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Settlor-interested trusts
Settlor-interested trustsWhat is a settlor-interested trust?A settlor-interested trust is one where the person who created the trust, the settlor, has kept for himself some or all of the benefits attaching to the property which he has given away. A straightforward example is where a settlor transfers assets to trustees for the benefit of himself and his family, and the terms of the trust allow income or capital from the trust assets to be paid to him.In certain circumstances the creation of a settlement would offer a tax advantage because, for example, tax will be deferred or the trustees will pay tax at a lower rate. Tax law operates to remove this advantage if the settlor has not effectively divested himself of the trust property.The term ‘settlor-interested’ arises in connection with income tax and capital gains tax. For inheritance tax, the creation of a settlement from which the settlor may benefit is categorised as a ‘gift with reservation’.This guidance note describes the primary provisions relating to income tax and capital gains tax, and provides links to other guidance notes dealing with more specialised provisions.Income tax ― the Settlements CodeSettlor-interested trusts fall within the ambit of the anti-avoidance provisions of ITTOIA 2005, ss 619–648, sometimes referred to as the ‘Settlements Code’. The effect of these provisions is, broadly, to treat the income arising from settled property as belonging to the settlor, rather than the trustees or other beneficiaries, thus countering any potential income tax advantage of placing the assets with a
Settlor-interested trusts ― calculations and compliance
Settlor-interested trusts ― calculations and complianceThis guidance note describes how the income of a settlor-interested trust is charged on the settlor in accordance with the provisions of the Settlements Code set out in ITTOIA 2005, Part 5, Chapter 5. See the Settlor interested trusts guidance note. The three categories of charge are:•on income arising under a settlement during the life of the settlor, from property in which the settlor has retained an interest•on settlement income paid to relevant (ie unmarried minor) children of the settlor, during the life of the settlor•on capital paid to the settlor by the trustees of a settlement (to the extent that it can be matched with undistributed income)General principles Under all three heads of charge, income tax is charged on a formal trust in the usual way, according to the type of income, at either standard rates or trust rates depending on the type of trust. See the following guidance notes:•Interest in possession trusts ― income tax•Discretionary trusts ― income taxNote however, that tax charged does not always enter a ‘tax pool’. See the different scenarios outlined below.The trustees must submit a trust and estate tax return SA900 giving full details of the trust income. The fact that the trust / settlor will be subject to one of the charges under the settlements code is indicated on the tax return as described below.The trustees must provide the settlor with details of the income to be charged and he declares
Tax on UK resident settlors of non-resident trusts
Tax on UK resident settlors of non-resident trustsWhere a UK resident settlor has created a non-UK resident trust, he may become personally liable to income tax or capital gains tax in relation to the trust’s income or gains, even if he does not receive a payment from the trust. The following legislative provisions levy a potential charge on UK settlors of non-resident trusts:•the settlements code set out in ITTOIA 2005, ss 619–648 imposes an income tax charge on settlors with respect to income arising within a ‘settlor-interested’ trust. The provisions apply equally to UK resident and non-resident trusts•the transfer of assets abroad code (TAAC) set out in ITA 2007, ss 714–747 imposes an income tax charge on settlors who may benefit from a non-resident trust as a result of a ‘relevant transfer’•TCGA 1992, s 86 attributes capital gains arising within a non-UK resident trust to settlors who have an interest in the settlement•TCGA 1992, s 87 imposes a capital gains tax charge on the settlor in relation to certain benefits received by himself or others. This applies principally (but not exclusively) to non-domiciled settlorsThere is a degree of overlap between the different provisions and the order in which they are listed above represents the order of priority to be applied. This guidance note outlines the application of each type of charge and provides links to more detailed material as appropriate.Significant changes to the domicile rules are to be made from 6 April 2025. The concept
Non-domiciled and deemed domiciled settlors
Non-domiciled and deemed domiciled settlorsSignificance of domicile for non-resident trustsThe extent of a trust’s liability to UK income tax and capital gains tax is dependent upon its residence status. Within the trust, the liability of a non-resident trust is restricted to UK source income. See the UK tax position of non-resident trusts guidance note.Since non-resident trusts may escape liability to UK taxation on their foreign income and gains, there are extensive anti-avoidance rules which charge UK residents who have created or benefited from them. These provisions and their application to UK resident and UK domiciled individuals are described in more detail in other guidance notes in this sub-topic. Their scope is so wide that the incidence of tax on UK domiciled settlors and beneficiaries of non-resident trusts is at least as burdensome, if not more so, than that of UK resident trusts.However, for non-UK domiciled settlors, there has been some mitigation from UK tax liabilities. Historically, individuals of foreign domicile who became resident in the UK have been able to avoid UK taxation by retaining their wealth within an offshore trust. By claiming the remittance basis of charge, a non-domicile could limit his UK tax liabilities to the income and gains he brings in to the UK. Meanwhile, if he chose a low tax jurisdiction for his trust, the non-remitted income and gains could accumulate virtually tax-free within the protection of the trust.Changes were introduced in 2008 to scale down some of the advantages of long-term non-domiciled status. The
Employee trusts ― implications of disguised remuneration and where are we now?
