Trusts are often set up by people who want to make a gift of property but do not want to gift it outright. Common examples are gifts in trust to children until they reach a certain age, or gifts made in a will (called a will trust) to someone for life. This might be to a partner, and on the death of the partner the property will pass outright to the children of the person who made the will.
The person who sets up the trust is called the settlor. He transfers the assets in the trust to trustees. The trustees hold the property in a separate fund (keeping it distinct from their own property) for the benefit of people who are called beneficiaries. A trustee can be a beneficiary.
To break this down:
Is an obligation placed by the settlor on the trustee to hold, manage and account for property in accordance with the terms of the trust.
This depends on the terms of the trust. The terms may be set out in the settlor’s will or a separate trust document made during the settlor’s life.
The choice of trustee is important. The settlor must trust the trustees (hence the name!), and they should be the type of people who will take their responsibilities seriously. There is normally more than one trustee. Where the trust is for children there must be more than one trustee.
The trust property:
This is the asset or assets given by the settlor to the trustee. The trustee must not benefit from the property for himself, he holds it for the benefit of the beneficiaries in accordance with the terms of the trust. The trustee is the legal owner of the asset, so for example shares or cash in bank accounts will be held in his name.
The person or people (often a class of people such as “my children”) for whose benefit the trust property is held. The trustee must account to the beneficiaries as to how the trust property is held, what is done with it etc. The beneficiaries will have a claim against the trustee if he does not abide by the rules of the trust.
Is the person who parts with the ownership of the trust assets to create the trust. The settlor can also be a beneficiary and a trustee of the trust, but he will no longer own the trust property for himself. He can’t reverse the terms of the trust and transfer the assets back to himself.
Creating a trust is generally a disposal of the property for capital gains tax and inheritance tax. There are also onerous income tax charges for income from trusts.
There is useful guidance at http://www.hmrc.gov.uk/trusts/index.htm
Capital gains tax:
Capital Gains Tax is a tax on the gain in value of assets at the point of disposal. A disposal may occur on creation of the trust. However if the trust is created on death there is no capital gains tax to pay, and the asset is revalued at the date of death.
The trustees will have to pay Capital Gains Tax if they sell, give away or otherwise ‘dispose’ of an asset in the trust that has increased in value. They only pay Capital Gains Tax when the overall chargeable gains for the tax year are above a certain level called the ‘annual exempt amount’.
The rate of Capital Gains Tax for trustees for the 2013-14 tax year is 28 per cent.
The annual exempt (tax-free) amount in 2013-14 for most trusts is £5,450.
Inheritance Tax is normally the tax paid on your estate when you die. However, it can also apply to your estate while you are alive, especially if you transfer some or all of it into a trust.
Assuming this is the only disposal of assets Inheritance Tax is only due if the assets in the trust are valued above the Inheritance Tax threshold (£325,000 in the 2013-14 tax year).
There are four main situations when Inheritance Tax may be due on trusts:
• when assets are transferred into a trust
• when a trust reaches a ten-year anniversary of when it was set up
• when assets are transferred out of a trust or the trust comes to an end
• when someone dies and a trust is involved when sorting out their estate
The rate of inheritance tax is 40%, but the first £325,000 is generally tax free. There are also various types of property (for example agricultural property) that are exempt. The ten year anniversary charge is complicated to calculate, you will certainly need professional help.
Different types of trusts are treated in different ways. However in general the income of trusts is taxed at a high rate. The “trust rate” is currently 45%.