Kirsten Franklin presents a back-to-basics guide on running trusts, and the compliance aspects to be aware of
Trusts can be established in a settlor’s lifetime by deed, or on their death by will or intestacy. On commencing the administration of a trust, it is important to establish what type of trust you are dealing with, what tax treatment applies, the powers and duties of the trustees, the assets comprised in the trust, relevant key dates, and the identities of all the interested parties.
What type of trust is it?
There are many types of trust arrangements and some trusts may have an element of more than one type. There are three types of trust most commonly encountered in day-to-day private client work.
Assets are held in the name of the trustees, with the beneficiaries absolutely entitled to both income and capital.
The life tenant is entitled to the trust’s income or to live in a trust property during their lifetime. On the death of the life tenant (or some other specified event), the capital of the trust passes to other beneficiaries (the remaindermen).
Assets are held in the names of the trustees, who have the power to decide (in accordance with the terms of the trust) who (from a pool of potential beneficiaries) benefits, at what time and how.
The following is a non-exhaustive list of key dates that should be diarised:
- annual trustees’ meeting
- annual investment review
- property insurance expiry dates and inspections
- vesting dates
- expiry of accumulation period
- 10-year anniversary date for relevant property trusts
- deadline for submission of annual tax accounts
- review of income payments
- contact with life tenant
- review / update information for the trust’s records and the Trust Registration Service (TRS) via the Government Gateway.
Income tax and capital gains tax
Trustees are usually responsible for the payment of income tax. The type of trust dictates how the income is taxed.
In discretionary trusts, the first £1,000 of income is taxed at the ‘standard rate’ – 7.5% on dividend-type income and 20% on all other income. Income over £1,000 is taxed at the ‘trust rate’ – 38.1% on dividends and 45% on other income.
If the trust is settlor-interested (where the settlor, settlor’s spouse or settlor’s minor children can benefit), all income is taxed at the rate applicable to the settlor.
The deadline for submitting a paper return is 30 October of the year following the end of the tax year, or 31 January for online submission.
In interest-in-possession trusts, it is possible to mandate income from the trust to a beneficiary, so that it is treated as being taxed in the hands of the beneficiary and not the trustees. Clear documentary evidence of the mandate should be kept.
The trustees should issue tax certificates following any distribution showing details of the income tax paid, so that any rebates can be claimed.
Capital gains tax (CGT) is charged on sales and, in some circumstances, when assets are transferred out of the trust. The rate of CGT that applies to trustees is 20% or, on the disposal of residential property, 28%. The trustees have an annual tax-free allowance (£6,150 for the 2020/21 tax year).
On the sale of a property after 6 April 2020, should a gain be made that needs to be reported within 30 days by a beneficiary, you must provide them with the requisite information to report and pay the tax.
Broadly speaking, there are two tax treatments applicable to trusts – those that fall within the relevant property charging regime (RPCR), and those that do not. Also, as bare trusts are usually transparent for tax purposes, they are taxed as if the beneficiary owned the assets.
Some trusts will have elements that fall into different regimes. The tax treatment of the trust should also be re-evaluated at key dates (such as a minor beneficiary reaching the age of 18 in a 18-25 trust).
Ten-year anniversary charges and exit charges may apply under the RPCR, depending on the value of the trust in relation to the nil-rate band (NRB). It is important to review existing trusts on a regular basis to check their value has not increased over time so that they now exceed the NRB.
Inheritance tax reporting (IHT) should be completed on form IHT100 with the appropriate event form.
The trustees are the persons or trust corporation named by the trust deed and any subsequent deeds of retirement and/or appointment. The trustees of any statutory trusts arising out of an intestacy will be the personal representatives (PRs).
Note that for will trusts where the executors are also appointed as trustees (as is often the case), if an executor does not prove the will or renounces their executorship, it does not mean that they are not a trustee of any trusts arising out of the will: they must formally retire or disclaim their trusteeship by deed.
Usually, trustees must make unanimous decisions in relation to any trust matter.
Changes in trustees should be properly documented by a suitable deed which is drafted in accordance with express powers provided for by either the trust deed or statute (sections 36 and 39 of the Trustee Act 1925 usually being of most relevance).
The trustees should ideally have no interest in the trusts and be able to act independently, fairly and in the best interests of all the beneficiaries
A suitable indemnity should be included on any trustee’s retirement.
The trust deed may provide that the consent of a particular party (for instance, the settlor) is required, and they should be made a party to the deed.
