Treating trusts has proven an effective way of passing wealth onto subsequent generations but according to HM Revenue & Customs, there may still be capital gains tax payable.
CGT applies in most cases when an asset that has increased in value is taken out of or put into a trust.
According to HMRC, trustees only have to pay CGT on a trust if the total taxable gain is above the trust’s tax-free allowance – the annual exempt amount, which has been the same since 6 April 2015.
Types of trust
There are many different types of trust, and each one has a slightly different tax treatment. Trusts involve three parties usually – a trustee (someone who looks after the trust), a settlor (someone who sets up the trust) and a beneficiary (whoever benefits from the assets in a trust).
According to HMRC, the main types of trust are:
■ bare trusts.
■ interest in possession trusts.
■ discretionary trusts.
■ accumulation trusts.
■ mixed trusts.
■ settlor-interested trusts.
■ non-resident trusts.
The tax-free allowance for trusts is £5,550, and £11,100 if the beneficiary is disabled.
If there is more than one beneficiary, the higher allowance may apply even if only one of them is disabled.
The tax-free allowance may be reduced if the trust’s settlor has set up more than one trust since 6 June 1978.
CGT may be payable if assets are put into a trust. It is paid either by the person selling the asset – unless they can claim hold-over relief – or by the person transferring the asset – the settlor.
If assets are taken out of the trusts, trustees will have to pay the tax if assets are sold or transferred on behalf of the beneficiary.
However, there is no tax to pay in bare trusts if the assets are transferred to the beneficiary.
Sometimes an asset might be transferred to someone else but CGT isn’t payable, for example when someone dies and leaves their assets to a trust or an ‘interest in possession’ ends.If managed well, trusts can be run tax-efficientlyJoan Foster, RSM UK
Also, sometimes the beneficiary of a trust becomes ‘absolutely entitled’ and can tell the trustees what to do with the assets (for example, if the beneficiary hits the legal age at which they can benefit from the trust’s assets). In this case, the trustees pay CGT based on the assets’ market value.
Where a trust is set up by a parent for the benefit of a minor, the parental settlement rules apply. Gary Smith, financial planner for Tilney Bestinvest, explains: “Each kind of trust has differing tax positions, which can be complicated.
“Care needs to be taken where a parent sets up a trust and the child is a minor, as any interest or dividends generated above £100 per parent will be taxed on the parent, even though the money is held in trust.”
Are there reliefs?
Trustees can deduct costs to reduce gains, such as the cost of improving property or land to increase its value, eg building a conservatory (but not repairs or regular maintenance), or any professional fees, such as for a solicitor or stockbroker.
Also, HMRC says trustees might be able to reduce or delay the amount of tax the trust pays if gains are eligible for tax relief.
“From a CGT perspective”, says Scott Gallacher, chartered financial planner for Rowley Turton, “there’s an option to gift the capital and sidestep the CGT by gifting investments to a discretionary trust and claiming holdover relief, which defers the tax until a later sale by the trustees.
“Alternatively, the trust can later transfer those investments to the beneficiaries, again claiming holdover relief, and the beneficiaries can then sell those assets against their own £11,100 CGT allowances and possibly at a lower rate – for example, at 20 per cent CGT rather than 40 per cent.”
But knowing how to use trusts for tax-efficiency can be tricky – as not all trusts qualify for various reliefs, and all trusts are taxed differently.
| Trusts and Relief |
| Private Residence ReliefTrustees pay no CGT when they sell a property the trust owns. It must be the main residence for someone the trust says can live there. |
| Entrepreneurs’ ReliefTrustees pay 10% Capital Gains Tax on qualifying gains if they sell assets used in a beneficiary’s business, which has now ended. They may also get relief when they sell shares in a company where the beneficiary had at least 5% of shares and voting rights. |
| Hold-Over ReliefTrustees pay no tax if they transfer assets to beneficiaries (or other trustees in some cases). The recipient pays tax when they sell or dispose of the assets, unless they also claim relief. |
Source: HMRC
Joan Foster, partner at RSM UK, says trusts are most often set up by parents or grandparents to help fund their children’s and grandchildren’s education.
