girl walking along rocks

Do trusts still serve a purpose?

Richard Bull, Partner, Private Clients,
girl walking along rocks
HMRC Trust statistics continue to show a decline in the number of existing Trusts and ones being formed. This is unsurprising given the impact of the 2006 tax changes. While Trusts may have fallen out of favour, should they be consigned to history just yet?

The old regime and the 2006 changes

Until 2006, it was possible for families to create certain Trusts to pass wealth down generations without upfront inheritance tax (IHT) charges.

Known as ‘accumulation and maintenance Trusts’, provided beneficiaries took certain benefits by age 25, in addition to no upfront IHT charges, these Trusts benefited from a simple tax regime that did not impose ongoing 10 yearly tax charges.

Such Trusts were often used to safeguard wealth for minors, with income being controlled by Trustees, but flowing directly to beneficiaries once capable of handling their own finances. This changed in 2006, with the majority of new Trusts being subject to the ‘relevant property regime’. 

This regime imposes a 20% entry charge on additions to a Trust in excess of a person’s tax free nil rate band of £325,000, and also means the Trustees become liable to 10 yearly tax charges on the value of the Trust fund and when funds exit the trust.

For many, these changes were too much to bear and Trusts fell out of favour.

The alternative?

Family investment companies (FICs) have become a popular choice, largely due to the absence of an entry charge and the lack of ongoing IHT charges under the relevant property regime. The other attraction is that clients tend to be familiar with limited companies as many entrepreneurs trade through that medium already. 
With suitable guidance, a company can echo many of the hallmarks of a traditional Trust; directors stand in the shoes of Trustees and shareholders as the beneficiaries, allowing directors to manage the company assets on the shareholders’ behalf. 

Furthermore, with suitable articles of association (the company rulebook) and a well-drafted shareholders agreement, directors can control the payments made to shareholders.

In addition to no upfront entry charges, due to the differing tax rate (FIC 19%, Discretionary Trust 45%), a FIC can enable wealth to be rolled up and the compounding effect of the different tax rates over time can be dramatic. In most circumstances dividends received by a FIC are not taxed.

Will this regime continue if we have a change of government?

A large part of the attraction to FICs is its ongoing tax efficiency due to the lower rate of tax on income and no tax on dividends. The current tax rate (19%), which is due to reduce in April 2020 to 17%, has not always been this low. In 2010, the main rate was 28%, so the current low rates may not last.

With the prospect of an imminent General Election, it is worth considering what impact a change of government might have.

While the Conservative party would likely make no changes, it being the brainchild of previous chancellors, Labour has previously announced they are committed to increasing corporation tax. In its 2017 manifesto, Labour stated it would look to increase the tax to 26%. 

While a 26% rate is still favourable compared to a 45% headline rate in a Trust, the difference is further reduced when the secondary tax charges on distributions are considered.


  FIC Discretionary Trust Discretionary Trust 
£  £ 
Dividend income  10,000  10,000 
FIC/Trust tax  Nil* (4,500)** 
Net retained for re-investment or distribution 
10,000   5,500 
Cash distribution  10,000 5,500
Tax on receipt  (3,048)***  Nil**** 
Net funds 6,952 5,500
1,452 or 14.5%   

* Assumes dividend receipt not liable to corporation tax.
** Actual rate of tax on dividends is 38.1%. However 45% used due to technicalities of ‘franking’ income distributions.
*** Assumes received by 45% taxpayer paying 38.1% after £2,000 dividend allowance.
**** Assumed received by 45% taxpayer so no reclaim of franking credit is possible.

Even though net funds received could vary depending on what changes occur to tax legislation, the 20% entry charge remains a key discrepancy between the two.

The stigma around Trusts and regulatory changes

There is a misguided perception that Trusts are just a tax avoidance tool but, as the statistics show, the majority of Trusts have relatively modest income. With the introduction of FATCA, CRS and recently the Trust Registration Scheme (TRS), the compliance burden hits these Trusts the hardest.
HMRC’s statistics report that 149,000 Trusts were created in 2017/2018 but, as of March 2019, only 107,500 were registered under the TRS. Therefore, a large number of Trusts are either late registering or do not yet meet the TRS criteria.
Given that the latest incarnation of the MIFID rules are set to extend the scope of TRS to all Trusts, a large number of Trusts which historically may have had no compliance requirements may be caught. 
Although TRS was introduced in 2017/18, the system is still in its infancy. Crowe is liasing with HMRC to update the system but, given the delays to date, it may be some time before the system can handle the increased volume.

Comparing this landscape to the corporate equivalent of Companies House filings is difficult. The advent of the PSC register did introduce some additional filing requirements for UK companies but, compared to TRS, there is a robust system in place to continue to handle filings and paper forms.

