Bare/absolute trusts

This type of trust is the simplest and is used to hold assets on behalf of someone else where it is intended that the beneficiary has the definite right call for the asset. The trust is called a bare trust where the beneficiary is aged under 18 and is called an absolute trust where they are 18 and over. The asset will form part of the beneficiary’s estate for IHT purposes and they have a legal right of ownership at age 18.

Gifts to a bare or absolute trust are treated as a potentially exempt transfer for IHT purposes, in the same way as gifts of assets to individuals. This means that no IHT is due at the time the gift is made to the trust and, as long as the person making the gift survives for seven complete years, the gift will fall out of account for IHT purposes. There is also no periodic (ten-yearly) charge on the trust’s assets (see below). However, the assets subject to a bare or absolute trust will count as the beneficiary’s for IHT purposes and will also be exposed to other potential ‘hostile’ creditors such as divorce and bankruptcy proceedings that might be brought against them in the future.

Income and gains arising from assets held in a bare trust are taxed as if they were the beneficiary’s, subject to them having full use of their personal income and capital gains tax allowance. The tax rate paid will therefore depend on the beneficiary’s other taxable income and capital gains. However, if the capital within the trust was provided by a parent (or joint parents), then while the child is aged under 18, any income arising from that capital over £100 per tax year (£200 if joint parents) would be taxed at the parent’s (or parents’ if jointly gifted) highest marginal income tax rate.

Where you are comfortable to make an outright gift to someone but they are under 18, you will have to own it (or have someone else own it) as a bare trustee. This can be as simple as opening a savings or investment account in your name with the child’s initials to signify you are not the beneficial owner. In this case the arrangement will be governed by the Trustee Act 2000, which includes rules on investments and how the trust should be managed. Alternatively, you could have a formal trust deed drawn up to override the Trustee Act’s default provision. As a general rule, for small amounts and simple assets such as a savings account or investment funds, a simple designation (initials) should be adequate. However, for more significant amounts, or in the case of land or other more complicated assets, a formal deed is likely to be desirable.

Clearly, the larger the amount, the greater the potential problem. If you have already made a gift to a discretionary trust up to the nil-rate band, which is currently £325,000, a bare trust is the only way that you can make a gift of non-IHT exempt assets without an immediate charge to IHT. One of the potential problems with a bare trust is that the beneficiary has an absolute right to the trust’s assets at age 18; many people are uncomfortable at the thought of an 18 year old having access to capital without any restrictions.

One potential solution to this problem for larger amounts (£100,000 or more) is to invest in a special type of offshore insurance bond, which has specific policy conditions that govern when the policy may be encashed and the values available. So while the beneficiary would have the right to the capital at 18, in fact all they would have a right to is an offshore insurance bond/policy that has prescribed policy conditions. The conditions of the policy are set at the outset but can, for example, stipulate that the policy has no cash in value until, say, the beneficiary’s 25th or 30th birthday. This enables you to combine the benefits of a PET and restrict access to the capital until the beneficiary is older. See Chapter 22 for a more detailed explanation of this solution.

A bare trust is usually preferable for people:

• who wish to make modest gifts
• who are happy for the child to have access to the cash at 18
• who require the investment strategy to be capital growth orientated and thus able to benefit from both the child’s capital gains tax allowance and 18% flat rate on any excess gains within their basic-rate income tax band
• for whom the £100 rule on income will either be insignificant or does not apply as the donor is not the parent.

Discretionary trusts

This type of trust, also sometimes known as a flexible trust, allows the trustees to choose who can benefit from the trust, from a wide class of potential beneficiaries, including those yet to be born, such as future grandchildren, etc. As well as giving the trustees maximum flexibility over who can benefit, in what proportions and when, this type of trust offers the possibility of avoiding IHT both against the estate of the person making the gift (known as the donor) and the estate of beneficiaries (known as donees).

All discretionary trusts created after 5 April 2010 may continue in existence for up to 125 years. In addition to providing flexibility over who might receive outright distributions of trust capital and/or income, trustees of a discretionary trust might prefer to lend capital to beneficiaries, provided that the trust powers permit this.

