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The Basics of Trusts & Tax Planning

What is a 'trust'?

Put simply, a trust is an obligation binding an individual (or a group of individuals or one or more companies) called a 'trustee' to deal with 'property' in a particular way, for the benefit of one or more 'beneficiaries'.

An asset become trust property by virtue of a disposal by one or more individuals (usually a 'gift into trust' but it can be, say, a sale at less than market value).

(Thus, from a taxation perspective one has to consider:

• the ramifications of the transactions creating the Trust
• the taxation of the Trustees of the trust
• the taxation implications of the trust assets passing from the trust to the beneficiaries.

In 1840, the case of Knight v Knight it was stated that, for there to exist a valid trust, there are three requirements:

1. There must be certainty of words or intentions of the settlor.
2. There must be certainty as to the subject matter of the trust, i.e. what asset(s) was the settlor thinking of when seeking to create the settlement in question.
3. There must be certainty as to the objects of the Trust, i.e. who is to benefit. (e.g. a reference to the beneficiaries being 'all my children' may be OK (but far from ideal) but a reference to 'all my friends' will not – unless the term friend is defined in the settlement deed (say a list of names and addresses)

What is a 'bare trust'?

A bare trust, is one in which each beneficiary has an immediate and absolute right to both capital and income. The beneficiaries of a bare trust have the right to take actual possession of trust property and can direct the trustees accordingly.

The property of a bare trust is held in the name of a trustee, but he/she has no discretion over what income to pay the beneficiary. The trustee is little more than a nominee in whose name the property is held.

For all taxation purposes, the assets held under such an arrangement are treated as being owned by the beneficiaries thereof. Such trusts are outside the scope of today's presentation. However, it should not be overlooked that, say, a grandparent, can make a gift into a bare trust for a grandchild under 18 with the grandchild's parent's acting as bare trustees until the beneficiary reaches 18. Whether it is prudent for an 18 year old to inherit a significant sum depends on many factors.

What does 'settlor' mean?

A settlor is a person who has put property into the trust. Property is normally put into the trust when it is created, but it can also be added at a later date.

Settlor includes persons who indirectly put property into trust.

What is a 'trustee'?

Trustees are the legal owners of the trust property. They are legally bound to look after the property of the trust in a particular way and for a particular purpose. Trustees administer the trust and in certain circumstances make decisions about how the property in the trust is to be used. The trust can continue even though the trustees might change, but there must normally be at least one trustee.

Trustees who fail in their obligations/duties may be liable to a claim for 'breach of trust'! N.B. Watch informal actions within a family (short cuts!) before a family bust up. Worst case scenario, disgruntled daughter marries solicitor.

Can the Settlor be a trustee?

The simple answer is 'yes' but it is usually advisable to have at least one other trustee. In addition, HMRC may look at the substance of the structure and exceptionally argue that the trust arrangement is simply a sham. If the sole trustee is the settlor practical difficulties might arise in contesting the position and two or more Trustees are recommended.

Do the Trustees need to meet?

The Trustees have to show they are discharging their duties as trustees and they should 'meet' (including having telephone conferences) at least once a year and there should be kept a proper minute book (i.e. showing the agenda's, minutes of meeting, discussion notes, etc). The trustees need to show that they have taken their role seriously. If the trust assets suffer a loss and, say, the remainderman (see below) sues the trustees for damages in respect of a loss caused negligent conduct, the absence of formal records will weaken the trustees' position.

Is a 'settlement' the same as a 'trust'?

The words 'settlement' and 'trust' are often used in place of each other, and to describe the same thing. For tax purposes, the term 'settlement' can have a wider meaning and can include various other arrangements or agreements. For today's presentation they are assumed to be one and the same.

What is an 'interest in possession trust'?

This type of trust exists when a beneficiary, known in this case as an 'income beneficiary', has a current legal right to the income from the trust as it arises.

A beneficiary who is entitled to the income of the trust for life is known as a 'life tenant' The life tenant will normally have no rights over capital though, depending on the terms of the trust, the trustees might have the power to pay capital to a beneficiary even though that beneficiary only has a right to receive income.

A beneficiary who is entitled to the trust capital is known as the 'remainderman'

What is a 'discretionary trust'?

Trustees of a discretionary trust generally have 'discretion' about how to use the income of the trust.

Even if they are required to use any income for the benefit of particular beneficiaries, the trustees may well be able to decide:

• how much is paid
• to which beneficiary or class of beneficiaries payments are made
• how often the payments are made
• what, if any, conditions to impose on the recipients.

The trustees may also be allowed to 'accumulate' income within the trust for as long as the law allows rather than pass it to the beneficiaries. Income that has been accumulated becomes part of the capital of the trust.

What is an 'accumulation and maintenance' ('A & M') trust'?

Pre March 2006, an A & M trust is one in which the beneficiaries will become entitled to the property or at least the income when they reach a certain age (no more than 25). The trustees can use the income for the maintenance (education or benefit) of the beneficiary before the date on which that beneficiary becomes entitled to the property or to an interest in possession in that property. Trustees of an A & M trust are given power to 'accumulate' the income of the trust until a date, prior to the beneficiary's 25th birthday, at which time the beneficiary must become entitled to either the property of the trust or to the income arising therefrom.

Broadly speaking, this legislation dictates the conduct of trustees where the Trust Deed, i.e. the documents giving evidence of the terms and conditions under which deal with property in a particular way, for the benefit of the beneficiaries. It also imposes overarching obligations on Trustees. For example, unless the Trust Deed determines what type of investments the trustees may hold, the Trustee Act lays down the rules to be followed.

Can Trustees charge for their services?

The trustees may charge for their services if the Trust Deed permits them do so. However, it is important that a settlor cannot do so because the ability for a settlor to charge for his services can be regarded as giving the settlor an interest in the funds held by the trustees. This can have serious tax consequences. Settlement deeds are usually drafted to excluded settlors from charging at any time, i.e. either in the present or any time in the future, for their services. For example, if a settlor can benefit from the Trust he has created the full income thereof can be assessed on him for income tax purposes. Furthermore, holdover relief is not possible on transfers to a settlor interested trust.

Can Trustees Borrow?

Yes, if permitted by the trust deed (and they can find a lender).

Can Make property rent free to a beneficiary?

Yes, if the trust deed allows.

What about a private residence provided rent free?

If the trust deed allows a beneficiary can be permitted to occupy a trust property and, whether or not paying market rent, the trustees can claim the benefit of the beneficiary's principal private residence exemption under Section 225 TCGA 1992 – note the conditions to be met. E.G. the beneficiary must reside in the property as his/her principal residence and be entitled to under the deed. Where the beneficiary resides elsewhere for part of the time, and election to treat the property as the main residence under section 222 TCGA 1992 will be required. The beneficiary must join in the claim under section 225.