Employee trusts ― implications of disguised remuneration and where are we now?Employee benefit trusts (EBTs) are commonly used to support employees’ share schemes and to provide other benefits to employees. For example, EBTs were used to provide additional benefits where the previous reduction of the pension lifetime allowance resulted in employees having significantly less tax efficient pension provision than was intended. Many employers established employer financed retirement benefit schemes although the trusts were in fact an EBT that permitted the provision of retirement benefits. EBTs were also used to provide what was believed to be ‘tax efficient’ bonuses ― contributions to an EBT would be held for an employee’s (or a class of employees’) benefit. The EBT would either invest for the benefit of the employees, or more widely, the EBT would provide a loan to the employee. The employee would have the benefit of the loan and not suffer the tax liability of a payment made outright to the employee.The use of EBTs has been significantly affected by the introduction of the disguised remuneration rules. For further information, please see the Disguised remuneration ― overview guidance note. There are statutory exclusions from those rules to cover many of the share scheme-related activities of EBTs. However, providing loans or opportunities for wealth creation through long-term investment schemes, has declined due to the tax and NIC treatment as a result of the disguised remuneration legislation.Legislation introduced in Finance Act 2014 promoted employee ownership of companies. Employee owners who dispose of
Heritage property strategies
Heritage property strategiesWhere an owner has claimed, or is considering claiming conditional exemption on heritage property, he may also wish to consider whether or not to establish a heritage maintenance fund; the income and capital of which may be used to support the conditionally exempt heritage property.If, on the other hand, he decides that he or his descendants can no longer maintain the heritage property, he may consider disposing of the property by gift or sale to a charity or a body listed in IHTA 1984, Sch 3 or, alternately, to HMRC in lieu of tax.Maintenance fundsAs part of the policy to preserve national heritage property, heritage maintenance funds may be established. These settled funds, whose assets (usually not heritage property itself) and income are used for the maintenance of heritage property, receive advantageous IHT treatment. Transfers of property into a maintenance fund are exempt transfers provided the maintenance fund meets the qualifying conditions set out below. The property does not rank as relevant property for the purposes of the principal and exit charges under IHTA 1984, ss 64–65. Although a recapture charge will apply when the trust fund loses its qualifying status, it can be avoided provided that the property reverts to the settlor or is used for alternative heritage purposes. Qualifying conditions for a maintenance fundThe requirements of the use of capital and income in the maintenance fund are as follows:•in the first six years after establishing the trust, the fund must only be used for:
Disabled and vulnerable beneficiary trusts ― uniform definitions
Disabled and vulnerable beneficiary trusts ― uniform definitionsIntroductionIt has long been recognised that special concessions are appropriate where property is held in trust for the benefit of a person who is unable to manage his financial affairs. Broadly, these concessions aim to treat the trust property as if it was owned outright by the individual, instead of applying special trust tax rules to it.Concessions have been introduced piecemeal with the result that the qualifying definitions and conditions were not consistent and at times contradictory.The Finance Act 2013 (and, for Scotland, the Social Security (Scotland) Act 2018) introduced amendments across the board to the tax legislation dealing with trusts for disabled persons and other vulnerable beneficiaries.In summary, the amendments:•updated the definition of a disabled person and applied it to all the relevant provisions•harmonised the qualifying conditions for all such trustsSpecial trust provisions for disabled persons and vulnerable beneficiariesThe provisions which are affected by these definitions are:Inheritance tax•trusts for bereaved minors ― see the Trusts for bereaved minors guidance note•age 18–25 trusts ― see the Age 18–25 trusts guidance note•the four types of disabled person’s trust ― see the Disabled person’s interest guidance noteCapital gains tax•hold-over relief available to settlor-interested disabled person’s trust ― see the Holdover relief for disposals by trustees guidance note•trust for a disabled person entitled to the full annual exemption ― see the Basic principles of CGT for trusts guidance note•special CGT treatment for vulnerable beneficiary trusts ― see