Lending capital to beneficiaries can sometimes be a better way of protecting the family wealth from creditors such as bankruptcy or divorce proceedings being brought against a beneficiary because, being a loan, the capital is not assessed as part of the beneficiary’s personal assets. Loans can also preserve beneficiaries’ entitlements to means-tested state benefits, including long-term care fees, assuming that any loan were called in by the trustees. Any loan owed by beneficiaries to a trust is also deductible from each beneficiary’s estate for IHT purposes, providing that it is actually repaid by the deceased’s estate and was not used by the deceased to acquire exempt assets such as business or agricultural assets, thus potentially saving up to 40% in IHT.

Tax charges on transfer to a discretionary trust

As explained in Chapter 20, the transfer of most assets to a discretionary trust will be treated as a chargeable lifetime transfer for IHT purposes. As long as there have been no other gifts to a discretionary trust in the previous seven years, the gift to this trust is within the NRB (currently £325,000) and any unused current and previous annual gift exemption (£3,000 per year), no immediate charge to IHT will arise. However, if the settlor dies within seven years of the date of the transfer to the trust, the gift will become chargeable and utilise some or the entire NRB applicable at the date of death, effectively pushing other assets into charge.

If the gift, when made to the trust, exceeds the available NRB, the excess will be subject to an immediate charge to IHT of currently 20% (i.e. half of the normal rate) if paid by the donee or 25% if paid by the donor. The available NRB will be the current NRB, less any other CLTs that have been made in the previous seven years. Whether or not the gift is subject to tax at the outset, after seven years, assuming no other gifts have been made, the gift will fall out of account for IHT purposes and the NRB will become available again to enable further lifetime gifts or a tax-free amount of the estate to pass free of IHT on death.

Certain assets, however, are exempt from IHT, such as qualifying business assets, qualifying agricultural property, commercial woodland and lump sum death benefits from registered UK or qualified non-UK pension schemes. If this is the case, no immediate charge to IHT can apply on the initial transfer value transferred to a trust. In the case of exempt assets gifted during lifetime, as long as the settlor survives for seven further years, the asset will fall out of their estate completely for IHT purposes, assuming that they can’t benefit from the trust.

It is possible, however, for a settlor’s spouse or civil partner to be a beneficiary of that same trust during the settlor’s lifetime, but this will cause the income and capital gains arising within the trust to be taxed on the settlor during their lifetime. If the spouse or civil partner is entitled to benefit from the trust only after the settlor’s death, i.e. as a widow or widower, income and gains arising will not be taxable against the settlor during their lifetime. Exempt assets can also be passed, free of IHT, to a trust via your will, whether that trust is an existing one or created within your will.

The discretionary trust periodic charge

If the value of the trust exceeds the available NRB at the time (currently a maximum of £325,000), on each ten-year anniversary of the trust or when capital is distributed out of the trust, the trustees may incur a tax charge of up to 6% of the value above the available NRB at the time. For example, if the trust fund were £100,000 above the NRB, £6,000 could be payable every ten years by the trustees. However, this needs to be weighed up against the 40% IHT charge that would otherwise have applied.

Each discretionary trust established or to which property/assets have been added on or before 6 June 2014* benefits from its own periodic charge allowance, as long as each trust was established on a different day and there were no prior gifts that used up some or all of the NRB. This can be very useful where trusts have been established, for example, to hold large life insurance policies or assets have been transferred to trusts that do not attract an immediate charge to IHT but that are subsequently sold and become chargeable assets. Any asset owned by the trust that is treated as exempt, such as a trading business, will also avoid the periodic charge.

Discretionary trusts created by a will, no matter what date they come into effect, are treated as being created on the same day (the date of death) and thus are subject to one NRB for all trusts created this way for the periodic charge every ten years. The exception to this rule is where the trust created via the will is specifically designated to receive only lump sum death benefits from a pension trust. In this situation the will trust is deemed to have been created on the date that the deceased joined the pension scheme. Therefore, for periodic charge purposes, the ten-year anniversary may be much sooner than ten years after death.

