A Trust is a way of managing assets such as money, investments, land or buildings, for people. There are many different types of Trusts and each one is taxed differently. We find that Clients usually set up a Trust for a number of reasons which can include protecting family assets, controlling family assets, when someone is too young to deal with their financial affairs, when someone does not possess the capacity to deal with their affairs, to pass on assets whilst they are alive and to pass on assets when they die which is often referred to as a “Will Trust”.
A Trust usually involves a Settlor. This is the person who puts the assets into the Trust. It also involves a Trustee, and this is the person who manages the Trust. It usually also involves a Beneficiary. This is the person who benefits from the Trust. The decision as to how the assets in a Trust should be used is usually set out in a document which is referred to as the “Trust Deed”. The Settlor usually decides how this will happen and there are times when the Settlor can also benefit from the assets in the Trust. This is referred to as a “Settlor Interested” Trust and has its own tax rules. You will need to seek independent advice as to the tax that is payable on a Trust by contacting a relevant professional such as an Accountant.
The Trustees are the legal owners of the assets that are held in the Trust. Their role is to:
- Deal with the assets according to the Settlor’s wishes, as are set out in their Trust Deed or Will
- Manage the Trust in a day to day basis and pay any tax due
- Decide how to invest or use the Trust’s assets
If the Trustees change, the Trust can still continue but there always has to be at least one trustee in order for it to continue. The beneficiaries can be a whole family, a defined group of people or an individual. The Settlor can decide if they benefit from the income of the Trust only. For example, renting out a house held in a Trust. They can also decide if they benefit from the capital only and such an example would be receiving shares held in a Trust when they reach a certain age, or they can receive the income and the capital of the Trust.
Types of Trusts
A Bare Trust is where assets are held in the name of a trustee. However, the Beneficiary has the right to all of the capital and income of the Trust at any time if they are over the age of eighteen. This means that the assets that have been set aside by the Settlor will always go to the intended Beneficiary. Bare Trusts are often used to pass assets on to younger people so that the trustees can look after the assets until the person is old enough.
The second type of Trust is referred to as an Interest in possession Trust and these are Trusts where the trustee must pass on all Trust income to the Beneficiary as it arises (less any expenses).
A Discretionary Trust is the Third type of Trust and this is where the trustees can make certain decisions about how to use the Trust’s income and sometimes the capital too. The Trust Deed often specifies what gets paid out in terms of income or capital, which Beneficiary will benefit, how often the payments will be made and any special conditions that are to be imposed upon the beneficiaries. A Discretionary Trust is usually set up to put assets aside for future needs such as a child or a grandchild who may need more financial help and other beneficiaries at some point in their life or for beneficiaries who are not capable or responsible enough to deal with the money themselves.
The Fourth type of Trust is called an Accumulation Trust, and this is where the trustee can accumulate income within the Trust and add it to the Trust’s capital. They may also be able to pay income out as you can with Discretionary Trusts.
The Fifth type of Trust is called a Mixed Trust, and this is a combination of more than one Trust.
Sixthly, there is also a Settlor Interested type of Trust which is where the Settlor, their spouse or civil partner, benefits from the Trust. The Trust can be an Interest in Possession Trust, an Accumulation Trust or a Discretionary Trust.
Seventhly, there is a Non-Resident Trust. This is where a Trust is set up for trustees who are not living in the United Kingdom for tax purposes. The tax rules for Non-Resident Trusts are very complicated and we will not be providing any information on this site about the rules. You would need to consult with an independent person for advice.
Finally, the last type of Trust is a Parental Trust. These are Trusts set up by parents for children under the age of eighteen who have never been married or in a civil partnership. They are not a type of Trust in their own right but will either be Bare Trust, An Interest in Possession Trust, An Accumulation Trust or a Discretional Trust.
Income Tax on income from the Trust is paid by the trustees, but a Settlor is responsible for it. In reality, this means that the trustee pays Income Tax on the trust by filling out a Trust and Estate Tax Return. They then give the Settlor a statement of all the income and the rates of tax charged on it and the Settlor must inform HMRC about the tax that the trustees have paid on their behalf when filling in their own Self-Assessment Tax Returns.
Capital Gains Tax
Capital Gains Tax may be due if assets are sold, given away, exchanged or transferred in another way and they have gone up in value since being put into a Trust. Tax is only paid be the trustees if the assets have increased in value above “the annual exempt amount”, which is currently set at £11,700 for people who have a mental or physical disability or £5,850 for other trustees. Please note that these figures are correct as of December 2018 and it is not our responsibility to update the figures.
Trustees are responsible for paying any Capital Gains Tax due. If the Trust is for vulnerable people, then the Trustees are likely to claim a reduction and a different form is usually used. The current form is the SA905. This may be subject to change and this needs to be checked at the relevant time.