Should a trustee die while in office, a copy of the trustee’s death certificate should be obtained for the trust’s records. If that person is the sole trustee, their PRs would take on the role of trustee.
Best practice would be to always ensure a minimum of two trustees are appointed (unless a trust corporation is appointed, which may act alone), up to a maximum of four (this maximum does not apply to charitable trusts). Having a minimum of two trustees:
- ensures that, for trusts of land, the trustees can overreach the beneficial interest
- means that in case of one trustee’s death or mental incapacity, another is available to act, and
- helps to ensure decisions taken are not affected by one trustee’s bias.
Thought should also be given as to the most appropriate trustees. The trustees should ideally have no interest in the trusts and be able to act independently, fairly and in the best interests of all the beneficiaries.
A professional trustee may be appropriate in matters where there are complexities, difficult family situations or high-value assets, for instance.
When acting as a professional trustee, check the terms of the trust for any fee-charging clause or the powers under the Trustee Act 2000.
The trustees’ powers will either stem from the trust document itself or be contained in statute. Care should be taken to ensure that the trustees act within the powers available to them. For instance, the trustees may have the power to apply income, but not to take capital out of the trust. Should the trustees act outside the scope of their powers, they may be personally liable to the trust and its beneficiaries.
Decisions taken in relation to the trust should be suitably documented. It is worth noting that it is not always necessary or prudent to provide reasoning in relation to the exercise of discretionary powers.
You should ascertain what the trustees wish to do, locate the relevant power allowing them to do that and consider logistically how it is best actioned.
As with the trustees, you should ensure that you have suitably identified all the beneficiaries and obtained the necessary identification documents for the trust’s records. This information should be reviewed on a regular basis. Any changes may also need to be recorded with the TRS.
Assets and trust accounts
Clear records should be maintained showing the trust assets. The trustees have a duty to produce annual accounts, which should include:
- the starting position of the trust at the beginning of the trust year (that is, value of the assets and any liabilities)
- changes in assets (such as sales of investments or trust property)
- capital gains / losses
- tax liabilities
- professional and legal fees
- the closing position.
Trustees have a duty to obtain annual investment advice from a qualified independent adviser to ensure that the investment profile and strategy for the trust remains suitable. Investment advice should also be sought in light of any relevant changes of circumstance specific to the trust or external factors.
For trusts comprising land or property, trustees should ensure there is suitable insurance in place. The duty to insure may lie with the trustees, or the person / party who has the benefit of that property (such as an occupying life tenant or commercial tenant under the terms of their lease). Even if insurance is not directly arranged by the trust, the trustees should ensure the appropriate person has suitable insurance in place, and that the trustees’ interest is noted on it.
Given the many obligations placed on landlords of tenanted private or commercial properties, in most situations the trust should employ an agent to ensure all formalities are being met, or to seek the appropriate legal advice.
It will be necessary to inspect any trust property at suitable intervals. Again, this can be delegated to an agent. Trustees must ensure that any property is being looked after and actively take steps to prevent any damage being caused.
Compliance and reporting
Trust Registration Service
Following the implementation of the Fourth Anti-Money Laundering Directive in 2017, obligations were imposed on trustees to keep and maintain records detailing information on express trusts, their beneficial owners and the beneficiaries. Should that trust be liable to pay tax, the trust had to be registered with the TRS.
On a new tax liability arising, the trust must register with the TRS by 5 October following the end of the tax year.
The recent introduction of the Fifth Anti-Money Laundering Directive greatly broadened the scope of trusts that must be registered with the TRS. All express trusts will have to register (taxable or not), unless they are expressly excluded.
Schedule 3A to the Money Laundering, Terrorist Financing and Transfer of Funds (Information on the Payer) Regulations 2017 sets out the exclusions. These include statutory trusts arising on an intestacy, trusts of a life / retirement policy, charitable trusts, will trusts only holding property (where that property was comprised in the deceased’s estate), personal injury trusts and trusts for a disabled beneficiary.
It should be noted, however, that the exclusion for will trusts is only for two years. If the trust is not wound up within two years, the trust must be registered.
The deadline to register any existing trusts which are now registrable following the changes is 10 March 2022. After this date, trusts will have to register within 30 days of becoming registrable.
Foreign account tax compliance
The Foreign Account Tax Compliance Act (FATCA) is legislation introduced by the US government to help counter tax evasion by any person liable to pay tax in the US.
