Trust taxation and opportunities for Trustee Investment

1
Trust taxation and opportunities for Trustee
Investment
For financial advisers only
2
Trusts

• Objectives of a trust and types of trust
• How are they taxed?
• Investment/Planning opportunities

3
Objective of creating the Trust

• Destination
• Control
• Gifts to minors
• Appropriate access
• Taxation benefits

4
Types of trust
5
Types of trust

• Bare/Absolute
• Interest in Possession
• Discretionary

6
Bare Trust

• Use beneficiaries CGT allowances
• Use beneficiaries personal allowances
• Care re parental settlements 100 income rule
• IHT treatment age of beneficiaries?

7
Interest in Possession Trusts

• One or more beneficiaries entitled to income
• Capital payments determined by trustees
• No IHT liabilities on beneficiary of post 22
  March 2006 trusts

8
Discretionary Trusts

• Trustees have total control over distribution of
  both income and capital
• Complex IHT issues

9
New lifetime trusts

• Broadly a two way selection
• But which one is most appropriate?
• Rigid or flexible
• IHT friendly or not
• Simple or complicated
• Size of asset/policy/premiums

10
Individuals involved
11
Individuals involved

• Settlor/Donor
• Trustees
• Beneficiaries

12
Taxation of Trusts - Inheritance Tax
Type of Trust In Out Periodic charge
Bare/Absolute PET Free N/A
Interest in Possession CLT Exit charge Every 10 years
Discretionary CLT Exit charge Every 10 years
13
Creating a trust IHT considerations

• Order of gifting
• Multiple trusts

14
Order of gifting
15
Planning order for trusts

• Exempt transfers (eg most protection policies)
• Loans (including gift loan schemes)
• CLTs (eg discount schemes and retained interest
  trusts)
• PETs (incl. to bare trusts)

16
Planning order example

• Client uses annual exemptions elsewhere
• Wants to make direct gift of 200,000 to son
  (PET)
• Wants to create discretionary trust for
  grandchildren with 250,000 (CLT)

17
Planning order example PET first

• PET of 200,000 no initial IHT
• CLT of 250,000 no initial IHT
• Death after 4.5 years when NRB say 350,000
• No tax on failed PET but uses up 200,000 of NRB
• So tax on CLT

18
Planning order example PET first

• PET of 200,000 no initial IHT
• CLT of 250,000 no initial IHT
• Death after 4.5 years when NRB say 350,000
• No tax on failed PET but uses up 200,000 of NRB
• So tax on CLT
• Need to revisit Entry Charge for CLT

19
Planning order example PET first

• Aggregate of chargeable transfers 450,000
• Less NRB of 350,000 100,000 x 40 40,000
• Taper relief of 40 reduces tax to 24,000

20
Planning order example PET first

• Aggregate of chargeable transfers 450,000
• Less NRB of 350,000 100,000 x 40 40,000
• Taper relief of 40 reduces tax to 24,000
• Payable at this time by CLT

21
Planning order example PET first

• At 10 year anniversary of CLT Trust Fund worth
  500,000 and NRB (say) 400,000
• Periodic charge (500,000 200,000 -
  400,000) x 6 18,000
• Total tax (24,000 18,000) 42,000
• (And 200,000 (failed PET) aggregated for this
  and all future periodic charges)

22
Planning order example CLT first

• CLT of 250,000 no initial IHT
• PET of 200,000 no initial IHT
• Death after 4.5 years when NRB say 350,000
• No tax on CLT but uses up 250,000 of NRB
• So tax on failed PET

23
Planning order example CLT first

• Aggregate of chargeable transfers 450,000
• 450,000 less NRB of 350,000 100,000 x 40
  40,000
• Taper relief of 40 reduces tax to 24,000 (as
  before)
• Payable at this time by PET

24
Planning order example CLT first

• At 10 year anniversary of CLT Trust fund worth
  
• 500,000 and NRB (say) 400,000
• Periodic charge
• (500,000 - 400,000) x 6 6,000
• Total tax (6,000 24,000) 30,000 (a saving
  of 12,000)
• (as failed PET after CLT not included in this or
  subsequent periodic charge calculations)

25
One Trust or more ?
26
Policy structure

• Mr A applies for a Skandia Protect plan for a sum
  assured of 1million
• Plan is written as one policy
• The premium is 20,000 per annum
• He confirms he has made no CLTs in the last
  seven years
• The plan is assigned into a discretionary trust

27
Policy structure

• In ten years time consider for periodic charge
• Periodic charge based on market value of trust
  fund
• Is Mr A still in good health?
• Medical evidence obtained
• Market value of trust fund (say) 800,000
• If nil rate band (say) 400,000 periodic charge
  will apply

28
Using multiple trusts for protection policies

• Consider related settlement legislation

29
Using multiple trusts for protection policies

• Alternative structure at commencement

Each individual policy is assigned into a
separate trust on different dates
30
Using multiple trusts for protection policies

