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Intergenerational planning – the use of trusts: Peter Legg, IHT Planning Matters Ltd.

  • By Sue Whitbread

As part of IFA Magazine’s series of features on the topic of intergenerational planning, Peter Legg of IHT Planning Matters Limited examines, at a time when financial planners and their professional brethren in the legal and accountancy worlds are increasingly faced with them, the background and some definitions for UK trusts.

What is a trust?

A trust is a legal relationship where an individual (the “settlor”) transfers assets to a person or persons (the “trustees”) who hold and manage those assets for the benefit of others (the “beneficiaries”) named by the settlor.

In simple terms, it is a way of gifting assets while retaining an element of control over who will benefit and when the benefits – either capital or income or both – are paid over (if ever).

In order for individuals to establish a valid trust, they must be of sound mind.  There are also three conditions which must be satisfied.  These conditions are known as the three certainties:

  • certainty of intention – it must be clear that the settlor intended to create a trust;
  • certainty of subject – the assets that are to be transferred into the trust must be clearly identified;
  • certainty of objects – the beneficiaries of the trust can be clearly identified, either by name or classification.

Where the trust is to be created by an individual’s Will, it must also meet the requirements of section 9 of the Wills Act 1837.  The Will needs to be:

  • made in writing;
  • signed by the testator or testatrix, in the presence of two independent witnesses.

As well as express trusts (where the settlor expresses his or her intention to create a trust), it is also possible for a trust to be created by the operation of law, for example, where assets are left under the law of intestacy to a minor child.

What are the benefits of settling assets in trust?

There are various different reasons why an individual may choose to set up a trust.  For example:

Inheritance Tax

By gifting assets into a trust, an individual can for Inheritance Tax purposes reduce the size of their potentially taxable estate on death.  Transfers will normally be outside the estate after seven years.  Such a transfer to trustees is not, for Inheritance Tax purposes, treated as a potentially exempt transfer but as a chargeable lifetime transfer, with a 20% Inheritance Tax liability on the excess over £325,000 by each settlor.

It should be borne in mind that the settlor has effectively gifted his/her assets and it cannot be used for their own benefit; otherwise it may be a gift with reservation of benefit (though there are trust structures where the settlor can in certain instances retain access to income but alienate access to capital).

Control over assets

The settlor may wish to prevent control of the assets from passing outright to the intended beneficiary for various reasons, for example if the beneficiary is a child or prey to unwelcome influences.

Speed of payment

If assets are placed in a trust, the benefits on death from financial products such as insurance policies can be paid out immediately on production of a death certificate.

There is no need to wait for Grant of Probate or Letters of Administration as the trustees are the legal owners.

Who can act as a trustee?

A trustee can be an individual or a corporation.  Provided that an individual is of majority age and is of sound mind, they can act as trustee.

When choosing trustees, the settlor should look to appoint trustees whom they feel will best carry out the settlor’s intentions.  A trustee may also be a beneficiary of the trust but consideration should be given to possible conflicts of interest before appointing such a trustee.

A corporate trustee, such as one offered by a Bank or specialist Trust Company, will of course be impartial.  They will also have specialist expertise in this field and being a corporation as opposed to an individual, cannot die.  However, corporate and other professional trustees will charge for their services.

Most trust deeds automatically include the settlor as a trustee but this does not have to be the case.  Consideration should always be given to appointing at least one additional trustee.  On the death of the last surviving trustee, the role of trustee will pass to that deceased trustee’s executors or administrators.   These individuals may not be the settlor’s preferred choice to act in this role.

What are the trustees’ responsibilities?

The role of a trustee can be an onerous one.  The trustees are the legal owners of the trust assets and their responsibilities include:

  • ensuring trust assets are registered in the name of the trustees;
  • complying with the terms of the trust deed;
  • acting impartially between all beneficiaries;
  • distributing the trust funds in accordance with the provisions of the trust document;
  • keeping accounts;
  • completing the trust self assessment returns;
  • paying any tax due;
  • investing trust funds.

The Trustee Act 2000 includes a statutory duty of care which the trustees must adopt when investing trust funds or delegating trustee duties.

What investment powers do trustees have?

Most modern trust wordings include provisions specifying the investment powers available to the trustees.  Typically these allow the trustees to invest in a wide range of investments such as shares, deposits and property.

Where the trust wording does not include any specific powers of investment, the trustees will be subject to the statutory investment powers contained within the Trustee Act 2000 or its equivalents in Scotland and Northern Ireland: the Charities and Trustee Investment (Scotland) Act 2005 and the Trustee Act (Northern Ireland) 2001.

These three acts replaced the Trustee Investments Acts 1961 which imposed a more restrictive set of investment powers and excluded investments such as life assurance and land.  Trustees may now make an investment of any kind as if they were absolutely entitled to the assets of the trust.  However, any restrictive powers of investment contained within the trust will continue to override the statutory provisions.

What duties and investment powers does the Trustee Act 2000 impose on trustees?

