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Assets and distributions in trusts

| Rebecca Bright | 29 November 2021

Trusts have been used for centuries as a flexible alternative to an outright gift, and they can be a very useful tool to assist with tax planning and asset protection.

A trust, essentially, is an arrangement resulting from a transfer of assets ‘the trust fund’ by a person ‘the settlor’, to one or more persons ‘the trustees’. The trustees will then hold these assets for the benefit of specified persons; ‘the beneficiaries’. 

The terms on which this is done are known as the trust, and the assets that are transferred are known as the ‘trust fund’.

Assets and trust funds

In theory, anything can be held by a trust, but typically the assets might include an interest in a family business, land, rental properties, cash or shares in a listed portfolio.

Trust funds can be a very useful and practical tool for passing on assets to future generations, ensuring provision for children in the event of a parent’s death, protecting money for future school or university fees, and protecting wealth or assets from divorce or Inheritance Tax. 

Advice should always be sought before undertaking any such transfer, to ensure that any costs are identified. While you may wish to minimise the potential Inheritance Tax liability (IHT) for your estate, you do need to retain sufficient funds to cover your future needs.

This should not necessarily be a barrier to setting up the trust, but should be taken into consideration when reviewing the full costs of settlement.

There can also be frictional tax costs associated with settling assets into trust, such as tax costs relating to disposal. In many cases, these can be reduced or eliminated with the use of holdover reliefs, which we can discuss with you. 

Distributions:

Discretionary trust 

Discretionary trusts provide the most flexibility, as the trustees (who have effective control over the assets) have complete discretion as to whether an income of capital is paid out to the trust’s beneficiaries. 

For a discretionary trust, distributions of either income or capital can be made. 

For an income distribution, this will be treated as having a 45% income tax credit attached to it. However, an added complication will be whether the trust has paid sufficient tax to cover the 45% tax credit. 

We can discuss the implications of this with you, and explore alternative options to manage any tax payments. 

Capital distributions can also be made by a discretionary, and potentially in an Interest in Possession (IIP) or Immediate Post-Death Interest in Possession (IPDI) trust also.

In the case of a capital distribution, no tax credit attaches to this, however, there will most likely be a requirement for the trust to report the capital payment to HMRC within six months of the end of the month of distribution. For a discretionary trust, there may be an IHT charge payable, depending on the values involved. 

If you are a trustee of a trust, and wish to make a payment to a beneficiary, we can discuss your options with you.

Interest in Possession trust 

For an Interest in Possession trust, either an IPDI trust, or an old-style IIP trust, the income is that of the beneficiary by right. 

The beneficiary then includes this on their tax return, and pays any additional tax due to HMRC, if they are a higher or an additional rate tax-payer. 

For an IIP or IPDI trust, the income can be paid directly to the beneficiary. If this arrangement is in place, the income is declared on the beneficiary’s tax return, and the trust does not need to report it.

Bare trust 

A bare trust is typically used where an asset is to be held for a minor, and any income arising is simply taxed on the individual beneficiary. Generally speaking, the asset will then pass to them absolutely when they turn 18. 

While this is the cheapest form of trust from a professional fees perspective, the trustees need to decide whether it is appropriate for the beneficiaries to have the capital on their 18th birthday or if it would be better to have further controls in place.

Winding up a trust

Sooner or later, the trust may become redundant, or the trust period may have come to an end. At this point, the trustees would look to wind up the trust arrangements. 

This will involve appointing out any remaining assets to beneficiaries, and notifying HMRC of the cessation of the trust.

It would be prudent at this stage to have a deed of cessation drawn up. If any beneficiaries then tried to dispute the treatment of the trust, the deed of cessation makes it clear that the arrangement has ended.

We can talk you through this process, and explain all the options available to you, to help you manage any tax consequences arising as a result of this.

While there are many important elements to consider, our team at Duncan & Toplis can help make the establishment, management and execution of a trust as straightforward as possible.

Contact us for more information, support and guidance.

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