When considering asset protection, there are many tools and paths open to you. One specific option is that of a trust.
Trusts have historically been used for the purpose of asset protection, but have also been linked with tax planning and often tax avoidance. Nowadays, the likelihood of tax avoidance through the use of a trust is relatively rare due to the almost complete removal of any related tax benefits to UK residents or domiciled persons.
So are trusts still relevant nowadays and in what context could a trust protect personal assets?
The answer to these questions is a resounding yes, perfectly demonstrated where a trust is used to protect assets from the possibility of a failed marriage, from children who may squander away capital assets, or even commercial creditors.
A trust may be used to gift shares, cash and other assets, under specific tax rules, allowing the donor to retain some control of their gift and not necessarily incur an immediate tax liability. Furthermore, the beneficiary involved may receive an income from the trust-held assets, for instance, dividends from shares placed in a trust. The trustees retain control and thus protect the gifted assets from the beneficiary, creditors and under certain circumstances, tax.
Assets cannot, however, be placed in a trust once a creditor has made a claim on them.
What are the tax issues involved in transferring assets into a trust?
Generally, gifting of assets will have a tax consequence. Where the asset is chargeable and stands at a gain, this will incur a capital gains tax liability. Chargeable assets do not include cash and there are several other exempt assets.
In certain cases, a transfer of a business asset may be eligible for holdover relief under the condition that the person receiving the business asset signs a joint election with the donor, agreeing to take on the gain once the asset is sold. In this situation, no tax liability will be incurred.
Where an asset is transferred to a trust, the gain on an asset may be held over under the following conditions:
- The trust is UK resident.
- The trust is not settlor interested.
- Minor children of the settlor will not benefit.
For example, a property which stands at a gain is transferred to a trust. The trustees agree to take over that gain with the understanding that should they sell the property, they will pay the incurred tax. Alternatively, where they assign the property to a beneficiary, the trustees and the beneficiary will sign a joint election.
For the purposes of inheritance tax, it is often more straightforward to simply make a gift. Should the donor live for more than seven years after the gift is made, they will not incur inheritance tax. If they do not live past the seven years, the gift is added to their estate on death and becomes subject to inheritance tax. Any inheritance tax must always be considered alongside any reliefs that may apply.
Alternatively, where the gift is made by transferring it to a trust, the transfer becomes a chargeable lifetime transfer. A bare trust may not be used in this way. Where the value of the asset is more than the nil rate band, and once any reliefs have been taken into account, any excess will incur a 20% inheritance tax liability at the time of the transfer. Should the donor die before seven years has passed, a 20% tax liability will be incurred at that point also.
What kind of trusts are there?
When considering using a trust for asset protection, it is important to understand the different kinds of trusts available and how useful each of those could be to you.
There are several kinds of trust available but the most commonly used are:
This is the simplest form of trust, with the beneficiaries and arrangements for distribution of capital and income defined from the outset. The bare trust offers no flexibility to change either of these factors at a later date, for instance, to add a beneficiary such as when a new child is born.
A bare trust demands regular meetings and communications between the trustees to discuss investment of trust funds, but they do not have the power to make any changes to the initial conditions of the trust, such as distribution of income. This means that the administration of a bare trust is generally straightforward and simple.
This type of trust offers little opportunity to protect assets because the beneficiaries are deemed to have ownership of the trust-held assets and any derived income or gains, for tax purposes.
Once a beneficiary reaches 18 years of age, they gain control of any trust-held assets, or of their share of the assets.
Bare trusts do, however, offer a number of advantages, including the fact that any gift made into a bare trust becomes a potentially exempt transfer. Should the settlor survive seven years after, the gift will not be subject to inheritance tax because it will not be seen as part of their estate.
A discretionary trust, as the name points to, is one where there is a level of ‘discretion’ involved, in this context, the discretion of the trustees.
This kind of trust offers the flexibility to alter the original arrangements made when the trust was formed, for instance, adding a beneficiary or changing the arrangements for distribution of gains. However, any change made must be in the best interests of the beneficiaries.
This flexibility makes the discretionary trust advantageous in regard to protection of assets. However, a discretionary trust is generally not a tax efficient structure.
Discretionary trusts are often used with regard to family businesses, subsequently holding shares, controlling any income from those shares, and generally paving the way to hand down the business to the next generation. A discretionary trust used in this context can also protect the trust-held capital and assets from external threats, such as a failed marriage or creditors.
The added flexibility of a discretionary trust, however, does demand more involvement from the trustees, can be more complicated to run, and often is more expensive to operate than other forms of trust.
What about offshore trusts?
As changes in UK tax legislation has reduced the possibility of tax avoidance through the use of a trust, offshore trusts have been similarly affected and therefore offer very little tax benefit to UK residents and domiciled persons.
The situation is different, however, for non-UK domiciles and non-UK residents. For these individuals, offshore trusts still offer a level of tax efficiency. However, the use of offshore trusts is not clear-cut and must be approached with caution.
Changes in UK tax legislation have less consequence for offshore trusts when it comes to protecting assets.
One benefit of using an offshore trust is the high level of protection of the trust-held assets from creditors. The reason for this high level of protection is the fact that the trust, by its nature of being ‘offshore’, will likely be subject to the tax and legal laws of more than one country or territory.
However, the rules for protecting assets through the use of an offshore trust is complicated and consideration must be taken of whether the trust, through a settlor or beneficiary, could be proved to have close ties to the UK, and hence have a UK tax liability with regard to income or gains.
Whether you are thinking of entering into a trust, or already have a trust in place, it is always advised that you take appropriate professional advice to ensure you are fully aware of all tax and legal implications.
How does a trust protect personal assets – final thoughts
Protecting your assets is a complicated tax planning process, especially where residence or domicile comes into play.
When considering whether a trust would be an effective structure to use for asset protection, it is always recommended to investigate how the related tax and legal implications will affect your personal situation.