*Changes to taxation of discretionary trusts

In June 2014 HMRC issued a third and final consultation on proposals to reform the taxation of trusts, including the periodic tax charge. The main proposed new rule is that the NRB will be shared between all trusts that have been created by an individual after 6 April 2014. Each trust can be allocated a proportion of the NRB (known as the settlement nil-rate band (SNRB)), as long as the settlor elects this before the ten-year anniversary or when property exits the trust. Figure 21.1 illustrates how this might apply in practice.

It is anticipated that the new rules will come into effect in the 2015/16 tax year, backdated to 7 June 2014. In this case there would be no tax benefit in having multiple trusts, although trusts in place prior to 7 June 2014 will continue to be treated under the old rules.

Figure 21.1 Trust periodic charge and the settlement nil-rate band

Prior lifetime gifts

If you make a gift to a non-bare trust in your lifetime, which counts as a CLT, but you subsequently die within seven years of that gift, the NRB will have been used up to the extent of that gift. Where you have established one or more pilot trusts in your lifetime on or before 6 June 2014, when each of these trusts reaches its ten-year anniversary, they will benefit only from the available NRB, which may be less than the full NRB amount, and this can lead to much higher ten-yearly tax charges than anticipated.

Example

Sheila is a widow who made a £325,000 lifetime gift to a discretionary trust (classed as a chargeable lifetime transfer), being the maximum amount she could gift without incurring an immediate tax charge. This was followed by further gifts of £10 to ten additional discretionary trusts, each created on different days but before the 7 June 2014 NRB anti-forestalling rule was announced in the trust taxation reform consultation. The large cash gift is within her NRB and the smaller initial gifts for each trust are within her annual gift exemption. In her will Sheila leaves her net residual estate equally to the ten pilot trusts.

Sadly Sheila dies three years later when her estate is worth £3.25 million (after IHT). Seven years after her death each of the pilot trusts reaches (on different days) its ten-year anniversary for periodic tax charge purposes. Regardless of whether or not Sheila survived the original £325,000 gift to the first trust ten years previously, each pilot trust would only have available, at the ten-year anniversary, an NRB to the extent that the NRB at that time exceeds the value of the original NRB at the time of the first, larger gift to trust. Thus, if the NRB remains at £325,000, then none of the pilot trusts would have a tax-free amount at the ten-year anniversary. Even if the NRB is increased by that time, the first £325,000 will always have been used by the lifetime gift made within the seven-year period prior to the establishment of the pilot trusts. Figure 21.2 illustrates this graphically.

Let’s now assume that Sheila had created the ten small trusts with the initial £10 each on different days, before the trust with the large £325,000 gift to the discretionary trust. The trustees are permitted, as in the previous scenario, to deduct the available NRB from the trust’s value, when working out whether any tax is due on the pilot trusts’ assets at the ten-year anniversary. However, because Sheila did not survive the £325,000 gift to the first discretionary trust by seven years, each of the pilot trusts will not have any tax-free amount (£325,000– £325,000) to deduct from the trust fund for periodic charge purposes, unless the NRB has been increased by then.

Figure 21.2 IHT position of pilot trusts created after CLT

However, if Sheila had survived at least seven years after the £325,000 gift to the first trust, the entire NRB would be available for each of the pilot trusts. If the value of each pilot trust at the ten-year anniversary was below the value of the NRB applicable, no tax would be due. This illustrates the importance of pre-7 June 2014 pilot trusts being created before any subsequent lifetime gifts to a trust, even if this is by just a few days. As long as you survive the lifetime gift to trust by at least seven years, each pilot trust will have the full NRB to deduct for the purposes of calculating the periodic tax charge. Figure 21.3 shows the IHT position of pilot trusts created before CLT.

