Types of trusts and their taxation

Question 1

CGT on setting up an Interest in Possession trust

Answer 1

• CGT is payable by the settlor on selling or transferring assets into the trust

Question 2

Income Tax on Interest in Possession trust

Answer 2

• The responsibility for paying the tax falls on the trustees at the basic rate (8.75% or 20%)
• Non-taxpayer beneficiaries can reclaim this tax through self-assessment
• Basic rate taxpayer beneficiaries will have no further liability
• Higher/Additional rate taxpayers must pay additional liability of 20%/25% respectively through self-assessment

Question 3

Capital Gains Tax on Interest in Possession/Discretionary trust

Answer 3

• Responsibility for paying the tax falls on the trustees at 20%
• The trust has an annual CGT exemption of £6,150 (divided across all trusts to a minimum of £1,230)

Question 4

On-going Inheritance Tax on Interest in Possession/Discretionary trust

Answer 4

• Potential periodic charge every 10 years if trust assets are valued in excess of the Nil Rate Band (maximum charge 6%)
• Exit charge on capital distributions from the trust (maximum charge 6%)

Question 5

Inheritance Tax on death on Interest in Possession/Discretionary trust

Answer 5

• Death of the settlor: only an IHT liability if death occurs within 7 years of setting up the trust
• Death of the beneficiary: typically no implications (IIP trust beneficiary only has a right to income)

Question 6

Inheritance Tax on death on Qualifying Interest in Possession

Answer 6

• Trust fund is treated as
  being within the life tenant’s estate for IHT purposes

Question 7

Accumulation and maintenance trusts

Answer 7

• Creation is a PET pre 6 April 2008
• Now relevant property
• So treated the same as a Discretionary Trust
• Periodic/exit charges

Question 8

Tax on setting up a Qualifying Interest in Possession trust

Answer 8

• No IHT as benefits from spousal exemption
• No periodic/exit charges

Question 9

Income Tax on Discretionary Trust

Answer 9

• Responsibility for paying the tax falls on the trustees
• The first £1,000 (standard rate band) is taxed at 8.75% or 20%
• Excess income is taxed at the trustee rate of 39.35% or 45%
• Standard rate band is divided across all trusts (minimum £200)
• Trustees do not qualify for tax allowances
• Non, basic and higher rate taxpayers can reclaim overpaid tax through self-assessment
• But no allowances can be used

Question 10

Features of a Loan Trust

Answer 10

• Settlor sets up Discretionary Trust and makes an interest free loan to the trustees
• No transfer of value on set up as the settlor has not made a gift
• Investment growth is held for the benefit of the beneficiaries, accruing outside of settlor’s estate
• Unpaid loan balance on death will form part of the settlor’s estate for IHT purposes
• Loan repayments to the settlor do not attract exit charges, which can vary in amount and regularity
• Not a GWR or POAT

Question 11

Features of a Discounted Gift Trust

Answer 11

• Settlor makes a gift into a bare/discretionary trust
• Settlor has the right to receive a series of fixed capital sums on pre-selected dates, which cease on death
• Gift is invested in an investment bond with 5% annual withdrawals
• Trustees cannot make capital payments to beneficiaries whilst settlor is alive
• Transfer is a PET/CLT
• Amount gifted is discounted by the settlor’s future income stream
• Periodic/exit charges may apply to discounted value at that time

Question 12

Flexible reversionary trusts

Answer 12

• Settlor makes a cash gift into an FRT trust. This can be a double trust or a single trust structure.
• Settlor invests in a series of single premium endowment policies with multiple lives assured
• Under the double trust structure, the settlor assigns the policies to a bare trust for their
  own benefit.
• Settlor then irrevocably assigns all their beneficial interest in each policy to a
  discretionary trust.
• With a single trust structure, the settlor simply assigns policies to a discretionary trust.
• If the discretionary trustees allow a policy to mature then the value of the units (original
  capital and growth) will be payable to the settlor as their income, and any chargeable gain
  will be assessed on the settlor at their marginal income tax rate.
• The settlor’s right to receive future maturity proceeds has no value because of the
  existence of the trustees’ powers to defeat the maturities.
• As the beneficiaries are under a discretionary trust, the initial investment will be a CLT.
• No discount or 5% withdrawals

Question 13

Trustee duties of administration

Answer 13

• Register the trust with HMRC
• Keep records of all transactions and tax
• Submit tax returns, pay any tax and issue a certificate of tax deducted

Question 14

Trustee duties of investment

Answer 14

• Consider suitability or the standard investment criteria of the investments
• Diversification
• Obtain professional advice
• Review investments periodically
• Invest in accordance with the trust deed
• Act as if the trust assets are their own
• Keep proper accounts and invest cash promptly

Question 15

Trustee duties of distributing income/capital

Answer 15

• When income arises, decide whether to accumulate/distribute it
• Document decisions taken and keep accounts
• Deduct any tax prior to a distribution

Question 16

Reasons for removing a trustee

Answer 16

• Death of a trustee
• Out of the UK for a continuous period of more than 12 months
• Trustee asks to be removed
• Trustee refuses to act
• Trustee is deemed unfit
• Trustee is deemed to be incapable

Question 17

Payment of tax by trustees

Answer 17

• Income Tax: trustee must make payments on account by 31 January in year of assessment (based on previous years income) and by 31 July of the following tax year. Then balancing payment of remaining tax by 31 January of the following tax year
• Capital Gains Tax: must be paid by 31 January in the following tax year OR within 60 days of selling a residential property

Question 18

Trusts for vulnerable beneficiaries

Answer 18

• Either disabled persons or relevant minor children
• Both trustees and the vulnerable beneficiary must jointly elect for favourable tax treatment
• Income Tax that the beneficiary would pay (with allowances) is deducted from the Income Tax that the trust would pay
• Same with CGT, trustees can claim difference
• IHT: part of beneficiaries estate on death, no periodic/exit charges

Question 19

CGT holdover relief

Answer 19

• Trustees acquire assets for settlor’s base cost
• Can also apply when assets are transferred to a beneficiary

Question 20

Exit charges

Answer 20

• Where capital is distributed during the first ten years, tax is
  chargeable on the basis of 30% of the lifetime rate (6%) that would have been charged on a
  hypothetical transfer by the settlor using their cumulative total of gifts in the seven years
  prior to creating the trust.
• However, only x/40 of the full tax is charged, with x being the number of full three-month
  periods (quarter years) for which the property has been held on a discretionary trust
  during the initial ten-year period.
• After the first ten years,
  the rate used is the last periodic charge rate, i.e. the rate charged on the last tenth anniversary of the trust, although the x/40 rule still applies.
• There is no exit charge on any payment that is treated as income for income tax
  purposes.