To say trusts can be extremely useful in estate and tax planning is an understatement. They deliver a legitimate means to make a gift “with strings attached”, which can help to overcome the understandable misgivings some would-be donors have about making outright gifts.
Done properly they can ensure the assets transferred into trust will be excluded from the taxable estate of the settlor, and income and any capital gains generated will be taxed on the trustees.
Over the years, however, HM Revenue & Customs has imposed rules that set clear conditions for a gift being effective for inheritance tax purposes (the gift with reservation and pre-owned assets tax rules) and made the income tax and CGT element less inviting for discretionary trusts.
Aside from the anti-avoidance provisions attributing trust income and gains to a settlor in an increased number of circumstances, income under discretionary trusts (other than the first £1,000 falling within the standard rate tax band) will be taxed at 38.1 per cent for dividend income (with no dividend income allowance available) and 45 per cent for all other income.
Broadly speaking, trustees only qualify for half of the CGT annual exempt amount and all realised gains above this will be taxed at the highest 20 per cent rate (28 per cent on residential property gains).
Against this background, HMRC’s annual trust statistics, published in January, reported the number of UK family trusts and estates required to complete a full self-assessment return has fallen to 163,000 in 2014/15 from 170,500 in 2013/14. There has been a 27 per cent decline in family trusts reporting under self-assessment in the last decade.
Not particularly friendly
So what is the reason for this? Have some trusts been wound up? Probably. It is thought the increase in trust taxation, especially the increase in the special rate for trust income, may have been partly responsible. After all, the tax environment for the undistributed income and capital gains of trusts is not what you would call particularly friendly.
Of course, it may be the fall in the number of trusts reporting is not due to a reduction in the number of trusts per se, but a change in their investment strategies so as to reduce the amount of reportable income and gains.
The number of interest in possession trusts reporting has also fallen and this could be for different reasons to those for discretionary trusts, as mentioned above. The fall in IIP trusts reporting (assuming the underlying cause is that the trusts have been wound up) could be tracked to the IHT changes in 2006 applying the relevant property regime to them, thus making them less attractive.
Life assurance-based investment bonds are non-income and non-capital gains producing assets, which keeps them out of assessment until any accumulated gain (or deemed gain on part withdrawal) is realised.
Trusts that have got the message in relation to bond investment would not need to report year-on-year daily accumulations to the extent of the bond.
The tax case for investment bonds as a trustee investment has been strengthened further since the dividend allowance of £5,000 (to be reduced to £2,000 next April) was denied to trusts. Combined with the high income tax and CGT rates, with low allowances and exemptions, this leads to a compelling case for bonds.
Tony Wickenden is joint managing director of Technical Connection. You can find him Tweeting @tecconn