Types of trusts
This article discusses the features and tax implications of the various types of trusts.
Nominee or "bare" trust
In a nominee or "bare" trust, the beneficiary has an absolute right to the capital and income held on trust, and the trustee has no discretion in his handling of the trust assets. From a tax perspective, bare trusts are essentially ignored, and the beneficiary pays income tax on the asset's income and capital gains tax on its disposal as if he or she were the direct owner of the asset.
If a person makes a gift of an asset into a bare trust, then the beneficiary is liable to pay inheritance tax if the person making the gift dies within seven years of the date of the gift (the amount of tax being on a sliding scale, which goes to zero after seven years).
A discretionary trust is, in a way, the opposite of a bare trust. In a discretionary trust, the trustees decide how the trust's income is to be used and how income and capital are to be distributed amongst the beneficiaries. The amount of discretion the trustees have is spelled out in the trust deed (the document that creates the trust).
In many discretionary trusts, the trustees are allowed to accumulate income in the trust. Years may go by during which some or all of the income the trust assets earn is kept in trust rather than paid out to the beneficiaries.
From a tax perspective, a discretionary trust is almost like a special holding company, run by the trustees for the benefit of the beneficiaries. The trustees have to file separate tax returns for the trust and pay tax on income and capital gains realized by the trust.
Interest in possession trust
An interest in possession trust lies somewhere between a bare trust and a discretionary trust: It is characterised by a beneficiary enjoying the right to possess all of the income (the "interest in possession") from a trust asset.
Often, interest in possession trusts give one beneficiary the right to the income from an asset and give another beneficiary the right to receive the asset itself on the death of the first beneficiary. (In these cases, the first beneficiary's right to income for life is called a "life interest".)
Accumulation and maintenance trusts
Accumulation and maintenance trusts are trusts set up prior to 2006, which were structured to benefit young people and secure certain tax advantages.
The trusts pay income to the beneficiaries until they reach a specified age, say 18. Upon coming of age the beneficiaries receive both the trust assets and the income.
On 22 March 2006, new rules governing the trusts took effect. These stipulate that the trusts (i) can no longer be created and (ii) those created before 22 March 2006 have to comply with more stringent conditions in order to benefit from continuing favourable tax treatment.
An accumulation and maintenance trust created today will be taxed as a "relevant property trust."
Relevant property trust
"Relevant property trust" is more of a tax classification than a functional trust classification. Most trusts will, for tax purposes, be classified as relevant property trusts unless they fall within one of the exception categories (see below). For most people, the most relevant exceptions are trusts created to benefit disabled persons, and certain trusts created on death, including trusts created for bereaved minors and "18 to 25 trusts".
Relevant property trusts are liable to inheritance tax. If a person creates a relevant property trust during his lifetime that does not fall within one of the exceptions, then inheritance tax will be payable (i) at the time the trust is created, (ii) every ten years thereafter until the trust ends, and (iii) on assets leaving the trust. The exact amounts due depend on the individual circumstances. For instance, for smaller trusts it may be possible to use the nil rate inheritance tax band so that no inheritance tax is payable when the trust is created.
(a) Bereaved minor trust
This type of trust is one of the exceptions to the "relevant property trust" classification. A trust for a bereaved minor is a trust created on death for the benefit of a child of the deceased. The trust must only be for the benefit of such children (with no other beneficiaries) and the beneficiary must become fully entitled to the trust assets on or before his 18th birthday. If the trust meets these conditions, the 10-yearly inheritance tax charge (see above) does not apply, and there is no inheritance tax charge on assets leaving the trust.
(b) 18 to 25 trust
This type of trust is another exception to the "relevant property trust" classification. The classification was introduced in March 2006 to replace accumulation and maintenance trusts. 18 to 25 trusts are more restricted than accumulation and maintenance trusts and have more limited inheritance tax advantages, but may serve some of the same purposes.
The beneficiary of an 18 to 25 trust must become fully entitled to the trust assets by the age of 25. Such a trust is exempt from the 10-yearly inheritance tax charge. The inheritance tax "exit charge" on assets leaving the trust is payable for the period that the beneficiary is between the ages of 18 and 25 (so there is no exit charge if all trust assets are paid out the beneficiary by the time he is 18).
A person can create an 18 to 25 trust while he is alive, or a bereaved minor trust can be set up as an 18 to 25 trust.