Capital
Taxes
Use
of Trusts
What
are Trusts?
Trusts
enable assets to be given away whilst still retaining some
control over them. Income can be paid to different persons
with the capital ultimately going to other persons.
Trusts, sometimes called settlements, have been part of the
legal and tax system for many years and much case law and
tax legislation has been formulated over the years. The government
is currently considering a package of measures to modernise
the tax system for trusts and the likely start date is April
2005. The reasons for using trusts are as valid today as they
have always been.
Types
of Trusts
There
are two basic types of trust:
- life
interest trust
- discretionary
trust.
A
discretionary trust with special tax privileges (an accumulation
and maintenance trust) can also be established.
Life interest trust
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A
life interest trust has the following features:
- a
nominated beneficiary has an interest in the income
from the assets in the trust. This right may be for
life or some shorter period (perhaps to a certain
age)
- the
capital will usually pass onto another beneficiary
or beneficiaries.
A
typical example is where the widow is left the income
for life and on her death the capital passes to the
children.
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Discretionary
trust
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A
discretionary trust has the following features:
- no
beneficiary is entitled to the income as of right
- the
settlor gives the trustees discretion to pay the income
to one, some or all of the nominated class of possible
recipients
- income
can be retained by the trustees for up to 21 years
- capital
can be gifted to nominated individuals or to a class
of beneficiaries.
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Accumulation
and maintenance trust
An accumulation and maintenance trust is often used by grandparents
to benefit their grandchildren.
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The
normal features are as follows:
- in
the early years this operates in a similar manner
to the discretionary trust, but usually after an initial
period income is given to the beneficiaries as of
right, as in the life interest trust
- capital
can be paid out when it is hoped that the recipients
are more able to control their finances
- capital
can be released in earlier years, at the trustees'
discretion, if needed to help a beneficiary.
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Tax
Advantages
Many
people have not realised how useful trusts can be as a tax
planning tool.
Giving property away to trustees (ensuring neither the settlor
or their spouse has a benefit) determines the settlor's inheritance
tax position for that gift.
Gifts to a life interest trust are potentially exempt transfers
(PETs) and providing the settlor survives seven years from
the date of the gift, no inheritance tax is payable.
Gifts to an accumulation and maintenance trust are also PETs.
There is a potential charge in setting up a discretionary
trust but if the gift is below £263,000, no tax will
be payable.
If assets are transferred to trustees, this is considered
a disposal for capital gains tax purposes but in many situations
any capital gain arising can be deferred.
Gains within the trust were charged at 34% (6% less than a
higher rate taxpayer). However this was increased to 40% in
April 2004 removing the 6% benefit.
Tax
Treatment of the Trusts
Life
interest trusts are taxed on their income at 10% (dividends),
20% (interest) and 22% (other income). Discretionary trusts
(including accumulation and maintenance trusts during the
‘discretionary’ period) previously paid tax at 25%
(dividends) and 34% (other income). These rates were increased
to 32.5% and 40% respectively in April 2004.
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 released at the trustees' discretion from discretionary
trusts, the beneficiaries will receive the income net of 40%
tax. They are able to obtain refunds of any overpaid tax and
if they pay tax at 40%, they will get credit for the tax paid.
Inheritance tax may have to be considered during the trust
period and each main type of trust is dealt with differently.
- Life
interest trusts will have to be valued when the income beneficiary
dies. The value of the trust assets is added to the value
of the beneficiary's personal assets to determine the rate
of tax payable, with the trustees being liable to pay the
trust’s share of the inheritance tax due from the assets
held.
- Discretionary
trusts are charged every ten years and by careful planning
the value can often be maintained under the taxable limit.
Where this is not possible or perhaps desirable, then it
should be noted that the maximum tax rate is 6% of the value
of the assets in the trust every ten years. There may alternatively
be a charge if assets are appointed out of the trust before
a ten year charge is due.
- Accumulation
and maintenance trusts do not pay inheritance tax if the
funds are released to the nominated beneficiaries.
Which
Trust is Right for Me
The
problem
To provide for your family's financial needs in a way
that permits maximum flexibility during a period of years
with a minimum tax burden.
Possible solution
Discretionary trust or possibly an accumulation and maintenance
trust.
The problem
To make gifts now but you are undecided how much to give
each donee.
Possible solution
Discretionary trust or possibly an accumulation and maintenance
trust.
The problem
Making a gift to start your seven year inheritance tax
gift clock running, but extra thinking time is needed before
deciding who should receive what.
Possible solution
Discretionary trust.
The problem
To make gifts to children or grandchildren in a tax efficient
way.
Possible solution
Accumulation and maintenance trust.
The problem
To make a gift of income to a particular individual, but
retaining control over what happens to the capital after the
death of that individual.
Possible solution
Life interest trust.
How
We Can Help
This
factsheet briefly covers some aspects of trusts. If you are
interested in providing for your family through the use of
trusts we recommend that you talk to us.
We will be more than happy to provide you with additional
information and assistance.
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of page
For information of users: This material is published
for the information of clients. It provides only an overview
of the regulations in force at the date of publication, and
no action should be taken without consulting the detailed
legislation or seeking professional advice. Therefore no responsibility
for loss occasioned by any person acting or refraining from
action as a result of the material can be accepted by the
authors or the firm.
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