The Trustee Act 2000 introduces statutory powers of investment for trusts which do not contain express investment powers.  It also imposes a duty of care on trustees and applies to trusts already in force, not just those created since its introduction.

There are three main aspects of the Act:

Power of investment

We have commented on this power above.

When selecting investments, trustees are required to have regard to the “standard investment criteria”.  Investments should be suitable and diversified, taking into account factors such as:

  • the size of the fund to be invested;
  • the risk profile of investments;
  • the need to produce an appropriate balance between income and capital growth;
  • the requirement to meet the needs of the trust; and
  • any relevant ethical considerations.

In addition, there is also a duty to undertake a periodic review of the investments held and to obtain and consider proper advice when doing so.

The requirement to carry out periodic reviews formalises the judge’s comments in the case of Nestle v National Westminster Bank PLC (1993).  It was argued that the bank (as trustees) had failed to carry out periodic reviews of the trust investments, creating a loss.  Whilst the judgement favoured the bank on the basis that no loss could be established, it criticised them for their “incompetence and idleness” in failing to conduct periodic reviews.  As a loss can be difficult to establish, the Act therefore imposes the duty to carry out periodic reviews.  Doing nothing is no longer an option for trustees.

Duty of care

Trustees have always been subject to general duties of care, established largely through case law.  For example, they should act only in the best interests of the beneficiaries of the trust.  They must treat all classes of beneficiary fairly and, in particular, where some beneficiaries are entitled to income and others to capital, they must invest to achieve both income and capital growth.  At common law, the standard of care expected from the trustees is that of the ordinary prudent man of business.  Trustees who are paid for their services as professional trustees are expected to meet a higher standard of care than other trustees.

The Act describes the new duty as that which can reasonably be expected of a person carrying out their duties, having regard to their specialist knowledge, experience or professional status.  The trustees have to show such skill and care as may reasonably be expected in the circumstances.  For example, a higher standard of care would be expected in relation to the purchase of stocks and shares from a trustee who is an investment banker than from a trustee who has absolutely no experience in that area.

Delegation of duties

The third major change under the Act is there is now a general power to trustees to appoint an agent to carry out the duties of the trust.  The main functions which the Act does not allow to be delegated to an agent are:

  • decisions as to how the assets of the trust should be distributed;
  • whether payments should be made out of income or capital;
  • the appointment of a trustee.

The Trustee Act 2000 applies only to England and Wales.  However, similar legislation applies in Scotland and Northern Ireland: the Charities and Trustee Investment (Scotland) Act 2005 and Trustee Act (Northern Ireland) 2001.

What is a breach of trust?

A breach of trust may occur when a trustee fails to comply with duties imposed upon him or her by law or the terms of the trust deed.

Some common examples of breach of trust include:

  • failure to invest the trust funds in an authorised manner;
  • failure to correctly distribute the trust assets;
  • making an unauthorised personal profit from the trust;
  • failure to register trust property in the names of the trustees.

Where a breach of trust has occurred, the beneficiaries may decide to take legal action against the trustees personally.  The trustees may be liable to restore the trust property or pay compensation for the breach.

Some trust definitions

The “settlor(s)” – the person or persons who establish the trust and transfer selected assets to the trustees.

The “trustees” – the persons or corporation the settlor selects (and which can include the settlor too) to administer the trust funds in accordance with the trust provisions and protect the trust assets.

The “trust fund” – the assets transferred to the trustees by the settlor.  This is likely to be an initially modest sum to get the trust established and will inevitably be followed by further transfers of assets as the settlor decides.

The “trust period” – the length of time (usually, in modern UK trusts, 125 years) that the trust can continue although it is likely to be terminated – by dint of circumstance, need, fiscal implications, etc – sooner than that.

The “beneficiary/beneficiaries” – the beneficiary or class of beneficiary that can benefit from the trust funds, either by receiving income arising on the trust funds or capital, depending on the terms of the trust deed and the trustees’ discretion.

Many settlements have power to add to the class of beneficiaries but that cannot extend to the settlor or their spouse (but it can extend to a widow or widower) or anyone else who has added assets to the trust (or their spouse).

The “income arising” – this will either be directed to be paid (with no discretion on the part of the trustees) to a specific beneficiary or beneficiaries in whatever shares the trust deed directs or is alternatively (depending on the type of trust it is) distributable entirely at the trustees’ discretion around a class of eligible beneficiaries depending on their needs or else can be accumulated and added to the capital.

A power to advance capital – in most trusts, the trustees are given power to advance up to the whole of the capital to a beneficiary or beneficiaries at the trustees’ discretion, possibly bringing the trust to an end.

The “ultimate devolution” of the trust funds – every trust must declare who the (remaining) capital will pass to at the end of the Trust Period.  There can be no uncertainty about this (many settlors will add charity as the ultimate beneficiary if all other beneficiaries have died).

