Why trusts still make sense

Iris Wuenschmann-Lyall TEP is a consultant at Toby Harris Tax Consultancy.

A trust can be used to plan the future of a family business, create tax efficiencies and safeguard family wealth. Are they just a domain for the very rich? Not necessarily, says Iris Wuenschmann-Lyall

The trust is a concept which is often viewed to be limited to the very rich. Most of us have heard stories of trusts going disastrously wrong; where assets were tied up for many years and legal fees exceeded the income of the trust. This negative image is unjustified. Trusts can still be a very tax efficient vehicle to pass wealth down the generations and to safeguard assets from spendthrift children or plan for difficult family ­circumstances. Additionally the British govern­ment has suggested changes to reduce the tax compliance burden on many smaller trusts.

What is a trust?
A trust is a formal transfer of assets to a small number of people (called trustees) to hold the assets for beneficiaries. A 'trust' or 'settlement' can be created on or shortly after death or during lifetime to take immediate effect. The trust deed in a lifetime settlement or the will, if the trust is created on death, names the trustees and beneficiaries, and include a number of rules or conditions which the trustees will have to adhere to.

Trusts can be drafted flexibly to enable the trustees to deal with unforeseen circumstances by giving them wide discretionary powers, which may include the power to terminate the trust or to transfer the trust assets to another trust. The settlor may wish to retain some control over the running of the trust, which can be achieved by appointing himself and his spouse as trustees. He may wish to retain the power to appoint or remove his co-trustees or beneficiaries, but he must not behave as if he still owns the trust assets.

How do they work?
There are two main types of trusts: the interest in possession trust gives the beneficiary a right to use the income or benefit (rent, free use of property or dividends of the trust asset) but no right to the capital. Sometimes the trustees may have discretion to advance capital to the beneficiary. This type of trust is often used in a will and allows the widower to enjoy the trust asset but he is prevented from dissipating the trust capital. The other type of trust is the discretionary trust. The beneficiaries do not have a right to income or capital and any distributions are at the discretion of the trustees.

The type of assets owned and someone's tax and family situation will determine which type of trust is most suitable. It is essential that the trust is tailored to suit someone's circumstances which require the help of a trust and tax expert. A list of experts in your locality can be obtained from the Society of Trust and Estate Practitioners (STEP).

Advantages
The discretionary will trust is an attractive estate planning option, as it ensures that the nil rate band of the first of a couple to die is not wasted. It may offer an immediate inheritance tax saving of £105,200 at current rates. A discretionary trust can also be set up during lifetime to set aside capital for children or grandchildren without giving them direct access to it, while at the same time reducing the estate for inheritance tax. If the intended beneficiaries are under 25 a grandparent can use an accumulation and maintenance trust which can help with school fees and other form of maintenance, which is not liable to inheritance tax like a general discretionary trust.

A trust can be used to plan for the future of a family business. For example, it is possible to settle shares in a family company on trust for the children to avoid a sale of the shares outside the family. It also means that children can benefit from the shares but the voting power of the shares remains with the trustees, whose appointment can be controlled during the settlor's lifetime. Assets can be passed down a generation without giving children control over these assets. In addition an inheritance tax efficient will may allow business property relief on shares to be used for further estate planning by the surviving spouse.

Capital gains tax holdover relief is available for assets passing into a discretionary trust, which may be particularly attractive if assets do not qualify for business property relief.

What of new tax legislation?
The government has recently closed a number of tax avoidance loopholes and has also increased the tax rate for trusts from 34% to 40% to reduce the incentive to set up trusts merely to minimise tax. The introduction of the new stamp duty land tax regime has reduced the options available to use the family home for tax planning.

The chancellor introduced new legislation in December 2003 to stop people using trusts to obtain full business taper relief on assets where the taper relief was 'tainted' and to stop people using trusts to obtain private residence relief on second homes.

The newly introduced income tax charge on pre-owned assets may affect people who pass property to their children, as they could be charged income tax on the 'market rent' which would have been payable if the property had been let to the person who had previously owned the asset.

Despite of the closure of a number of tax planning opportunities and the increase in the trust tax rate, trusts can be very effective in reducing a potential inheritance tax liability and safeguarding family wealth through the generations. In addition trusts are very useful to provide for difficult family circumstances. They are certainly not just a domain for the very rich.