trust is, who the individuals are involved in setting up and running a trust, and the benefits of transferring assets into a trust and the associated tax implications.
Put simply a trust is an arrangement whereby assets owned by a settlor are transferred to trustees who hold them on trust for the benefit of other individuals, known as the beneficiaries.
A trust is set up by way of a legally binding agreement, known as a trust deed. A solicitor will draft the trust deed in accordance with your wishes. They will then go through it with you and explain what it all means to ensure that you are happy with it.
A trust can be set up in your lifetime or come into effect on your death as part of your will.
A trust fund is an ideal way to protect your assets and provide financial stability for your chosen beneficiaries. Trusts can also help to reduce the value of your estate so that more of your money, shares and property are passed to your loved ones in the most tax efficient way.
Trusts are also an excellent way to protect the assets of vulnerable beneficiaries who may not be able to take control their own financial affairs.
Setting up a trust often means that you no longer have any access to the funds or property you have settled onto trust, although you are able still retain control over how the assets are used.
A letter of wishes provided by the settlor can be used to guide the trustees as to how you would like the trust to be administered. This tends to accompany a discretionary trust, where the trustees may require some guidance.
These can be summarised as follows:
Bare Trust
This is the simplest form of trust. The beneficiary has an absolute right to the income and capital of the trust. They are commonly set up for minors who do not have the capacity to own assets personally.
Settlor-interested
As the name suggests, the settlor retains an interest in the trust and can continue to benefit from the assets held in the trust. This type of trust has a special set of tax rules.
Interest in possession
With this type of trust, the trustees must pass all the income to the beneficiaries as of right, when it arises.
Discretionary
The trustees have discretion over which assets are paid to the beneficiaries and when. They are particularly useful where there are minor or vulnerable beneficiaries who may not be able to manage their own money. A settlor can provide the trustees with a ‘letter of wishes’, which can guide the trustees in their decision-making process, but it is not legally binding.
Income tax
A trust is a separate legal entity and so has its own set of tax rules.
Trust and Estate Tax Returns
Tax paying trusts are issued with annual tax returns to complete, unless as in some cases the income is paid directly to the beneficiary and there are no capital transactions to report.
Trust and estate self assessment tax returns are entirely different from individual self assessment tax returns and require specialist knowledge to complete correctly.
The Tax Angel can complete the trust tax return on your behalf I can also calculate the trust income tax and capital gains tax liability and advise you what tax payments are due and when. I can calculate any payments on account which may be due for the following tax year, and where appropriate submit a claim to reduce or cancel these to HM Revenue & Customs.
Tax pool
A tax pool is unique to discretionary trusts and is a running total of the tax paid by the trustees which is used to cover the tax due on any income paid to the beneficiaries. When tax is paid by the trustees to HMRC, an equivalent amount of tax is added to the tax pool and when a payment is made to the beneficiary the relevant amount of tax is deducted from the tax pool. If there is insufficient tax in the tax pool when an income payment is made to a beneficiary, an additional tax charge will be due.
I can advise you on the tax pool and calculate if any further charges arise.
Forms R185 (trust)
When trust income is paid out to beneficiaries, you are required to provide them with evidence of the trust income distributed and any tax deducted on a form R185(trust). This will enable the beneficiary to include the trust income on their own tax return. Quite often in the case of a minor beneficiary, this will enable them to claim a tax refund of the tax paid on their share of trust income.
The Tax Angel can complete the forms R185 (trust) on your behalf and also the income tax repayment claims (forms R40) on behalf of the beneficiaries.
Capital Gains Tax
There is capital gains tax due (CGT) on the settlor when an asset they transfer into trust has increased in value since they acquired it.
There will also be CGT due if there is a gain on an asset sold or transferred by the trustees since it was settled into trust, this will be assessed on the trustees.
In some instances, there may be an option to defer a gain until an asset is eventually disposed of. This can apply to assets transferred into or out of a trust.
Trusts are also subject to the 60-day CGT reporting requirements if a residential property is sold owned by the trust. I can deal with the whole reporting process on behalf of the trustees, ensuring that any chargeable gains are identified, calculated, reported and settled on time.
Inheritance Tax
Inheritance tax (IHT) is not only due on death.
There can be a lifetime charge to IHT in relation to trusts. IHT can be due when assets are transferred into and out of trust and also on the 10-year anniversary of the trust.
Whether you are a settlor and have already set up a trust, or are just considering setting one up, or you have been appointed as a trustee or are a beneficiary, you need to understand and be clear about the tax implications. This will ensure that any taxes on transferring assets into trust, any tax due on the assets once in the trust and any tax considerations when distributions are made to the beneficiaries are correctly dealt with.
Depending on whether you have made any other chargeable transfers within the last 7 years, you made be required to complete an IHT return, form IHT100 to report and pay the tax due on any assets transferred into trust.
An IHT100 may also be required if capital distributions are made to the beneficiaries, or assets are transferred out of the trust or on each 10-year anniversary of the trust.
The IHT100 can be complicated to complete and the IHT calculations can be onerous. There are also strict deadlines to submit any IHT returns and pay any tax due.
As part of the UK’s implementation of the fifth EU Money Laundering Directive, trustees are required to register all UK express trusts and some non-UK express trusts on HM Revenue & Customs’ (HMRC) online Trust Registration Service (TRS), unless they’re exempt.
As a trustee, you must ensure that the relevant information is collated, and the trust registered with the TRS within 90 days of the trust being set up. It is also your duty to ensure that the TRS is updated within 90 days of any changes to the trust.
If as a trustee, you fail to register the trust on time or update the register when there are changes, you may face a fine.
You must also declare when completing the annual trust tax return, that the trust register has been maintained and updated to show any changes in relation to the trust.
Read more: Trusts and taxes: When you must register a trust – GOV.UK (www.gov.uk)
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