Discounted gift schemes
Discounted gift schemesDiscounted gift schemesThese types of scheme are particularly suitable for those who have available liquid assets which can be realised without incurring any substantial tax liability (such as capital gains tax). In essence, the money is transferred into the scheme with the tax payer retaining a right to a pre-determined series of cash payments during his or her lifetime. Whatever else remains in the scheme at the time of his death is given away at the outset to his or her children or grandchildren or other beneficiaries. Therefore, there is a lifetime gift to those beneficiaries but the value of it is discounted to take account of the value of the right retained by the tax payer.The schemes are usually operated by life insurance companies with the funds invested in a single premium investment bond. This structure is ideal for an arrangement where the pre-established return is to be paid back to the person setting up the scheme, because the legislation relating to single premium bonds permits up to 5% of the initial premium paid to be withdrawn tax free each year for 20 years (a return of capital). See the Life insurance policies guidance
Appointment of trustees ― legal aspects
Appointment of trustees ― legal aspectsThis guidance note explains the legal requirements for who can act as trustee, the number of trustees that can be appointed and how trustees are appointed. Trustees should be appointed by deed and writing deeds is a reserved legal service under the Legal Services Act 2007. See the Reserved legal services guidance note. Therefore, a lawyer will need to be instructed to appoint a trustee.This note deals with appointment of trustees only. The removal and retirement of trustees is covered in the Changing trustees guidance note. For practical advice on choosing a trustee, see the Appointment of trustees ― practical considerations guidance note.This guidance note deals with the position in England and Wales only. See Simon’s Taxes I5.8 for details of the provisions affecting Scotland and Northern Ireland.Who can act as trustee?Acting as a trustee is a serious undertaking which imposes significant fiduciary duties on the person accepting the role and should not be accepted lightly. The Trustees’ powers and duties guidance note sets out the duties of a trustee. This guidance note considers whether someone can undertake the role. See the Appointment of trustees ― practical considerations guidance note for considering whether someone should undertake the role.Any person who has capacity to hold property can act as a trustee. This disqualifies certain groups without capacity from trusteeship.MinorsMinors are those under 18. Minors cannot be appointed as trustees in England and Wales and any appointment would be void. Lack of mental capacityA person who
Transfer of assets to beneficiaries ― legal, administration and tax issues
Transfer of assets to beneficiaries ― legal, administration and tax issuesThis guidance note outlines how assets are transferred to beneficiaries and the tax consequences that flow from the transfer. Whether a payment is income or capital is discussed in the Payments to trust beneficiaries guidance note.This guidance note is designed to give outline and background for accountants and tax advisers who deal with clients establishing trusts. It is not targeted at lawyers.This guidance note deals with the position in England and Wales only. See Simon’s Taxes I5.8 for details of the provisions affecting Scotland and Northern Ireland.Three issues to consider when transferring assets to beneficiariesTrustees may decide to exercise their powers by appointing assets to a beneficiary. There are three key issues that need to be considered when making or considering such a transfer:•how they must document the exercise of their powers•the formalities that should be complied with to transfer the asset•the tax consequences of the transferDocumenting the exercise of the trustees’ powersThe deed may require the exercise of the trustees’ power to be documented by deed. If no deed is required then the trustees decision and actions can be recorded by a written resolution. However, it is important that the correct documentation is prepared. If an appointment requires a deed but is made without one then the appointment is void.A deed should be used where the trustees require an indemnity for tax or other expenses.Preparing deeds is a reserved legal service and is regulated by
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