Trusts - down but not out

A recent paper published by HMRC documents a steady decline in the number of trusts required to complete a full self-assessment tax return. Many commentators have taken these figures as showing a fall in in the use of trusts by individuals for inheritance tax mitigation and succession planning.

In some respects, they are not wrong. A combination of the government's 2006 attack on accumulation and maintenance trusts, by removing their inheritance tax exemption after 18 years, and the introduction of the transferable nil-rate band in 2007, have both played their part in reducing the use and attractiveness of trusts.

Steady decline

While the changes have meant that trusts for children and young adults pay more tax, they have not necessarily dampened the wish of testators to delay the payment of capital to their children beyond the age of 18. I rarely encounter a testator when drafting a will, who is happy for their children to inherit at 18, rather than pay a maximum 4.2 per cent inheritance tax charge on capital above the nil-rate band at the age of 25.

However the 2006 changes have made the setting up of lifetime trusts for children less popular, as the relevant property regime taxation is punitive. This has led to the increased use of bare trusts.

While bare trusts have no exit or anniversary charges, and the income tax rate is based on the rate of the beneficiary when they are over 18 (or when the trust was not set up by a parent) they offer neither control nor protection when a beneficiary is over the age of 18. This is because the assets can be accessed by the beneficiary when they are no longer minors.

The 2007 transferable nil-rate band has, without doubt, had a very real impact on the number of trusts set up through a will. Before October 2007, the nil-rate band discretionary trust was common place in most professionally drafted wills, as it was the main way to guarantee the full use of both of a married couple's nil-rate bands. This meant that even in modest estates, discretionary trusts were being used to mitigate inheritance tax.

The transferable nil-rate band now allows couples in a marriage or civil partnership to use the first to die's nil-rate band, without the need for a trust on first death. This has allowed the drafting and execution of wills to become far simpler, and has reduced the need for trusts.

The key now is to make sure that the nil-rate band is preserved for the second death. The transfer is the percentage of unused nil-rate band, rather than the actual cash amount of the unused band. Individuals should minimise legacies to non-exempt beneficiaries on the first death. Instead the survivor could gift money and then rely on the seven year survival rule.

With some of the more common trusts losing their attractiveness and necessity, it is not surprising that HMRC is seeing a decline in numbers completing a tax return. The decline is also explained by trusts with low income or, because those just holding capital assets no longer need to report to HMRC on an annual basis.

Discretionary trusts can however be a useful tax planning tool for assets that attract agricultural and business property relief. For example, for the transfer of farm land that may see future development. If the development does happen, then the growth in value is within the trust rather than an individual who would then have an inheritance tax responsibility.

Another example is the transfer of a family shareholding to keep voting rights intact, meaning that any proceeds of sale is out of the beneficiaries' absolute ownership. In both examples, trusts can also help to keep the assets together and protect against a divorce, misadventure or bankruptcy.

Unfortunately trusts have had a rough time of it over the last few years, both as a result of government legislation and due to the public's perception that they are only for the rich and privileged. It is unlikely that future legal changes will make this any better.

However they still have a key part to play in protecting assets for future generations, especially when the settlor or testator wants to retain control over their assets after the gift, or their death. 

James Ward is a partner at Seddons