Do you still need that trust?

A recent article in the FT suggested that as many as 1 million trusts in the UK could be caught by a new requirement to register with HMRC. The truth is, of course, that nobody knows the true number of trusts in the UK.

According to the latest available statistics from the National Statistics publication produced by HMRC   last October, the TRS had 122,000 registrations as of 31 March 2020, an increase of 12,000 on the previous year (since 31 March 2019). These are the trusts that have had to register because the trustees had incurred a tax liability. 

The statistics report further tells us that the total number of trusts that have  made Self Assessment (SA) returns has continued to decline, reducing by 6% in the tax year ending 2020 in comparison to the previous year.  This represents a sixth year of consecutive declines, continuing the long-term downward trend. There were 225,000 taxable trusts and estates in the UK in the tax year ending 2004, which has fallen to 145,000 in the tax year ending 2020. This corresponds to a drop of approximately 34% over the past 15 years.

Again, all the figures relate only to those trusts that have had to pay tax/submit tax returns, thus ignoring all those trusts holding non-income/non-gains producing assets, such as a property occupied by a beneficiary or an investment bond (technically a life assurance policy under which the trustees will become liable to tax only in certain limited circumstances).

Even HMRC has apparently acknowledged that there were “significant inherent uncertainties” estimating the number of trusts in the UK and it said one of the benefits of the new rules would be to provide greater clarity about the number of trusts.

Given that the registration of non-taxable trusts only started on 1 September 2021 and will not become compulsory until 1 September 2022, we are still a long way off before the statistics get closer to the true figure of the number of trusts and even then, given the number of "exclusions", we will never know the actual number. Nevertheless, the fact remains that a huge number of clients/trustees have to register their trust or risk potential fines (not yet announced by HMRC) or not being able to deal with professional advisers or financial institutions. 

For financial advisers the TRS debacle should be seen as an opportunity to revisit their clients and review their existing trust arrangements. Among those, doubtless there will be some trusts that may have lost their purpose. For example, one particular type of trust that has been in the news recently.

 

Trusts set up to protect assets from creditors and from the local authority 

Over the years some firms have actively promoted the so-called “Asset Protection trusts”, sometimes called “Family” or “Universal” Asset Protection trusts. 

These trusts promote the idea that transferring your assets, usually your home, to a trust during your lifetime is a great way to protect them from inheritance tax (IHT), care home fees, creditors etc, not to mention ex-spouses. And all this can, allegedly, be done without losing control over the assets and being able to continue to deal with them as you wish. 

It really should not need saying that if you continue to live in a property that you have transferred to a trust, this will not work as an IHT mitigation scheme. What's more it may have additional IHT consequences such as periodic or exit  IHT charges (even if there was no IHT entry charge because the value of the property going into the trust fell within the IHT nil rate band)- (N.B. The only exemption from this rule is in respect of settlors who are disabled or “prospectively disabled”, and   different rules apply to trusts set up before 22 March 2006).

Regarding trusts and care home fees, most advisers will be aware that while, in theory, asset protection trusts can be used to protect one’s assets, the local authority may decide that a particular individual “deliberately deprived themselves of assets for the purposes of avoiding paying for care” and, in such a case, they would assess the contribution as if the settlor still held the assets. And, if assets have been transferred (whether to a trust or outright) with the intent of avoiding to use them to pay for care within six months of entering a home, or while a person is in a home, the local authority has powers to recover from the person to whom the assets were given (i.e. the 'third party' such as the trustees) any money owed to them in respect of the original owner's place in a home. If the asset in question is a house, the local authority can put a charge over it.

Even ignoring the deliberate deprivation issue, the IHT inefficiency as well as the fact that some of the promoters of these schemes have been jailed for mis-selling, there are other potential problems with these arrangements. 

A recent edition of BBC's Money Box included a story of a brother and sister who inherited their  father’s estate on his death. The father had set up one of these trusts a few years back. He never needed care. The brother and sister were the remaindermen under the trust. However, when they attempted to claim their right, they found that the trustees who were the legal owners of the house (the firm who set up the trust) demanded some £700 plus vat to terminate the trust and let them have the property. Considering that the father had spent several thousands to set up the trust (the fees for these arrangements varied but were usually in the region of £3,000 - £4,000), the whole exercise, turned out to be a waste of money as well as a lot of inconvenience. 

Interestingly, some of the justification proffered by the firms setting up these trusts for the high fees they charged, was that they were acting as trustees and so it was to cover their expenses upfront (as there would be no ongoing fees). Of course, there would normally be no trust expenses and nothing to do for the trustees while the settlor was living in his/her  home and nothing else happened.  A solicitor recently posted a question on a legal forum, saying that their firm had hundreds of such trusts on their books and did they really have to register these trusts on the TRS? The answer, of course, is that yes, now all such trusts (those in existence on or after 6 October 2020) have to be registered on TRS. So potentially this will be quite a big job for the trustees.