Figure 21.3 IHT position of pilot trusts created before CLT

Flexibility for lifetime gifts

Where you want to make gifts now but don’t want to make a decision on who gets what and when until some time in the future, a discretionary trust is ideal. The trustees usually have wide powers to invest, distribute, lend assets or borrow funds, depending on the needs of the beneficiaries. Although the trustees (who will usually include yourself in your lifetime) have the discretion to decide how benefits are provided, you can provide them with a side letter setting out some guidelines that you would like them to take into account. Although such guidance doesn’t bind the trustees, it can provide a useful reference point where trustees are faced with competing demands or difficult decisions. Making lifetime gifts to a discretionary trust is also useful if giving assets directly to your chosen beneficiaries would exacerbate their own IHT position or where there is a concern about the beneficiary getting divorced or becoming bankrupt.

No immediate IHT charge will apply on gifts to a trust that:

• are within the available NRB (currently £325,000) every seven years
• are within the annual gift exemption of currently £3,000 (plus £3,000 for the previous year if not used)
• meet the test for gifts out of surplus income
• are exempt assets such as unquoted business shares or agricultural property
• are a bare trust for a minor beneficiary
• are derived from the death benefits from a UK or qualifying non-UK pension scheme.

Using trusts to diminish the value of jointly owned assets

If a property is owned by two people who are not married to each other or in a civil partnership, then each person’s share is, for IHT purposes, subject to a discount in value. The discount is typically between 10% and 15%. If you are married or in a civil partnership you can take advantage of the joint property discount by ensuring that you have appropriate provisions in your and your spouse’s/partner’s will to deal with the ownership of your or their share of the home depending on who dies first. Under this arrangement a small part of the share of the house belonging to the first spouse/civil partner to die is placed in trust for your children or grandchildren. The rest of the deceased’s share of the property is held in a life interest trust for the surviving spouse/civil partner. This has the effect of reducing the value, for IHT purposes, of the share that is owned (both personally and via the trust) by the surviving spouse/civil partner. The joint property discount is shown in Figure 21.4.

Figure 21.4 Joint property discount trust – saving IHT on the family home

Spousal bypass trust

It is common for exempt assets, such as business, agricultural property or commercial woodland, to be passed to a surviving spouse or civil partner who then disposes of it for cash. Alternatively, the executors will dispose of the exempt assets and pass cash to the surviving spouse or civil partner. In both cases the surviving spouse or civil partner ends up with cash that will potentially be chargeable to IHT on their subsequent death. A better approach would be to create one or more discretionary trust(s) either in your lifetime, or via your will, of which your surviving spouse or civil partner would be a potential beneficiary, and pass any exempt business or agricultural property to the trust(s) to avoid the exempt asset falling into your spouse’s or civil partner’s estate and thus avoid 40% IHT on his or her subsequent death.

In the case of a family business, agricultural property or commercial woodland that is to be retained after the death of the first spouse or civil partner, the surviving spouse or civil partner (or the trustees of any immediate post-death interest trust (IPDI) established by the first deceased spouse’s will) could purchase the business or agricultural property from the trustees using their personal (or the IPDI) cash or assets, which ideally have no latent gains. This means that the surviving spouse/civil partner (or IPDI trustees) has swapped assets that would otherwise be subject to IHT on their eventual death, with business assets or agricultural property which will be IHT exempt once they have been held for two years. The bypass trust would then hold family assets that would be subject to IHT only at a maximum of 6% on the trust value to the extent that it exceeds the then applicable NRB (currently £325,000). Figure 21.5 illustrates graphically how this type of trust would operate in simplified form.

Figure 21.5 Spousal bypass trust (double dip)

Life insurance policies

Personally owned life policies should always be written under a suitable trust deed, to avoid the proceeds falling into your estate for IHT purposes and to speed up the distribution of assets. Assuming the life policy has no value or is a new policy at the time the trust is declared, there should be no immediate charge to IHT. Subsequent payment of premiums will be exempt from IHT as long as they are paid from ‘surplus’ income (and meet the conditions for expenditure out of surplus income) or are within the annual gift allowance of £3,000.

Where the life cover amount required is more than £325,000 (or whatever the IHT nil-rate exemption band is), and the intention is not to distribute policy proceeds immediately, the tax payable every ten years is currently a maximum of 6% on the amount in excess of the available nil-rate band. See Figure 21.6.

