Introduction to Trusts and Tax Planning

What is a trust?

Sir Arthur Underhill, a barrister at Lincoln's Inn in London once provided this useful definition:

"An equitable obligation binding a person (who is called a trustee) to deal with property over which he has control (which is called trust property) for the benefit of persons (who are called beneficiaries or cestuis que trust) of whom he may himself be one and any one of whom may enforce the obligation."

This definition is useful because it emphasises the point that the trust property is held for the benefit of the beneficiaries. It is the beneficiaries who hold the equitable interest in the property, subject to the terms of the trust and it is the trustees who own the legal interest.
 

Who are the parties to a trust?

Settlor

The Settlor is the provider of the funds for investment. A Settlor can also be a beneficiary of his or her own trust although this would represent a ‘Gift with Reservation’ and therefore would generally make the trust ineffective from an Inheritance Tax perspective. Although some of our trusts allow for joint Settlors, this option should only be chosen where both parties are the providers of the funds, or joint policy owners in the case of an existing policy.

Trustees

Trustees must be at least 18 years of age, of sound mind and not bankrupt. Beyond that, as the name implies, trustees should principally be people whom the Settlor feels can be trusted. Our International Flexible Trust automatically appoints the settlor and a trustee but the settlor may also appoint himself/herself as a trustee of any of our other trusts if they so wish. Additional trustees could include family friends, family members, professional advisers or a trust corporation. Beneficiaries may also act as trustees although care should be exercised to avoid any potential conflicts of interest.

When accepting the role of trustee, it is important that the trustees fully appreciate the terms contained within the trust deed and the legal principles which govern the trust. The Trustee Act 2000 came into force on 1 February 2001 for trusts established in England and Wales and updated the statutory powers and duties of trustees contained in the Trustee Act 1925 and the Trustee Investments Act 1961. Although the full provisions and implications of this Act are outside the scope of this guide, under this Act trustees have a new statutory duty of care when carrying out their duties as well as a duty to act in the best interests of the beneficiaries. Similar legislation, the Trustee Act (Northern Ireland) 2001, came into operation in Northern Ireland on 29 July 2002. The Charities and Trustee Investment (Scotland) Act 2005 received Royal Assent on 14 July 2005. This Act gives trustees of Scottish Trusts similar statutory powers and obligations as trustees elsewhere in the UK.

Beneficiaries

These are the beneficial owners of property held within the trust. If a client establishes a flexible trust, the trust will appoint both discretionary and named beneficiaries. Alternatively, if a client establishes a Bare Trust, there will be no discretionary beneficiaries and instead the Settlor will appoint one or more absolute beneficiaries. The differences between these three types of beneficiary are explained below:

Discretionary

Discretionary beneficiaries may only benefit from the trust funds at the trustees' discretion. Consequently, they have neither a right to income or capital from the trust fund and may also be excluded from benefit at a future date by the Settlor. The death of a discretionary beneficiary does not have any Inheritance Tax implications for the trust.

Named

A named beneficiary has an entitlement to income but not capital. In the event that the trustees do not make an appointment of capital during the lifetime of the trust, the trust fund would default to those individuals who are named in the trust deed as named beneficiaries in the percentage shares stipulated in the trust deed. Where a trust was created on or after 22 March 2006, the percentage share of the trust fund allocated to a beneficiary will not form part of a named beneficiary's estate for Inheritance Tax purposes and neither will his or her death trigger an Inheritance Tax charge. A named beneficiary cannot be removed during his/her lifetime, although the trustees do not have to make any appointment of capital to the named beneficiaries if they do not wish. They could instead pay any trust fund monies to an individual or individuals included within the discretionary class of beneficiary.

Absolute

An ‘Absolute’ beneficiary is the name given to beneficiaries of a Bare Trust. An absolute beneficiary will have an outright entitlement to capital from the trust and is able to demand payment of their share of the trust fund once they reach the age of majority. If an absolute beneficiary dies, the portion of the trust fund belonging to him or her forms part of their estate for Inheritance Tax purposes. Therefore, after the beneficiary's death, his or her share must be passed to his or her estate to be distributed in accordance with the terms of the will or via the laws of intestacy in their particular jurisdiction. If a client establishes a Bare Trust it is not possible to change the absolute beneficiaries once they have been named in the deed.
 

Why use a trust in conjunction with an offshore bond?

There are various reasons why an individual might wish to place their bond into a trust or invest through a trust into a bond. The most common reasons are listed below:

To avoid Manx Probate

We are registered in the Isle of Man. Any policies issued therefore are classed as Manx assets and Manx Probate will be required on the death of a policyholder before either proceeds can be paid out or the policy is re-registered into the name of the new owner. Grant of Probate/Letters of Administration (in Scotland referred to as Confirmation) refers to the situation where, on a person's death, the court must confirm that the executors are entitled to deal with the deceased's estate before any assets can be distributed. If a bond is placed into trust, legal ownership lies with the trustees and neither Manx nor UK Probate will be required on the Settlor's death. Proceeds from the bond can therefore be paid to the beneficiaries without any delay. An exception to this of course is where a settlor dies and he/she is also the sole trustee and life assured.

To control family assets

Trusts have an advantage over an outright gift since the settlor can exercise a degree of control and can still have access to capital in some limited cases. Many investors wish to set aside assets for the future benefit of members of their family whilst restricting beneficiaries' access until it is thought appropriate that those assets should be distributed. If the bond is written in a flexible trust, the trustees can be instructed to hold the bond until the beneficiaries reach a certain age or for future children or grandchildren.

Inheritance Tax planning for UK domiciled individuals

For individuals who are domiciled or deemed domiciled in the UK, Inheritance Tax applies to their worldwide property and would therefore include offshore investments. By arranging for the offshore bond to be held under trust, all or part of the proceeds from the bond may be removed from the Settlor's estate for Inheritance Tax purposes depending upon the type of trust chosen.

As you will see later in this guide, we offer a range of trusts which can be used to mitigate UK Inheritance Tax.

Inheritance Tax planning for non-UK domiciled individuals

An individual who has been a long term resident of the UK for Income Tax purposes but is not UK domiciled or deemed UK domiciled may wish to consider the establishment of an Excluded Property Trust in which to hold their offshore bond. This is because non-UK domiciled individuals who are likely to remain in the UK in the medium to long term can avoid future liability to Inheritance Tax on non-UK assets if those assets are placed in trust whilst the individual is still non-UK domiciled.

Under section 48(3) of the Inheritance Tax Act 1984, the trust assets will remain excluded property for as long as they remain in trust and situated outside the UK.

Please note that all of our trust range (with the exception of the Probate Trust when established as a Bare Trust) can be used for the purpose of establishing an Excluded Property Trust. However, where a bond already exists, it would only be possible to use a Gift Trust or the International Flexible Trust. If a Settlor required access to the trust fund the International Flexible Trust may be more appropriate.

Please note that every care has been taken to ensure that the information provided is correct and in accordance with our current understanding of the law and Her Majesty's Revenue and Customs (HMRC) practice as at December 2008. You should note however, that we cannot take on the role of an individual taxation adviser and independent confirmation should be obtained before acting or refraining from acting upon the information given. The law and HMRC practice are subject to change. Legislation varies from country to country and the policyholder's country of residence may impact on any of the above.