On 6th March, many changes impacting the UK tax system were announced in the Spring Budget, however very little was discussed regarding Trusts and Estates.
Even with no proposed changes, navigating the world of Trusts can often be difficult, as different rules apply depending on the type of Trust.
The following article highlights some of the common types of Trusts and taxation and non-taxation rules which apply, which should provide a foundation for navigating Trusts in 2024.
What is a Trust, and why are they created?
A Trust is a relationship created at the direction of an individual (the settlor) in which one or more persons (the Trustees) hold the individual’s property, subject to certain duties, to use and protect it for the benefit of others (the beneficiaries).
Every person who can hold and dispose of property, or an interest in property, can create a Trust in respect of it. A Trust is usually created by the settlor executing a trust deed in their lifetime or via their Will on their death.
Settlors normally create establish Trusts for the following reasons:
- Greater control of asset distribution
- Ensuring assets go to the right people
- Possible tax advantages, such as reducing the value of their estate for Inheritance Tax purposes, as Trusts fall outside of their chargeable estate. The Inheritance Tax advantages make the idea of establishing a Trust very appealing for many individuals and they are often a very important part of estate planning. However, tax savings should not be regarded as the only reason for executing a Trust. The wishes of the settlor are paramount in considering whether a trust is the right vehicle when contemplating tax planning.
Types of Trusts
There are various types of Trusts however the three main types are Interest in Possession Trusts (IIPs), Discretionary Trusts and Bare Trusts.
IIP Trust
IIP Trusts give a named beneficiary or beneficiaries (life tenants) specifically mentioned in the Trust deed, the right to the net income, after administration costs and tax. It is not necessary for assets held in the Trust to produce income as the Trustees usually have discretion to advance capital to the life tenants and/or other beneficiaries.
The right to income could also be satisfied by allowing the life tenant to benefit from the Trust property without actually owning it i.e. living in a property owned by the Trust.
Discretionary Trust
The distribution of the income and capital of the Trust property is entirely at the discretion of the Trustees. No beneficiary has a right to receive anything. The beneficiaries of a Discretionary Trust do not have to be specifically named in the Trust deed at creation and are often defined as a class instead, i.e. children, grandchildren and remoter issue. This offers more flexibility for settlors.
Essentially, a Trust which has the power to retain and accumulate income within the settlement is a Discretionary trust.
Bare Trust
A Bare Trust is arguably one of the simpler types of Trust arrangement. A Bare Trust exists when a Trustee holds property on behalf of a beneficiary and acts in accordance with the beneficiary’s wishes. Whilst the Trustee is the legal owner of the Trust property, they have no discretion, and the beneficiary is absolutely entitled to the assets of the Trust. The most common type of Bare Trust is a parent setting up a bank account for their minor child.
The Taxation of Trusts
Just like individuals, Trusts may be subject to pay Income Tax, Capital Gains Tax and Inheritance Tax.
Income Tax
The Income Tax rules differ depending on the type of Trust.
The rate of tax on Discretionary Trust income is equal to the highest rate of tax for individuals, being 45% for non-savings and savings income and 39.35% for dividend income. The beneficiaries may be able to claim a repayment of income tax paid by the Trust on their personal distribution. The level of the repayment would depend on the beneficiaries’ personal Income Tax position.
Income received by Interest In Possession Trusts is normally taxed at the basic rate, being 8.75% on dividend income and 20% on other income. If the beneficiaries are non-taxpayers a claim can be made to repay the Income Tax the Trust has paid. However, the beneficiaries who are higher rate taxpayers may have additional tax to pay.
The beneficiary is liable for Income Tax on income received by Bare Trusts at the rate applicable to them.
Capital Gains Tax
Trustees of Discretionary and IIP Trusts are liable to pay capital gains tax (CGT) at the rate of 20%, or 24% if the sale is of a residential property.
For the 2023/24 tax year, Trusts are entitled to a CGT annual exemption of £3,000. This amount is shared if the settlor has created more than one Trust but if more than five Trusts have been set up, each Trust will receive 1/5th of the maximum annual exemption.
Inheritance Tax
Trusts created in the settlors’ lifetime after 22 March 2006 usually fall within the relevant property regime. This means the assets of the Trust are not in anybody’s estate for Inheritance Tax (IHT) purposes however the creation of the Trust and subsequent additions will be treated as a gift which may have IHT implications. Instead, the Trust has its own Inheritance Tax regime which applies every 10 years or when property exits the Trust. At present, such charges do not exceed 6% and can be lower.
Calculating the IHT payable on 10-year anniversaries and exits is not always a simple task. Various factors such as related settlements, additions of property and accumulated income could all have an impact on the amount of tax payable.
How Churchgates can help
Navigating through the world of Trusts can often be very complicated but we are here to make things a bit simpler. Our Trust team can assist with a wide variety of Trust matters from the compliance side of filing annual self-assessment, dealing with the Trust Registration Service, and Inheritance Tax Returns to the advisory side of Trust and estate planning. We also have a Trustee company that can act as Trustee where appropriate.
If you are a Trustee of a Trust and would like some assistance dealing with the compliance requirements or are seeking advice, please contact us at 01284701271 and our reception team will put you through to a member of the Trust team who will be able to arrange a free initial meeting and see how we can help.