The pension bypass trust

As previously detailed in Chapter 20, a lump sum death benefit payment from a registered pension (and certain overseas pensions) is exempt from IHT. Depending on the type of trust under which the pension has been established, it can make sense to nominate a separate lifetime or will trust for any death lump sum payments, so that this can pass free of IHT and avoid falling into the estate of your surviving spouse or other family members. The trust should permit the trustees to make loans available to beneficiaries to further improve the IHT efficiency. See Figure 21.7.

Figure 21.6 Life policy in trust and the periodic charge for settlements created on or before 6th June 2014

Figure 21.7 Pension bypass trust

The loan trust

As I briefly mentioned in Chapter 20, you could set up a trust (discretionary is usually best) for a nominal amount (say £10) and then loan capital, usually interest-free, to the trustees to invest as appropriate. Any future growth generated by the invested trust capital will arise outside your estate and also outside that of any of the beneficiaries if it is a discretionary trust. This allows you to freeze the value of the loaned capital, which remains in your estate, while retaining access to it by way of repayments on terms that you agree with the trustees. See Figure 21.8. The ten-year periodic tax charge is calculated on the value in excess of the available IHT NRB but after deducting any outstanding loan due to you.

Figure 21.8 The loan trust

Discounted gift trust

A discounted gift trust allows you to give away capital that then qualifies for an immediate IHT saving, which would lead to the entire gift being outside your estate if you survive seven years. However, you have to agree a fixed amount of ‘income’ that the trust will pay you throughout your lifetime and it is not possible to vary or stop this amount. As such, it is important that you spend such ‘income’, otherwise the arrangement won’t be as IHT-efficient as possible. The amount of immediate IHT saving, which is prescribed by HMRC and subject to medical underwriting by an insurance company, is obtained by applying a discount to the amount that is gifted to the trust. The discount will vary depending on your age and the amount of income taken, with the highest discount given to younger ages taking a high income. Table 21.1 sets out a range of discounts based on various levels of income and ages.

Reversionary trust

Although the general rule is that you can’t give away an asset and then benefit from it (the gift with reservation rule), there is a little-known exception¹ that applies to what is known as a ‘reversionary trust’. This is achieved by creating a discretionary form of a reversionary trust from the gift² of the current value, death benefit or extension benefits of a single-premium, investment-based ‘life’ policy (although the underlying investment could be an investment fund if desired), but you benefit from the trust by way of regular maturities (reversions) of the policy.

The initial gift to the reversionary trust is treated as a CLT and as long as it is within the NRB (currently £325,000) there will be no immediate charge to IHT. The growth on the trust fund accrues outside your estate from day two and, as long as you live for seven years, the original gift will fall out of your estate for IHT purposes. The amount and frequency of ‘reversions’ must be selected at the outset and will if not spent fall back into your estate for IHT purposes. However – and this is the clever part – if you don’t want to receive a reversion of the trust capital, you can disclaim this by advising the trustees before the reversion date and they will effectively defer it to a later date. The act of ‘disclaiming’ the reversion is not treated as a further gift and, as such, does not fall into your estate. Figure 21.9 illustrates how this arrangement works.

Figure 21.9 Reversionary trust and single-premium life policy

Source: Canada Life.

Combining a loan and reversionary trust

If you have substantial assets but want to make only a small commitment to estate planning initially, gradually protect your estate from IHT and preserve maximum flexibility for the rest of your life, you could consider combining a gift and loan trust and a reversionary trust. This involves first creating a trust (usually discretionary) with a modest gift, say £10, and then loaning capital to it. You can draw down the loan at any time and, as such, retain full access to that capital, although any growth arising occurs outside your estate immediately.

Shortly after creating the gift and loan trust, you then gift £325,000 (or whatever your available NRB is) to a reversionary interest trust and set this up to provide yearly optional ‘income’ by way of regular maturities. Any growth arises outside your estate immediately and, as long as you live for seven years, the gift will also fall out of your estate for IHT purposes. You then repeat this process every seven years, creating additional reversionary trusts equal to the NRB, while being able to benefit from the regular but optional ‘income’ reversions.

