Simon Mitchell, ‘Complex considerations’, published by STEP Journal Plus August 2020.
What is the issue?
Estate planning can be complex at the best of times, but never more so when there are complex family arrangements to consider. Trusts have historically been a good way to effectively estate
plan, however there have been a fall in the number of UK registered trusts and there are due tom be changes introduced to how trusts will be registered in the UK.
What does it mean for me?
Trusts work very well, but the rules around setting them up and administering them are increasingly complex and advisers need to ensure they have access to in-depth experience and
expertise when advising clients on the best course of action, especially when there are complex family arrangements and vulnerable clients to consider.
What can I take away?
This article will outline the types of trust available in the UK, the changes coming in in regards to how trusts need to be registered, which arrangements could best suit complex family structures and how to set up trusts and estate plan so that they are tax efficient and unlikely to be challenged during probate.
UK trusts remain an effective way of carrying out estate planning for complex families, not only as a way of mitigating tax but also for asset-protection purposes. This might be for vulnerable beneficiaries (such as young children, beneficiaries with disabilities or mental health issues, beneficiaries claiming means-tested benefits, etc.) or to guard against the possibility of a beneficiary divorcing or going bankrupt. However, trusts require careful consideration when being created, given that the rules governing them can be complex.
Lifetime tax planning
Anyone can create a trust during their lifetime and then transfer cash or other assets into it. The usual reason for doing so is to pass assets out of the person’s estate so that they do not form part of the inheritance tax (IHT) calculation when the person later dies. The most common type of trust created in this scenario is a discretionary trust in which the class of beneficiaries named in the trust deed have no rights as such to either the trust capital or income. Instead, it is for the trustees who are named to run the trust to decide which beneficiaries benefit, how and when, by exercising the powers provided to them in the trust deed.
Where a person transfers assets into a lifetime trust, careful consideration of the rules relating to lifetime gifts is necessary. Since the Finance Act 2006, a gift into most trusts is chargeable at the point it is made1 at a rate of 20 percent2 but only to the extent that the value of the gift exceeds the donor’s nil-rate band (NRB) for IHT purposes: GBP325,000 since 6 April 20093. Other chargeable transfers made in the seven years prior to the gift into the trust must also be taken into account, and this can lead to a cyclical pattern of gifting into trust every seven years, once previous chargeable gifts have fallen out of play.
For the above reasons, transfers into a lifetime trust are usually assets worth less than the NRB of GBP325,000 or assets that might otherwise benefit from a tax relief. Both business assets and agricultural assets can benefit from these reliefs if certain conditions are met, and certain types of investment (such as shares in the Alternative Investment Market) can also benefit from business relief. A share in the business or partnership must have been owned by the donor throughout the two years leading up to the date of transfer4, and the business must be trading (rather than wholly or mainly investment) in nature5.
In July 2019, the UK Office of Tax Simplification published a report6 suggesting that the reliefs available to businesses and farms for IHT purposes should be reviewed, though the government has yet to do so. If the reliefs for businesses in particular become more limited in the future, transferring business assets into trust now while the current reliefs still apply might be a worthwhile exercise so that the value of the assets no longer form part of the donor’s estate when they later die. However, if the donor or their spouse/civil partner can benefit from the trust during the donor’s lifetime, this will trigger the ‘reservation of benefit rules7, which could potentially undermine the tax planning.
Post-death tax planning
Trusts are also commonly created by will to receive either specific assets in the estate or all of the residuary estate (after tax) of someone who has died. For couples who are married or in a civil partnership, discretionary trusts in wills are commonly used to receive agricultural or business assets if they qualify for IHT relief when the first person dies. This allows the assets to be sold by the trust so that the proceeds of sale remain outside of the estate of the surviving spouse. It may not be desirable for the survivor to receive the proceeds of sale outright, as the funds will then be subject to IHT in the survivor’s estate when they later die. If the trust receives the proceeds, it can loan the money to the survivor, allowing them to benefit from the funds for life, and the loan can then be repaid out of the survivor’s estate when they later die. This repayment keeps the value of the loan outside of the survivor’s estate for IHT purposes.
Discretionary trusts are also used to protect children or other vulnerable beneficiaries. Any assets that pass into the trust do not belong to the beneficiaries outright and are protected in the event that the beneficiaries are very young, go bankrupt, get divorced, or are otherwise vulnerable. Using a trust can also allow the beneficiaries to carry out IHT planning of their own by keeping the assets away from their own estates, thereby saving IHT when they later die.
As assets in a discretionary trust do not belong to the beneficiaries, there can often be an IHT charge within the trust. This applies once every ten years after the trust has been created or, if created by will, ten years after the death of the testator8. The tax charge also applies on a pro-rata basis to distributions made at other times9. The rate of tax is currently no more than 6 per cent and may be less, but will need to be planned for. Discretionary trusts are also subject to capital gains tax and income tax on any gains and income they generate, respectively.
Immediate post-death interests10 are often used in wills in relation to married couples who may also have children from previous relationships. The surviving spouse has a right to income from the estate or from specific assets rather than inheriting the estate outright. This can also allow the survivor to have the right to live in the deceased person's house. When the survivor later dies, the survivor is treated as being beneficially entitled to the trust assets for IHT purposes11, which means they are included in the IHT calculation that arises on the survivor’s death. However, the assets must then pass according to the will of the spouse who died first (not the survivor), which allows those assets to be ring-fenced, usually for the children of the spouse who died first.
Historically, only trusts that generate tax liabilities of some kind have needed to be registered with Her Majesty’s Revenue and Customs, although the EU Fifth Anti-Money Laundering Directive12 suggests that all trusts (whether they pay tax or not) will need to be registered unless specifically exempted. The UK government consultation paper on trust registration expired in February 2020 and if the proposals are introduced as suggested, the number of trusts that need to be registered will increase considerably. The government is looking at whether the rules can be introduced in a proportionate way and the outcome should be known in the next few months.
Simon Mitchell TEP is a Partner at Thomson Snell & Passmore
1 Section 2 of the Inheritance Tax Act 1984 (the Act)
2 Half of the usual IHT rate of 40 per cent as per s.7(2) of the Act
3 Schedule 1 to the Act
4 Section 106 of the Act
5 Hybrid businesses that are part trading and part investment therefore have to place extra emphasis on the
trading aspects of the business such as in Vigne (deceased) v HMRC  and Graham (deceased) v HMRC
, which involved a livery yard and holidays lets respectively, in both of which relief was granted
6 Office of Tax Simplification, ‘Inheritance Tax Review, Second Report: Simplifying the Design of Inheritance Tax’,
published July 2019
7 Section 102 of the Finance Act 1986
8 Sections 64, 66 and 67 of the Act
9 Sections 65, 68 and 69 of the Act
10 Section 49A of the Act
11 Section 49(1) of the Act
12 EU Directive 2018/843