Unlike Trusts, there is no stigma attached to companies. Most of the UK’s household names are companies and, while some may have made headlines for their tax policies, they are not all tarred with the same brush.
Do Trusts still serve a purpose?
Despite losing out to FICs in certain circumstances, Trusts still have many benefits. As Trusts are set up for a class of beneficiaries, it is easy to include future generations. Trustees can also add and remove beneficiaries and choose which beneficiaries benefit and to what extent; giving more flexibility to respond to future unknowns.
A well-drafted family Trust could be used to educate grandchildren, or even great grandchildren by paying for school fees or a university education. Alternately Trust capital could be used to assist beneficiaries with stepping on the property ladder. 
The flexibility allows different approaches, which is much harder to replicate in FICs, where only shareholders benefit and other tax consequences need considering when shares are moved between family members.

A real life example

Trusts can come into their own when dealing with succession issues for owner-managed businesses. 
For some, the family business is the most valuable asset. Usually there is a desire to split family wealth 50:50, such as seen with family homes. With a family business, splitting down the middle is more difficult and can cause conflict regarding when to sell and who benefits from future growth in value if, for example, one sibling is doing the majority of the work. 
A further difficulty comes when considering the payment of dividends. If all the shares are the same class, any dividend must be consistent between shareholders. In some circumstances, the business will be able to facilitate a purchase of own shares or some other buyout to ensure the child not involved in the business can take cash. 
Even in these circumstances there are difficult decisions to be made as to whether 50% of a business worth, say, £2 million is £1 million, or should it be discounted? Businesses unable to finance a buyout can be left with two 50% shareholders in deadlock which can cause viable businesses to go under.

A solution – a flexible family Trust

If shares are left to a flexible family Trust, the tax position would be no different to leaving the shares directly to the children.
The Trust could be set up to serve for several generations if needed, but its initial focus is on holding the family business interest. While the children may be Trustees, it may be easier for impartial family members or specialists (accountants/solicitors) to take up the mantle, removing personal self-interest. 
In order for the Trustees to understand the purpose behind the Trust, a letter of wishes is advised to provide context to aid decision making.
The reason why a Trust can work well in these scenarios is that it enables separation of income and capital.
The Trustees could decide that the sibling not involved in the business is due a dividend of, say, £30,000 each year being a return on their 50% share of the capital. However, the Trustees could decide to pass on a dividend of £70,000 to the sibling involved, to reflect the value they are adding beyond their basic return.
Set up correctly, the tax treatment on the dividends can be the same as if the shares were owned directly by the children. This allows each child to take an annual return that could be considered ‘fair’, relative to their involvement in the business.
Then, when deemed time to sell, the offer can be accepted by the Trustees, who can then determine whether to end the Trust and pay out the sale proceeds.
Should they decide this, the Trustees can determine how to split it. If the business has not grown significantly in value, the proceeds may be split 50:50. If, however, the child involved has grown the business so it sells for say, £4 million, the Trustees may split the proceeds to reward those efforts.
With prior planning, it is possible to structure things so that the Trustees are eligible to claim 10% Entrepreneurs Tax rate on the sale proceeds.
This flexibility means that Trusts are often an excellent way of holding onto the shares as custodian to benefit multiple family members without burdening the business with different shareholders with dissenting views.
country side road


The traditional Trust may lose out in a number of ways compared against a FIC; it can pay more income taxes and there can be entry tax charges and ongoing 10 yearly tax charges.

However in some circumstances the flexibility offered by a family Trust can mean it is still the right tool for the job.

When dealing with assets that are eligible for certain tax reliefs (such as family businesses), the entry charge and ongoing 10 yearly tax charges can be mitigated to eliminate many of the negatives.

For some clients, the right answer is often a combination of the two; a family investment company within which the wealth is invested but to enable benefits to be passed onto future generations; a number of the shares are placed into a family Trust.

So while the number of new Trusts may be falling, they still have much to offer the informed client and advisor.

Time for an overhaul?

The statistics show that just over 60,000 Trusts have income of £10,000 or less. With the current complexity of the UK tax system, the compliance costs for such Trusts are often a large proportion of their income. Given the increasing vulnerability of the youngest members of our society to online fraud, Trusts still have an important role to play. Is it time that the rules were overhauled to offer genuine simplicity? For example, such Trusts could be exempted from income tax to remove the need to report annually. However whenever any funds were distributed, they could then be taxed on the beneficiary at that time. This simplification would also allow HMRC to better target their limited resources on the more complex Trusts.

This was first published in FT Adviser in November 2019.

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Richard Bull
Richard Bull
Partner, Private Clients