TRUSTS

• Bare Trusts
• Interest in Possession Trusts
• Discretionary Trusts
• Accumulation and Maintenance Trusts

Bare Trusts

A bare trust is one in which the beneficiary has an immediate and absolute right to both capital and income. The beneficaries of a bare trust have the right to take actual possession of trust property.

The property is held in the name of the trustee, but that trustee has no discretion over what income to pay the beneficiary.

Example

Peter leaves his sister Mary some money in his will. The money is to be held in trust, with Mary entitled to money and any income, such as interest, it earns. She also has a right to take possession of any of the money at any time.

This is a bare trust because Mary is absolutely entitled to both the capital (the original money settled in the trust) and the income (any interest earned).

How are bare trusts taxed?

Bare trusts are treated for tax purposes as if the beneficiary holds the trust property in his or her own name. Income tax and capital gains tax are charged on the beneficairy, as if the trust did not exist.

The beneficiary must declare any income and capital gains on his or her personal tax return. Although trustees can pay income tax on behalf of a beneficiary, it is the beneficiary who is chargeable to tax.

This type of trust exists when a beneficiary, known in this case as an 'income beneficiary' has a current legal right to the income from the trust as it arises. The trustees must pass all of the income received, less any trustees' expenses and tax, to the beneficiary.

A beneficiary who is entitled to the income of the trust for life is known as a 'life tenant'.

A beneficiary need not have any rights over the capital of such a trust. Normally, the capital will pass to a different beneficiary, or beneficiaries, at a specific time in the future or after a specific future event. Depending on the terms of the trust, the trustees might have the power to pay capital to a beneficiary even though that beneficiary only has a right to receive income.

A beneficiary who is entitled to the trust capital is known as the 'remainderman'.

Example

Paul is married to Anne. On his death, Paul's Will creates a trust and all the shares he owned are to be held in trust. The dividends earned on the shares are to go to Anne for the rest of her life, and when she dies the shares pass to the children or grandchildren.

How is an interest in possession trust charged to income tax?

The trustees are normally chargeable to income tax on income, so

• Rent and trading income are chargeable at the basic rate (currently 22%)
• UK dividend income is chargeable at the starting rate for dividends (currently 10%) and the tax credit attached to the net dividend meets the trustees' liability
• Savings income, such as bank interest, is chargeable on the trustees at the lower rate (currently 20%). Such income usually has tax deducted at source by the bank or building society, and this is taken into account in taxing the trustees.

Trustees of a discretionary trust generally have 'discretion' about how to use the income of the trust. They may be required to use any income for the benefit of particular beneficiaries, but the trustees can decide

• How much is paid and when
• To which beneficiary or class of beneficiaries payments are made.
• What, if any, conditions to impose on the recipients.

The trustees may, or may not, be allowed to 'accumulate' income within the trust for as long as the law allows rather than pass it to the beneficiaries. Income that has been accumulated becomes part of the capital of the trust.

Example

Anne puts money into trust, to be held for 20 years, for the benefit of her two grandchildren, Bob and Ray.

The trustees can decide how to invest or use the money and any interest it earns to benefit the grandchildren. So, when the children are young, the trustees might decide to pay for golf lessons for them. As they get older, the trustees might pay towards a wedding. After 20 years, the trustees wind up the trust and distribute all of the money to Bob and Ray.

How is a discretionary trust charged to income tax?

The trustees are liable to tax on the income received at the rate applicable to trusts (currently 40%), but dividends and other similar income are chargeable at the trust rate that applies to dividends (currently 32.5%).

All income paid to the beneficiaries carries a credit at the rate applicable to trusts. So, the payment is treated as if it had been made after the reduction of tax at that rate. If beneficiaries are basic or starting rate taxpayers, or non-taxpayers, they will be able to reclaim some or all of the tax paid. If they are liable at higher rates no further tax will be due.

If the trustees also have power to accumulate income, they can choose to do so and that income becomes additional capital of the trust. If, in later years, the trustees distribute some of the accumulated income to the beneficiaries the payment is a capital distribution, and not and income distribution. Beneficiaries are not taxable on capital distributions

An accumulation and maintenance trust is one in which the beneficiaries will become entitled to the property or at least the income when they reach a certain age (no more than 25). The trustees can use the income for the maintenance of the beneficiary before the date on which that beneficiary becomes entitled to the property of to an interest in possession in that property.

Trustees of an accumulation and maintenance trust are given power to 'accumulate' the income of the trust until a certain date, at which time the beneficiary, or beneficiaries, are entitled to the property of the trust or to the income arising from that property.

In England and Wales, the beneficiary (unless the terms of the trust say otherwise) becomes entitled to the income from the property held in trust when he or she reaches age 18 and interest in possession trust is created at that point.

Example

Phil puts money into an accumulation and maintenance trust for the benefit of his grandson Steve.

The trustees can make payments to Steve from the trust for his maintenance and will accumulate and remaining income. The terms of the trust give Steve the capital and any accumulated income at the age of 25. so on his 25th birthday Steve is entitled to all the money at that date.

How is an accumulation and maintenance trust taxed?

In the period during which the trustees can accumulate income, the trustees and beneficiaries are taxed in the same way as as discretionary trust, as described previously.

When the accumulation period ends, the tax treatment depends on what happens to the trust property. For example if

• an interest in possession trust is formed, then the tax treatment for trustees and beneficiaries of interest and possession trusts will apply.
• it becomes a discretionary trust, then the tax treatment for trustees and beneficiaries of discretionary trusts will apply.
• the trust comes to an end, and the trustees pass the trust property to the beneficiaries, the trustees may have to pay capital gains tax on any gain arising at that point, but will not have any liability on future income or gains.