Table 21.2 illustrates how this would work with £1.5 million of capital where £1.2 million is lent to the first trust and £300,000 (i.e. below the current NRB) is gifted to the reversionary trust. If you are married or in a civil partnership, you could gift up to £650,000 to the reversionary trust if neither of you has made gifts to a discretionary trust in the previous seven years.

Everything should be outside the estate after 35 years while providing the individual with access to the £1.5 million during that period through a mixture of loan repayments and regular reversions of capital. Based on an assumed 6% p.a. investment return net of tax and charges, the amount held outside the estate would amount to nearly £8 million. Although each settlement would pay the periodic (ten-yearly) charge of 6% on the excess over the available NRB, this would still be much lower than the full 40% tax that would otherwise apply. See Figure 21.10.

Borrow and gift

Where you have a property or asset that could act as security, you could borrow capital against that asset and then gift it to an individual or a trust. As long as you, as the borrower, pay the interest arising on the loan (i.e. it is not rolled up), this is IHT-effective. This solution is particularly useful if you have an asset that is standing at a gain, as capital gains are washed out on death for CGT purposes, but the gifted monies will reduce your estate if you survive for seven years, providing that the original loan is actually repaid by your estate following your demise.

Figure 21.10 Projected value of combined £1.5 million loan and reversionary trust

Source: Canada Life.

Spouse/civil partner asset transfer

One spouse or civil partner could sell the other spouse or civil partner an asset (which could be their share of the family home) at full market value in return for an IOU of equal value. There will be no capital gains tax implications due to the CGT spouse/civil partner exemption. The IOU can then be gifted to one or more individuals and will fall out of the donor’s estate after surviving for seven years. Figure 21.11 gives an example of how this works.

The only downside to this idea is that Stamp Duty Land Tax must be paid on the amount of the property sold to the other spouse. This should, in any case, be substantially less than the IHT otherwise payable, while allowing both parties to use or enjoy the property. In addition, the IOU must actually be repaid from the purchasing spouse’s estate when they die, in order for it to be deductible for IHT purposes. This solution is useful where the family home is the only or main asset available for planning.

Figure 21.11 Inter-spouse asset sale and IOU

Source: Bloomsbury Wealth Management.

Investment property standing at a gain

Where you own an investment property that is standing at a gain but want to gift this to, say, your adult child or children, you can gift this to a special type of trust for their benefit, while at the same time making an election to defer the capital gains (known as a holdover election) to the trustees of the trust. This starts the seven-year IHT clock ticking and ensures that capital growth arises outside your estate, while ensuring that any future rental income is taxed against the beneficiaries. The trustees may, after a reasonable interval (at least four months is advisable), wish to transfer the property to the beneficiaries and at the same time defer (hold over) the latent capital gains to when the beneficiaries eventually dispose of the property. This would allow the trustees to hold over the gain to one or more beneficiaries, who can then dispose of the property at a time of their own choosing and potentially pay a lower rate of, or even no, capital gains tax. See Figure 21.12.

Figure 21.12 Gifting property standing at a gain

Source: Bloomsbury Wealth Management.

Gift and rent

With this idea you gift your home to your chosen beneficiaries and pay them a market rent for the right to live in the home. The rental income is taxable in the hands of the beneficiaries but the rental payments are immediately deductible from your estate for IHT purposes. It is vital to ensure that formal valuation advice is obtained, that the rental agreement is properly drawn up, that rental payments are physically paid to the new owner of the home and that the amount of the rent is periodically reviewed, otherwise it may not be IHT-effective.

Gift and buyback

A variation of the gift and rent solution involves you gifting your home to your chosen beneficiary and paying a market rent (see Figure 21.13). You may then offer to buy back a right to live in the property, rent-free, for the remainder of your lifetime. The value of the right to live in the home for the rest of your life rent-free is based on your life expectancy and the market rent applicable to the property.

The cost of buying the right to live in the home rent-free is immediately exempt for IHT purposes, as will be any subsequent increase in value. The value of the property gift will fall out of your estate after seven years. Although the value of the lifetime right to live in the property will remain in your estate for IHT purposes, this should be valued at nothing on your death.