 

Other trusts that may be redundant 

Many people have set up  “Bypass trusts” as potential recipients of the death benefits under their pension scheme. Most such trusts would be created with £10.  The legislation refers to these trusts as "pilot trusts" and all those set up since 6 October 2020, even if all that is in the trust is the initial £10, still need to be registered on the TRS. The older pilot trusts, so those set up before 6 October 2020 only need to register if they hold assets of more than £100. 

One other consequence of having such a trust is that its existence may be relevant to the tax treatment of other trusts created by the same settlor. Remember that the trustee annual capital gains tax (CGT) exemption as well as the amount of the standard rate band for income tax available to some trusts depends on the number of trusts created by the same settlor. 

Some of the settlors of these trusts would have retired and are drawing and spending their pension. In which case, is the trust still needed? 

Another question which occasionally comes up relates to existing IHT planning schemes, such as a discounted gift trust (DGT), which were set up some time ago and where after a while the settlor (who would typically have fixed rights under the trust) finds they no longer need that “income”.  Is the trust still needed?  Can it be ended easily? 

 

Bringing a trust to an end   

Unfortunately, terminating a trust, or "closing" a trust, will not avoid having to register it on the TRS if it otherwise needs to be registered.  This is what HMRC has said on this point: 

"Trusts that were in existence on or after 6 October 2020, and have since ceased, are still liable for registration on TRS. Trustees of such trusts should register them on TRS and then immediately close the trust record. We appreciate that it may be challenging to raise sufficient awareness of this requirement with former trustees and agents of trusts that no longer exist, however we have an obligation to produce and maintain a comprehensive register of trusts in the UK from 6 October 2020 onwards. HMRC will take a proportionate approach should any such trust come to our attention after the deadline for registration of 1 September 2022.” 

However, regardless of the need for registration, closing a trust may be useful for practical purposes and to avoid even more potential formalities in the future. 

Generally, a trust will continue until one of the following happens which will involve a beneficiary or beneficiaries becoming absolutely entitled to the trust assets. 

• The expiration of the trust period (now 125 years under the law of England) – here the default beneficiaries will become absolutely entitled at that time
• Exercise of a power of appointment and/or advancement by the settlor or the trustees, as appropriate, to bring the trust to an end
• The beneficiaries ending the trust by, for example, application of the rule in Saunders v Vautier
• By the Court exercising its power, say to set aside or adjust a settlement in matrimonial proceedings
• As a result of particular events occurring, e.g. the subsequent failure or satisfaction of the purposes of the trust.

 In the case of private trusts created as part of estate planning, the most relevant occasions are the termination by an advancement to a beneficiary and termination by agreement of the beneficiaries. 

Cleary the terms of the trust will need to be verified before an appropriate action can be taken to advance trust assets and it may involve the trustees executing a deed of appointment and advancement. Most modern trusts will allow for this and if not, there are statutory provisions which are likely to help.

Sometimes there will be a requirement for a minimum number of trustees before this power may be exercised and there may be a special “no conflict of interest” clause which requires that there is at least one trustee who does not benefit from the appointment. This is to ensure that the trustees who are also trust beneficiaries do properly exercise their power (which includes having to consider the needs of all the trust beneficiaries), rather than simply paying the benefits to themselves. 

Once an appropriate deed is executed, the trustees will then need to transfer legal ownership of the trust assets to the beneficiaries - the normal rules for transferring different types of property apply. They will also need to draw up final trust accounts and obtain an appropriate release or discharge from the beneficiaries.

 

Tax implications of the termination of a trust 

If the appointment /advancement is out of a flexible or discretionary trust, and obviously before the appointment is actually made, the trustees need to consider the tax consequences of their action. It should be noted that an appointment of an absolute interest in trust property will amount to the termination of the settlement for tax purposes, whether the trust assets are actually transferred to the beneficiary or not. 

If the trust assets are other than cash or an investment bond, such an appointment will amount to a disposal for CGT purposes. In some cases, hold-over relief may be claimed. 

In relation to life interest trusts, termination of a life interest will also be a disposal for CGT and, in some cases, it may not be appropriate if a better tax outcome would be achieved by  leaving the trust untouched until the death of the life tenant, when the assets will be revalued, providing a tax free uplift for CGT purposes. 

For IHT purposes, an absolute appointment may involve an exit charge. Any liabilities should be calculated (and provided for prior to any payment to a beneficiary). For pre-2006 flexible interest in possession trusts, an appointment/advancement to other than the default beneficiary would also have IHT consequences for the original beneficiary. Clearly, professional advice should be sought.

  

Comment 

Trusts continue to provide an extremely useful tool in financial and estate planning.  When reviewing existing arrangements, the purpose of the trust needs to be revisited. If it turns out that the trust is no longer needed, it may well need to be closed, however the tax consequences need to be considered, as well as the legal method of doing so. Remember a trust is not just another piece of paper that can be discarded if no longer needed. 

If a trust is to continue, say because of possible adverse tax consequences of termination, it may be, in some cases (like the one discussed by the Money Box), appropriate to ask the professional trustees to retire or for the settlor to remove them (if the trust deed allows this),  thus leaving the family in control and possibly avoiding additional costs when eventually (after the death of the life tenant) the trust will be closed.