Trusts and tax

As advisors, we are bound to say Trusts are a fantastic thing. Asset protection is a great way of sharing income around the family, and a potentially Inheritance Tax (IHT) efficient store of value. Many clients have found a place for them in their business, but there can also be a reluctance to take the plunge. This article talks about why, in the right circumstances, you should.

Income and capital sharing

During lifetime, a trust offers a great opportunity for income and capital sharing. 

• On the income side, a senior family member receiving £10,000 of dividend income, who is paying higher rate income tax at 33.75% each year could route the same income through a trust to a junior member of the family who has a full personal allowance, paying no tax. This generates a saving of more than £3,000. 
• On the capital side, a trust can appoint assets standing at a gain to a junior family member before it is sold, accessing their capital gains tax annual exemption. In the 24/25 tax year this is equal to £3,000 of tax-free gains, saving up to £720 versus a higher rate taxpayer paying 24% tax.

Inheritance Tax planning

Many unlisted trading companies will qualify for 100% business relief and therefore may not be of major concern for IHT purposes, as this relief reduces their IHT value to nil.

However, companies with surplus cash, investments, or which are potentially going to be sold or liquidated, can be dragged into the IHT net at 40%.

Transferring shares into trust not only banks the business relief at the time of transfer, but also freezes the value of the shares at that time, which will be relevant if values are expected to increase. 

• For example, a family member holding 20% of a trading company which may be sold over the next few years. The undiscounted value of their shares might be £1 million, but with a minority discount, these shares might be valued at £500,000. IHT is not an immediate issue as business relief applies, but the shares are sold for cash, a 40% exposure on the full value arises immediately because the minority discount is lost, and the cash does not qualify for business relief. 
• Instead, the shares might be transferred into trust before a sale. The transfer benefits from business relief therefore avoiding any immediate lifetime IHT. It also freezes the value in the transferor’s estate at the discounted value. If a sale is delayed and the shares remain in trust for 10 years while continuing to qualify for business relief, the trust will benefit from a further 10 years of IHT exemption even if the company is sold.

Asset protection

Once the shares are in trust they are more easily kept out of the reach of any perceived hot-headed beneficiaries, creditors, or a marital breakup. The Trustees, with discretion, can exercise complete control over who gets what. This could be a good incentive to keep family members on track.

Downsides

The main perceived downside of trusts are complexity, cost, and potential for conflict if beneficiaries feel they are not being treated fairly.

In practice, and in the right circumstances, the tax savings can significantly outweigh the costs. Complexity can be kept to a minimum by setting up a structure that can be managed within the family without significant external involvement (e.g. by mandating income to beneficiaries and keeping Trustees within the family).

The fairness issue is ultimately a question for the Trustees, but with openness and the backing of a Family Charter or council, there is no reason why a trust should be any more disadvantageous than a direct shareholding.

Next steps

Setting up a trust does need professional advice, and there are potential tax charges to consider, many of which are negated in the family and owner managed business environment with the correct claims. Where they don’t work, families might consider a Family Investment Company (FIC) or partnership as an alternative. You can read more about Trusts on our Family Investment Companies insight.

Please get in touch with Nick Latimer or your usual Crowe contact to discuss trust planning further.