Trusts

Trusts can be a very useful way of both sorting out your financial affairs and avoiding tax.

There are essentially three different types of Trust, brief details of which are set out below:

Interest in Possession Trust

An Interest in Possession Trust provides the beneficiary with the right of income from the Trust (usually for his/her lifetime) but defers the right to the capital until some future date.

The capital of the Trust may, however, be given to the beneficiary should the Trustees wish to do so. The Settlor may also be a Trustee.

Capital Gains Tax

There is a charge to CGT on passing property into this type of Trust, but the transaction may be eligible for:

Retirement Relief (if applicable)

Holdover Relief for business assets

Nil rate for cost plus indexation.

There could be a charge to CGT if the Trustees sell any of the Trust assets. This is the same as if an individual sold the assets, but there is a beneficial tax rate of 34%, whereas an individual would pay at his/her top rate (which at present could be 40%).

There may be a charge to CGT on appointing the capital to the beneficiary, although this could be the subject of a Holdover Relief claim (for business assets only).

Inheritance Tax

There is no immediate IHT charge on the gift into the Trust, as it is a potentially exempt transfer. Furthermore, if the transfer is survived by seven years there is no IHT charge whatsoever. If the asset qualifies for Business Property Relief, 100% will fall out of account immediately - unless the Settlor dies within seven years and the original business property has been converted into non-business property by the time of death.

The assets then form part of the beneficiary’s Estate for IHT purposes.

Income Tax

Trust income is taxed at 20/22% within the Trust.

Discretionary Trust

In a Discretionary Trust, the beneficiaries have no right to income and no right to the capital - except at the Trustees’ discretion.

Capital Gains Tax

There is a charge to CGT on passing property into the Trust, but the transaction may be eligible for:

Retirement Relief (if applicable)

Holdover Relief for business assets

Nil rate for cost plus indexation.

Holdover Relief for assets generally

There could be a charge to CGT if the Trustees sell any of the Trust assets. This is the same as if an individual sold the assets, but there is a beneficial tax rate of 34%, whereas an individual would pay at his/her top rate (which at present could be 40%).

There may be a charge to CGT on appointing the capital to the beneficiary, although this could be the subject of a Holdover Relief claim (for business assets) or Holdover Relief (for assets generally).

Inheritance Tax

There will be an IHT charge on the gift into the Trust as it does not qualify as a potentially exempt transfer, but 100% Business Property Relief and the IHT threshold (currently £300,000 from April 2007) could reduce the charge to nil.

There is a charge to IHT on the Trust of up to 6% of the fund value every ten years, payable by the Trustees. This charge will be eligible for Business Property Relief (assuming this remains applicable) and the IHT threshold (if appropriate). There is also an IHT charge on assets leaving the Trust when they are eventually given to the beneficiaries.

Income Tax

Trust income is taxed at 34%, although dividend income is taxed at a special rate of 25%.

Accumulation & Maintenance Trust

Accumulation and Maintenance Trusts are a special privileged type of Discretionary Trust, usually set up by grandparents for the benefit of their grandchildren.

Capital Gains Tax

The CGT implications are the same as for Discretionary Trusts.

Inheritance Tax

The gift into Trust qualifies as a potentially exempt transfer and 100% Business Property Relief will be applicable to relevant assets. There is no ten-year charge to IHT, and no IHT when the assets are eventually given to the beneficiaries.

There is a requirement that beneficiaries must become entitled to a fixed interest in the income of the Trust before age 25, but entitlement to the capital may be deferred for a considerable time, where required.

Income Tax

Trust income is taxed at 34% (dividend income is taxed at a special rate of 25%).