The main “types” of trust – there are a wide variety of trust types but the most frequently used are:

  • a “discretionary” trust, where the allocation of any income arising – including the power for the trustees to withhold it from a particular beneficiary and accumulate it – is entirely at the trustees’ discretion. The trustees are likely to have a power to advance up to the whole of the capital too but that is common in most types of trust;
  • an “interest in possession” trust, where there is no such discretion over the allocation of income. The trustees are directed to pay the income arising to a named beneficiary or named beneficiaries (either equally or unequally) such that that beneficiary or beneficiaries have a right as against the trustees to all income arising on the trust funds.

The use of trusts in a tax planning exercise

The commentary above concentrates more on the legal as opposed to the fiscal implications of a trust.  The latter might be the subject of a separate article.  In short, however:

For Capital Gains Tax, a transfer of assets to trustees would be treated as a chargeable event.  The net increase in value from the date of acquisition of the transferred asset to now would be the chargeable gain.  The settlor’s annual Capital Gains Tax exemption of £11,700 (unless already used) would reduce the chargeable gain but this would then be payable at 20% or at 28%.

The tax payable could be significant and would be payable in one sum by the settlor and would have to be paid – no sale having occurred at the time of the transfer which would have put the settlor in funds to meet the liability – out of his or her other resources or with monies borrowed and secured on the other assets he or she retains.

However, it is presently possible, by transferring assets to a trust, to defer the Capital Gains Tax charge which would otherwise arise by taking advantage of hold over relief under section 260 of the Taxation of Chargeable Gains Act 1992 (hereafter “TCGA”).  In this way, the trustees would acquire the transferred asset at the settlor’s own acquisition cost and no attendant Capital Gains Tax charge would be payable.

The gift of the transferred asset to the trustees would also represent a chargeable lifetime transfer for Inheritance Tax purposes (the reason the Capital Gains Tax liability can be deferred is to avoid a double charge to tax on the same disposal).  The liability would be calculated at the 20% lifetime rate of Inheritance Tax on the excess over the available taxable threshold (£325,000).  We doubt the values usually provided by the settlor will bear the weight of this calculation and more authoritative valuation advice will need to be taken.

If the settlor feels this attendant Inheritance Tax cost is too great (notwithstanding it might be capable of being “staggered” over ten years), he or she can merely reduce the level of his or her transfer.

This liability would be a case of pain today for significant gain tomorrow (as stated, a potential Inheritance Tax saving) and would be payable by the trustees rather than by the settlor himself or herself and might be spread over ten years by annual instalments (of one tenth of the liability each year) and these instalments could be funded by the settlor by transfer of unspent income or out of his or her annual Inheritance Tax exemptions.

The settlor will want to take more considered valuation advice on the whole valuation issue.  It puts an onus of responsibility on the settlor now to produce defensible values of the transferred asset; we would strongly recommend a second opinion be taken on the values adopted given the adverse tax consequences of proceeding on values which prove, in negotiations in due course with HMRC, to be very much on the low side.  The values which are advised must be capable of passing muster with HMRC in due course.

There is a possibility that, by proceeding with the lifetime gift to the trustees, the settlor could suffer a disadvantage.  This would be on the basis that he or she made the gift and then failed to survive the gift by seven years.  There would be no elimination of the capital gain on the donor’s death for the transferred asset and the gift would need to be taken into account to calculate the Inheritance Tax implications of that death.

It is of course a difficult issue to call and it is the settlor’s decision.

One further disadvantage is that every ten yearly anniversary (should the trust continue that long), there would be an additional charge (at 6% on current rates) on the value of the trust assets held over and above the then tax free threshold.  These liabilities can be calculated more precisely in due course.  It would be our view that the option of a lifetime gift of the transferred assets to the discretionary trust – with a lowering of the eventual Inheritance Tax charge – is an infinitely better way forward than doing nothing, where an eventual Inheritance Tax charge of significant proportions could arise on this asset as part of the settlor’s potentially taxable estate.

For Income Tax purposes – should any income be produced on these assets – trustees are assessed at different rates depending on the level of income.  The first £1,000 of income in any tax year – known as the standard rate band – will generate only basic rate tax at 20% on untaxed income such as rental.  Above that, income is assessed in the trustees’ hands at 45% (2018/2019 rate).

Were the trustees to then apply income to any of the eligible beneficiaries as primary beneficiaries, the trustees will give those beneficiaries a voucher indicating that they had received income which had already borne a higher Income Tax liability – even though the first £1,000 of trust income only suffers tax at 20%.  These factors would have to be borne in mind when calculating the amount to distribute to/apply for which particular beneficiaries.  They will have received income which has already borne a higher rate of Income Tax and if any are a non or basic taxpayer, this will result in a tax repayment.  Thus in effect HMRC will be contributing in no small part to whatever benefits are taken by such beneficiaries.

These Notes are intended for guidance only and should not be relied upon as a definitive or exhaustive analysis of the law on the subject.  We are not qualified to provide such an analysis. IHT Planning Matters Ltd.

Contact details for Peter Legg: –

Telephone:  0800 023 2449

Mobile:  07717 740055




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