Under FATCA, any person liable to pay tax in the US should report any monies they receive from a “foreign” account (see below) to the US equivalent of HM Revenue & Customs (HMRC) – the Internal Revenue Service (IRS). In addition, UK “foreign” entities have a duty to report to HMRC (which in turn reports to the IRS) with details of any distributions made from trusts to any person who is liable to pay tax in the US. This dual system of reporting ensures that no US person evades paying the necessary tax to the US government on monies they receive originating from outside the US.
FATCA is applicable to trust arrangements and, as such, trustees must consider whether they have to register for FATCA.
Registering for FATCA
When administering a trust, first you will need to consider whether the trust is a “foreign financial institution” (FFI) or a “non-financial foreign entity” (NFFE).
As the legislation originated in the US, it is important to remember that the UK is “foreign” when considering trusts in terms of FATCA.
FFIs must register for FATCA, while NFFEs do not have to. However, NFFEs will need to provide the FATCA status of their “owners” (a misnomer, referring, depending on the context, to settlors, trustees, protectors and/or beneficiaries).
You do not necessarily have to be currently resident in the US to be liable to pay tax
Whether a trust is an FFI can depend on both the identity of the trustees and the assets it contains. It does not depend on the tax-residence status of any of the beneficiaries (this only affects whether a report has to be made).
The FATCA legislation contains an extensive definition of an FFI and some trusts are included. If the trust is registrable for FATCA, you will need to obtain a global intermediary identification number (GIIN) via the FFI registration service.
If the trustee of the trust is itself an FFI, the trust will, by definition, be an FFI. In this instance, the FFI trustee obtains one GIIN which covers all the trusts of which it is a trustee.
Once you have established the FATCA registration status of the trust, consider whether you need to make any reports to ensure FATCA-compliance.
You will need to report if one of the beneficiaries of the trust is a “reportable person”. For FATCA purposes, that means that they are liable to report and pay taxes in the US. It is important to note that you do not necessarily have to be currently resident in the US to be liable to pay tax.
In order to establish the tax status of your beneficiaries, you should ask them to confirm in writing:
- their tax residence status (you can be resident for tax purposes in more than one country)
- their National Insurance number and any other tax identification numbers
- whether they are a US person for tax purposes
- their place of birth
- their place of domicile.
For FATCA purposes, non-US status can be confirmed by completing IRS form W8-BEN for individuals or W8-BEN-E for entities. Should any beneficiary advise you that they are liable to pay tax in the US, they will need to complete IRS form W-9.
If a reporting duty arises on the trust, you will need to provide information to HMRC annually, the deadline for which is 31 May. You will need to register to return the information (known as an automatic exchange of information (AEOI)) at least 24 hours before the deadline.
Common Reporting Standard
The Common Reporting Standard (CRS) was developed in 2014 by the Organisation for Economic Cooperation and Development in response to the G20’s request for greater exchange of information between jurisdictions. The CRS provides for AEOI between countries to ensure tax compliance by their residents in relation to funds received from other jurisdictions. For the most part, the CRS adopts the same rules and definitions as FATCA and is applicable to trust arrangements.
Whereas FATCA only applies to persons with US tax-residence status, the CRS applies to tax residents for all signatory countries (currently approximately 110).
Practically, the trust’s CRS reporting duties can be considered at the same time as its obligations under FATCA. The beneficiary information required by FATCA (as outlined above) will also cover the details to consider if the CRS applies.
CRS reporting is made through the Government Gateway. The deadline for annual reporting is also 31 May.
French wealth tax reporting
Should the settlor, or any of the trust’s beneficiaries or trustees be a French resident, the trust will also have additional reporting duties to the French tax authorities, outlined in article 1649 AB of the French Tax Code.
An annual report must be made by 15 June each year, providing details of the terms of the trust, relevant parties, assets and value of the trust (as at 1 January).
An annual report will also be required by the French tax authorities, if any assets, rights or income are located in France, even if all parties to the trusts are non-resident.
In addition to the annual reports, event reports may also be required by the French tax authorities within 30 days of a specific trust event occurring (such as a distribution of trust assets).
Any failure to comply with the reporting obligations imposed by the French tax authorities may give rise to stringent penalties, such as a €20,000 fine per non-filed return.
Given the above, should you be administering any trust where there is a French aspect, seek proper advice on the reporting responsibilities at the outset from an appropriately qualified French tax adviser.
Having a key-date system in place and keeping accurate records will ensure the trust administration runs as smoothly as possible.
A common-sense approach should be effective for most issues. It is important, however, to understand when to seek expert advice, with the cost of doing so being legitimately borne by the trust fund.-