Figure 21.13 The gift and buyback home plan

Source: Bloomsbury Wealth Management.

Settlor interested trust

This idea works for gifts of cash or where an asset is standing at a loss of up to the available IHT NRB and where you need to retain access to rental or investment income from that asset. The gift is settled into a trust of which you are the life tenant, i.e. you have the right to income from it. However, you are prohibited under the terms of the trust from having any entitlement to capital, as this is reserved for your chosen beneficiaries.

The key benefit of this type of arrangement is to remove future capital growth from your estate from the outset and the original capital value if you survive seven years, a potential saving of up to £130,000 after seven years, while still allowing you to retain access to any ongoing income. See Figure 21.14.

Figure 21.14 Gifting rental property and retaining rental income

Source: Bloomsbury Wealth Management.

Corporate trust

This idea works where there are shares in a company that do not (or may cease to) qualify for BPR (perhaps because it is an investment company) but it has significant value, whether or not there are unrealised capital gains on the shares. See Figure 21.15.

The company creates a special corporate trust with non-UK resident trustees. The shareholders then transfer some or all of their shares to the corporate trust. The corporate trust is intended to be a trust for the benefit of employees. The class of beneficiaries would be structured to exclude capital payments being made to the current shareholders of the company, in order to ensure that there is no IHT on the gifts to the corporate trust. Income payments would be permitted to ex-shareholders but will be subject to income tax in their hands.

The transfer of the shares to the corporate trust should avoid capital gains tax due to a special concession and the trust is treated as having acquired the shares at the original shareholder’s base value, plus uprating for inflation. If the trustees of the corporate trust subsequently dispose of the shares and realise a capital gain, then no charge to CGT will arise, unless and until capital payments are made to UK-resident beneficiaries. If the beneficiaries can become non-UK tax resident, the gain can be avoided entirely.

Figure 21.15 The corporate trust

Source: Bloomsbury Wealth Management.

Although 20% IHT would normally be charged on the gift of the shares to the trust, a special concession exists to exempt this charge when the gift is to a corporate trust. Although the tax rules on company trusts have changed recently, as long as it is correctly structured the transfer will immediately remove the shares from the original shareholder’s estate for IHT purposes.

Wealth preservation trust

This solution allows you to obtain an immediate reduction in the value of your estate while retaining access to the capital without falling foul of the various anti-avoidance provisions that have been introduced over the years. It also avoids the 20% initial charge on gifts to trusts above the NRB (currently £325,000).

A trust is created by an unconnected person who is UK non-domiciled settling, say £1 million cash (see Figure 21.16). The trust has two interests, which are capable of being bought and sold. You then pay the trust £1 million to acquire both interests in it. The interests need to be acquired in a particular way to avoid falling foul of IHT anti-avoidance rules.

Figure 21.16 The wealth preservation trust

Source: Bloomsbury Wealth Management.

The trust does not form part of your estate for IHT purposes as you did not create it or settle the original value. The amount you paid for the trust interests is immediately removed from your estate for IHT purposes. If you require access to the trust funds, you can request a loan from the trustees at any time. This loan is also deductible from your estate for IHT purposes and repayable upon your death.

The capital in the trust is protected from unjustly being taken by various ‘hostile’ creditors and after your death the trustees can make a tax-free capital distribution to your chosen beneficiaries or another trust.

A word of caution. Using trusts to hold family wealth can help to avoid IHT and a range of other hostile creditors and also provide proper oversight of those assets so that they can be preserved within the family for their use. However, it is essential to make sure that you make decisions about the use of trusts within the context of your overall wealth plan. In addition, make sure that you have any trust correctly drafted, choose your trustees very carefully and check that they are aware of their responsibilities and duties. Finally, take personalised professional advice on the establishment, management and investment of trust assets. At the very least you need to ensure that the trustees know what they are doing and are well supported in the ongoing management and operation of the trust. That way, your family will reap the rewards of good planning without it becoming a drama.