There is no Inheritance Tax charge if the person who set up the Trust survives seven years from the date it is set up or on transfers made out of the Trust to a vulnerable Beneficiary. Trusts usually have a ten year Inheritance Tax charge but Trusts with vulnerable Beneficiary are exempt. It is also important to note that different types of Trusts’ income have different rates of Income Tax and each type of Trust is taxed differently.
If you have an Accumulation or Discretionary Trust, the trustees are responsible for paying tax on income received. On a Bare Trust, the Beneficiary of that Trust is responsible for paying the tax on the income from it, and they must tell HMRC by submitting a Self-Assessment Tax Return form. If you have a Settlor Interested Trust, the Settlor is responsible for the Income Tax even if the income is not paid out to them. However, the Income Tax is paid by the trustees as they receive the income. The trustees pay Income Tax on the Trust by filling in a Trustee and Estate Tax Return. They give the Settlor a statement of all income the rates of tax charged on it and then the Settlor tells HMRC about the tax paid by the trustees on their behalf on a Self-assessment Tax Return. The rate of Income Tax depends on the type of Trust the Settlor Interested Trust is.
Capital Gains Tax
Capital Gains Tax is a tax on the profit when something increases in value and it is taken out of the Trust or put into a Trust. Capital Gains Tax might be payable if assets are put into a Trust and the asset is being sold to the Trust or is being transferred. If the asset is being taken out of the Trust, the trustees usually have to pay the tax if they sell or transfer assets on behalf of the Beneficiary. There is no tax to pay in a Bare Trust if the assets are transferred to the Beneficiary. Sometimes, an asset might be transferred to someone else but Capital Gains Tax is not payable. This happens when someone dies and an Interest in Possession ends. Trustees only have to pay Capital Gains Tax if the total tax gained is above Trust’s tax free allowance which is called the Annual Exempt Amount. As stated above, the current Tax Free Allowance for a Trust is £5,850 or £11,700 if the Beneficiary is a vulnerable individual such as a disabled person or a child whose parents has died.
If you are a trustee you have to report any gains to HMRC and also submit the appropriate Tax Returns, documentation and also report any losses.
Inheritance Tax may have to be paid on a person’s Estate when they die. This is usually at 40% on anything above the threshold which is currently £325,000 as at December 2018. If assets are transferred in to a Trust, Inheritance Tax is usually due. When a Trust reaches a 10-year anniversary from when it was set up, Inheritance Tax is likely to be due and when assets are transferred out of a Trust, there are exit charges to pay or when the Trust ends. Finally, when someone dies and a Trust is involved, Inheritance Tax is likely to be due. Inheritance Tax is payable on property, money, shares, houses or land and this includes assets in most Trusts. There are some occasions when you may not have to pay Inheritance Tax and this can be where the Trust contains excluded property. A Bare Trust may be exempt from Inheritance Tax, providing the person making the transfer survives seven years after making the transfer.
With regards to an Interest in Possession Trust, on assets transferred into this type of Trust before 22nd March 2006; there is no Inheritance Tax to pay. On assets transferred after this date, the ten yearly Inheritance Tax charge may be due. During the life of the Trust, there is no Inheritance Tax to pay as long as the assets stay in the Trust and remains the “interest” of the Beneficiary.
It is also important to note that if you are the Beneficiary of a Bare Trust, you are responsible for declaring and paying tax on its income by submitting a Self-Assessment Tax Returns. Whether or not you will have to pay tax depends upon your own situation and your tax band.
Trustees’ Tax Responsibilities
As a trustee you are responsible for reporting and paying tax on behalf of the Trust. You also need to register your Trust with HMRC if it pays or owes either Capital Gains Tax, Income Tax or Inheritance Tax. You can only register one Trust at a time and before you start doing any of this, you will need to have a Government Gateway Account set up your own National Insurance Number, passport or driving licence number, details of the assets put into the Trust along with the date they were put into the Trust. The same information is required about any individuals in the Trust. It is also important to note that new Trusts must be registered by 5th October in the tax year after the Trust starts to pay any of the aforementioned.
You should then receive a unique tax pay reference within fifteen to twenty-one days, which you will need, to send your Tax Returns. If you have an existing Trust, the deadline is to register by the 31st January with regards to Capital Gains or Income Tax. You will then need to report your Trust’s income and gains in a Trust and Estate Report after the end of each tax year. You may wish to seek independent advice as to your liabilities and how to do this. After you have submitted your return, HMRC will usually inform you as to how much you owe and then you will need to keep accurate records of what you have paid. You must also give the beneficiaries a statement with the amount of the income and tax paid by the Trust, if they ask. You can use Form R185 (Trust) to do this. There is a different form if you need to give a statement to a Settlor who retains an interest. If there is more than one Beneficiary, you must give each of them the same information relative to the amount that they receive.
For specific enquiries about your tax position, please consult a Tax Advisor. If you wish to explore whether or not a Trust is for you, please feel free to contact us.