Tax 

Time to treat trusts with neutrality and fairness

  • Describe the importance of using trusts in financial planning
  • List the problems that changes to tax charges might create
  • Describe the impact of periodic charges
CPD
Approx.30min
Time to treat trusts with neutrality and fairness

The UK government is currently considering major reform of the taxation of trusts. 

In November 2018, it launched a public consultation to that end, inviting views on the principles that, in the government’s view, should form the basis of the taxation of trusts: transparency, fairness/neutrality, and simplicity.

The consultation document set out examples of where the government felt these principles were not met, and sought views for and against reform.

The consultation closed at the end of February 2019, and practitioners and clients with any involvement with trusts now await the government’s resulting policy proposals. 

It therefore seems an appropriate time to consider the purpose of trusts, their current tax treatment and the ways in which this might be reformed.

The focus of the government’s consultation is primarily the tax treatment – in particular, inheritance tax – of private trusts for individuals.Key Points:

  • The UK government launched a consultation last November into the taxation of trusts
  • Many trusts are taxed unfairly and defeat the object of using them
  • Most people use trusts for legitimate reasons, not tax avoidance or evasion

Accordingly, this article focuses on the tax treatment of life interest trusts, discretionary trusts, and vulnerable beneficiary trusts. 

Transparency, fairness and neutrality, and simplicity constitute a reasonable approach to ensure an effective trust taxation system.

Tax neutrality is one of the government’s key aims in assessing the tax treatment of trusts. Neutrality is taken to mean ensuring that tax considerations neither incentivise nor disincentivise the use of trusts.

There are many examples where the use of trusts is clearly disincentivised by the existing tax regime, where the aims of fairness and neutrality are not met, and where reform would be desirable.  

The current landscape

Trusts are sometimes viewed as morally questionable and inherently obfuscatory mechanisms, used primarily to hide wealth and avoid or evade tax.

The consultation document suggests that the government believes some trusts may still be used for tax avoidance or evasion.

In reality, the taxation of trusts in the UK has in some areas become so unduly onerous and complex that it can disincentivise the use of trusts: a result contrary to the aims of the consultation.

Most clients create trusts not for the purpose of saving tax, but for a number of wholly legitimate reasons: asset protection (for example, to avoid assets being at risk in divorce financial proceedings); preserving major assets such as farmland and heritage property; providing for intergenerational family planning or to ensure a long-term family legacy; or providing for vulnerable people.

Tax avoidance is no longer a significant motivator.  

Two particularly common types of trust are lifetime interest-in-possession trusts – trusts created during a settlor’s lifetime that give the beneficiary the right to benefit from the trust income/property during their life, but no right to the underlying capital – and discretionary trusts.

Lifetime IIP trusts can be a particularly useful way of providing for family members, vulnerable people, or indeed settlors themselves.

Discretionary trusts are invaluable where it is desirable for the trustees to use their judgment as to who should benefit and to what extent (if at all) from a trust, depending on the beneficiaries’ circumstances.

CPD
Approx.30min

Please answer the six multiple choice questions below in order to bank your CPD. Multiple attempts are available until all questions are correctly answered.

  1. What does the concept of 'tax neutrality' mean when applied to trusts?

  2. Which of the following is NOT one of the conventional legitimate reasons for using trusts?

  3. What are the implications of the periodic charges on trusts?

  4. Why might structures designed for asset protection be broken up?

  5. In the case of lifetime Income in Possession trusts, the tax treatment of them is deemed to be fair and neutral, true or false?

  6. Any increase in IHT on lifetime IIP trusts would have what impact?

Nearly There…

You have successfully answered all the questions correctly, well done!

You should now know…

  • Describe the importance of using trusts in financial planning
  • List the problems that changes to tax charges might create
  • Describe the impact of periodic charges

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