• Revised tenth anniversary periodic charge
  calculation

NRB 400,000 NRB 400,000 NRB
400,000 NRB 400,000
Assumed nil rate band in ten years
31
Taxation the continuing trust
32
Taxation the continuing trust
Nature of trust Income tax Bare
Beneficiary Interest
in Possession 20/22 Discretionary
40

• Care with UK dividends tax rate 32.5
• Settlor/Settlors spouse included

33
Basic rate band (applied from 6 April 2005)

• First 1,000 income per annum taxed at basic rate
  for all trusts
• Where income which has been taxed at source is
  less than 1,000 per annum, no further tax so
  self-assessment avoided

34
Taxation the continuing trust
Nature of trust Income tax
CGT Bare Beneficiary
Beneficiary Interest in Possession
20/22 40 Discretionary
40 40

• Care with UK dividends
• Settlor/Settlors spouse included
• Trustees receive annual CGT allowance of half
  normal allowance

35
CGT trust planning

• Rysaffe impact on CGT allowance
• Multiple trusts division of CGT allowance

36
Trustee Investment

• Investment/Planning opportunities

37
Investment by trustees

• Objectives of trust
• Taxation of trust
• Type of investment
• Tax status of beneficiaries

38
Investment by trustees

• Income?
• Capital appreciation?
• Mixture?
• Long/Short term?
• Risk profile?

39
Investment by trustees

• Role of trustees in investment decisions
• Trustee Act 2000

40
Trustee Act 2000

• Section 3 any kind of investment...if he were
  absolutely entitled...
• Section 4(3) standard investment criteria -
  suitable/diversification
• What does diversification mean?
  

41
Trustee Act 2000

• Section 5(1) must...obtain and consider proper
  advice
• Section 5(2) similarly when reviewing
• Section 5(4) proper advice of a person who
  is reasonably believedto be qualified to give it
  by his ability in and practical experience of
  financial... matters

42
Which investment vehicle?

• Collective
• Investment bond
• Equities

43
Taxation of UK dividends under a discretionary
trust
44
Trustee investment - UK equities

• Dividend 80.00
• Tax credit (1/9th) 8.89
• Total 88.89
• Income tax at 32.5 28.89
• 60.00

45
Trustee investment - UK equities

• Dividend 80.00 (after tax credit)
• Income tax 20.00
• 60.00

So how much can the trustees distribute?
46
Trustee investment - UK equities

• Dividend 80.00 (after tax credit)
• Income tax 20.00
• 60.00

Trustees can only distribute an amount which
equals 80 less 40 48.00 Balance of 12.00
paid to HMRC
47
Trustee investment - UK equities

• So beneficiary receives 48.00 net
• with a tax credit of 32.00

What are tax consequences for beneficiary?
48
Trustee investment - UK equities

• So beneficiary receives 48.00
  net
• with a tax credit of 32.00

Tax on 80.00 _at_ higher rate 32.00 Tax to pay
0.00 48.00 0.00 48.00 Effective tax rate
46.00
49
Trustee investment - UK equities

• So beneficiary receives 48.00 net
• with a tax credit of 32.00

Tax on 80 _at_ basic rate
17.60 Tax refund
14.40 48.00 14.40 62.40 Effective tax
rate 29.80
50
Trustee investment

• So is there an alternative to equities that will
  avoid this reduction?

51
Investment bonds
52
Trustee investment - Bonds

• Trustees own an onshore investment bond which
  receives a dividend of 80. The tax credit
  accounts for the insurance companys tax
  liability in respect of the dividend.

53
Trustee investment - Bonds

• Insurance company receives 80.00 net
• Tax on 80.00 _at_ Trustee rate (ie 20)
  16.00
• Net distribution 64.00
• Effective tax rate 28

Subject to any exit charge
54
Chargeable event gains

• Bonds in trust
• s.467 ITTOIA 2005

55
Chargeable event gains

• Bonds in trust assess settlor if alive and UK
  resident
• If not, UK trustees
• If not, UK beneficiaries

56
Single premium bonds - flexibility

• Trustee options
• 5
• Compare settlor/trust rate to that of beneficiary
• Trustees encash or assign to adult beneficiary
• Beneficiary encashes - gain assessed on
  beneficiary

57
Why a single premium investment bond ?

• Simplicity/Tax control
• Non-income producing asset
• The anti-avoidance provisions relating to
  settlements only apply to income and capital
  gains arising in the trust
• No fuss switching
• No problem re CGT and multiple trusts
• HMRC returns simplified/avoided

58
Structure of a portfolio

• Capital Gains Tax
• Low yielding unit trust
• Income
• Gilts/Corporate Bonds
• Capital Payments/income top up
• Investment Bonds

59
Summary

• Structure (eg Rysaffe)
• Order of gifts
• Interaction of investment opportunities and
  taxation

60
This presentation is based on Skandias
interpretation of the law and HM Revenue
Customs practice at October 2006. Whilst this
interpretation is believed to be correct, Skandia
can give no guarantee in this respect. This
presentation is only intended to provide a
general description of the Skandia products and
trusts. Further details of the products and
trusts can be found in the relevant technical
guides and Policy Terms, available from any
Skandia office.
61

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