However, she says: “Tax is certainly not the only reason to set up a trust. They are an excellent vehicle to provide protection of capital while giving flexible for a number of beneficiaries to benefit from the income and capital as determined by the trust.
“This can also protect family wealth from matter such as a divorce or bankruptcy or from beneficiaries who are not mature enough to manage their own finances.”
Ms Foster says the most common type of trust used by families is a discretionary trust, although there are inheritance tax implications of setting one up, if the values settled exceed the available nil rate band.
In the 2016 to 2017 tax year, the tax-free IHT allowance is £325,000 – and has been since 2010 to 2011. It has been frozen until at least 2019.
James Badcock, partner for Collyer Bristow, highlights the effect of breaking through the £325,000 ceiling: “Amounts added to a trust in excess of this (or £650,000 for a couple) will be subject to IHT at 20 per cent.”
However, for CGT purposes, gains can be held over on the creation of a discretionary trust, with the trustees acquiring the assets at a base cost, equal to that of the settlor.
Ms Foster adds: “Trusts do have their own income tax, CGT and IHT regimes but if managed well, trusts can be run tax-efficiently.
“For example, when distributions of income are made, these can use the personal allowances and basic-rate tax bands of the beneficiaries, depending on their level of other income.
“After seven years, the value in trust will also be outside of the settlor’s estate for IHT purposes, helping to mitigate IHT on death.”
She concludes: “Therefore, if planned correctly, trusts can be set up with no immediate charge to tax.”
Death and CGT
There is no capital gains tax due on personal investments on the death of an investor.
Sounds simple enough but as Sue Moore, technical manager, private client, tax faculty for the Institute of Chartered Accountants in England and Wales, points out: “The taxman giveth and the taxman taketh away.”
While on death a client will get a CGT-free uplift to market value, she warns: “that market value is then used for the inheritance tax calculation”.
Ms Moore adds: “So the only CGT planning to think about on death, in short, is to try to avoid realising a gain just before you die.”
Many lay investors may labour under the impression trusts can be used to mitigate CGT on death, but as Rowley Turton’s Mr Gallacher points out this is not always the case.
“There is no CGT on death for individually owned assets; consequently rather than mitigating CGT on death, the use of trusts can create a CGT problem where one did not exist before.
“For example, with a discretionary trust, there is no individual owner of the asset, and therefore the CGT does not disappear on the death of the individual.”So the only CGT planning to think about on death, in short, is to try to avoid realising a gain just before you dieSue Moore, ICAEW
However, a person can use hold-over claims into and out of discretionary trusts to pass the CGT from one person to another, with a potential inheritance tax (IHT) saving, providing the seven-year rule applies.
James Badcock, partner for Collyer Bristow, explains: “Where assets are left to a house, there is no IHT, and there is CGT up-basing, so the surviving spouse could gift the assets to their children and there will be no CGT.
“If the spouse survives seven years and do not retain a benefit in the asset, there will be no CGT.”
That said, Tilney Bestinvest’s Mr Smith says although gifting can be used throughout life to defer potential CGT liabilities he believes “this is a highly complex topic”.
| Hold-Over Relief |
| According to HMRC, gift hold-over relief means you don’t pay CGT when you give away business assets.The person you give them to pays CGT (if any is due) when they sell (or dispose of) them.Tax isn’t usually payable on gifts to your husband, wife, civil partner or a charity.The conditions for claiming relief depend on whether you’re giving away business assets or shares. |
Mr Gallacher adds: “There can be arguments for not undertaking some IHT planning exercises for older investors as to do so would trigger a definite CGT liability which might disappear on death, and might not achieve an IHT saving if the investor died too early.”
Source:
Check out up-to-date Nil rate band here
https://www.gov.uk/guidance/inheritance-tax-residence-nil-rate-band