Tax – It’s a Matter of Trust

Date Added 02.06.20

It is often said that inheritance tax (“IHT”) is a voluntary tax and provided early and if planned action is taken by making gifts during lifetime, it can often be legitimately avoided or reduced significantly.  However, many people are reluctant to make substantial lifetime gifts for fear that money or other assets gifted to children or other relatives will be wasted on the proverbial “wine, women (or men – SIC) and song”!

For those that have such concerns, a Discretionary Trust could provide the perfect solution.  Trusts have acquired a bad reputation for being complicated, inflexible and expensive to run but this is not the case with a Discretionary Trust which allows a person (“the Settlor”) to make a substantial gift of assets but at the same time retain legal protection and more importantly, control over the assets gifted.  Trusts have been used successfully for hundreds of years to protect family wealth.  A Discretionary Trust is the most flexible type of trust.  No beneficiary has any right to income or capital and the trustees, being the persons who have legal ownership of the assets given, have complete freedom to decide who (from the specified beneficiaries) receives any benefit, being income or capital, and when. The trustees also have complete freedom to invest monies in any investment authorised by the trust deed which will usually include a very wide power of investment. Because the trustees have such control, this type of trust can be particularly useful for settlors who wish to protect assets from, among other things, divorce or being swallowed up in care fees and/or bankruptcy

The tax treatment of Discretionary Trusts can be complex and the following is a very brief outline.

Inheritance Tax

The gift by a Settlor into a Discretionary Trust is what is known as a “chargeable transfer” for IHT purposes but provided the value of the assets gifted, aggregated with any other chargeable transfers made in the previous 7 years does not exceed the IHT Nil Rate Band (currently £325,000) then no IHT is payable when the gift is made.  If more than £325,000 is gifted then IHT is payable at the lifetime rate of 20%. If the Settlor dies within the 7 year period, then an additional 20% is payable bringing the tax up to the death rate of 40%.

Death within the 7 year period effectively means that the value of the assets gifted are added back into the estate for IHT purposes.

Discretionary Trusts can also be subject to an IHT charge in their own right every 10 years or when assets leave the trust.  However, provided the value of the trust when it is created is within the IHT Nil Rate Band then no charge will arise in the first 10 years and, barring any drastic increase in the capital value of the trust, any subsequent tax charges are likely to be relatively small.

Income Tax

Generally, Discretionary Trusts pay income tax on any income the trust receives at 45% (38.1% on dividends) but when income is distributed to a beneficiary, they receive a tax credit and may be able to reclaim any surplus tax depending upon their personal circumstances.

Capital Gains Tax

Any gains inherent in an asset gifted to a Discretionary Trust can be held over into the trust and likewise, when an asset which has a capital gain leaves a trust, e.g. is given to a beneficiary that gain can also be held over to the beneficiary.  This does not, however, apply where it is the family home that is owned by the trust.  Holding over the gain effectively means that the trustees or the beneficiary take on the asset at the value it had when it was acquired by the original owner, or the value at which the trust purchased the asset.

If trustees make a chargeable gain on the disposal of assets held by the trust then CGT is due at the rate of 20% (28% on residential property) on anything above the trust allowance, a maximum of £6000 at current rates.

In summary, a Discretionary Trust can be a very useful vehicle for those who have an inheritance tax problem and wish to exercise control over assets that they are prepared to give away.  For example it is possible for a married couple to remove £650,000 (2 x £325,000) from the value of their estate every 7 years, which on death would otherwise be taxed at 40%, so saving £260,000 in tax every 7 years!

For more advice and guidance…Talk to Tollers Wills, Trusts and Estates team on 01604 258558 and they will be able to assist you to make the best decisions for you and your beneficiaries.



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