What is a Trust?

If you would like to find out more about Trusts and how RRL can assist, please contact our Tax Partner, Steve Maggs, on 01872 276116/01736 339322or steve.maggs@rrlcornwall.co.uk.

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What is a trust?

You may consider it normal that the legal owner of property can also derive benefit from that property. For example, if you are the legal owner of a house, then you probably have the right to occupy it.

However, in a trust arrangement, the legal title of trust property is held with one group of people known as the trustees, whereas the beneficial title is held with another group of people known as the beneficiaries. In other words, the trustees control the property but only the beneficiaries can benefit from it.

Of course, someone must have set up the trust by giving away their assets and this person is known as the settlor.

It is important to note that a trust is a separate legal entity.

Who can set up a trust?

As a general rule, if a person can give property away, he has sufficient legal capacity to set up a trust with the property. People under the age of 18 (also known as minors) are not legally capable of holding land and shares in their own name and so cannot gift such assets. The settlor must also understand the nature of his actions. Therefore, people of unsound mind such as mentally handicapped individuals cannot create a valid trust. In theory, a child could create a valid trust with certain assets such as cash, but only if he understands the nature of his actions.

Can the settlor be a trustee?

The settlor can also be a trustee, and in practice this is quite common as it allows the settlor to keep control over the assets he has given away.

Can the settlor be a beneficiary?

It is also possible for the settlor to be a beneficiary but it should be noted that this can have several unfavourable tax consequences.

Can anyone be a trustee?

There are two categories of people who cannot be trustees. The first is minors and the second is people of unsound mind.

A beneficiary can also be a trustee, although this could lead to a conflict of interest as this individual, in his capacity as trustee, could favour himself over other beneficiaries.

Companies can act as trustees, and this is particularly common in the case of offshore trusts.

How many trustees are required?

There are few limitations on the number of trustees. The main exception is for trusts which contain land where there must be at least two trustees but no more than four.

Why set up a trust?

In England, the concept of a trust can be dated back to the Crusades during the 12th and 13th centuries. Prior to leaving England, a Crusader would often transfer the legal title of his land to a friend, on the understanding that he would get the land back on his return. The Crusader was the ‘settlor’ and ‘beneficiary’, and his friend, who would look after the estate in the Crusader’s absence, was the ‘trustee’.

But why do people set up trusts today?

There are many reasons trusts are created but we shall briefly consider some of the more common ones.

Trusts are frequently used for tax planning, particularly in relation to inheritance tax but also to mitigate the effect of other taxes.

However, trusts are also set up for non-tax reasons.

A trust allows an individual to pass down wealth to successive generations in a controlled and flexible way. As mentioned already, if a settlor appoints himself as one of the trustees, then he himself can exercise some control over the trust assets. The settlor could also decide at some future date who should ultimately benefit.

Setting up a trust may be preferable to making an outright gift in order to protect family wealth. This could be because the intended recipient is not capable of holding property themselves. The beneficiary may be considered financially irresponsible or may be a vulnerable person such as a mentally handicapped individual or a child. Trusts can also offer some protection against the financial implications of unsuccessful marriages. Divorce is considered in more detail later on.

Creation of a trust

A trust is typically set up in one of the following ways:

  • A written trust document (usually referred to as a trust deed);
  • A Will;
  • An oral declaration; or
  • A Court Order.

It should be noted that in England & Wales, trusts over land must be evidenced in writing.

Common types of trust

There are three common types of trust, a bare trust, an interest in possession trust, and a discretionary trust.

In a bare trust, the beneficiary is absolutely entitled to both the trust capital and the income generated from the capital. The trust assets are held in the name of a trustee, but the trustee has no discretion over the trust assets. Bare trusts for children are particularly common as minors cannot hold land or shares in their own right.

In an interest in possession trust (also known as a life interest trust), there are two different types of beneficiaries: life tenants and remaindermen. Life tenants are entitled to trust income during their lifetime and can also use trust property, for example occupy a house owned by the trust. The capital, on the other hand, passes to the remaindermen on the life tenants’ death.

A discretionary trust is one where the trustees have discretion on how to distribute trust income, and in some cases capital, to beneficiaries. The extent of the trustees’ discretion depends on the terms of the trust deed. It is the most flexible form of trust; and the trustees can take account of the needs of beneficiaries and of changing circumstances.

Accumulation of income – Do trustees have to pay out trust income to beneficiaries?

Trustees of interest in possession trusts are obliged to distribute income arising in the trust to the life tenants. However in the case of discretionary trusts the trustees may have a choice between paying out income to beneficiaries and keeping the income within the trust to increase the trust capital. The latter is known as accumulation of income.

The rule against accumulations was introduced to avoid the excess build-up of wealth within trusts, and limits the period of time during which income can be accumulated. This length of time is known as the accumulation period. When this period has elapsed, the trustees must distribute all trust income.

The Perpetuities and Accumulations Act 1964 sets out a choice of possible accumulation periods. By far the most common choice was for a 21 year fixed period.

However, the Perpetuities and Accumulations Act 2009 allows the accumulation period to be up to 125 years. This applies to all trusts created from 6 April 2.010, and will help avoid the situation where income must be distributed to inappropriate or immature beneficiaries.

Bankruptcy and Divorce

Over the centuries, law has evolved indicating that in certain circumstances trusts may be held to be invalid, for example where the object of the trust is clearly illegal. Bankruptcy and divorce as well as being generally unpleasant situations, are also potential problem areas for trusts.

Bankruptcy

Can an individual gift assets to a trust in order to protect those assets from his creditors?

In the following four situations, the court can set aside a trust. If this action is taken, the trust will be void and treated as never having existed:

  • A petition leading to bankruptcy is presented within two years of creating the trust;
  • Where presentation of the bankruptcy petition takes place more than two years but less than five years after the creation of the trust, and the settlor was insolvent (i.e. unable to pay his debts) at the time of setting up the trust, or as a consequence of it being set up;
  • Where it can be proved to the court’s satisfaction that the trust was set up by the settlor in order to put his assets beyond the reach of existing or future creditors;
  • Where the settlor becomes bankrupt as a result of a crime. In this case the trust property can be recovered without any regard to a time limitation.

Divorce

Is it possible for one spouse to put family wealth in a trust in order to exclude the other spouse from benefitting on divorce?

A trust may be set aside if it is made with the intention of preventing financial relief being granted to a party to the marriage. If divorce proceedings are instigated within three years of creation of the trust there is a rebuttable presumption that the trust was made with the intention to defeat a claim for financial relief. The onus of proof, therefore, would be on the spouse who set up the trust.

In addition, where a spouse is a beneficiary of a trust, in divorce proceedings the Court will take into account money which the spouse may reasonably expect to receive from the trust.

Furthermore, as part of a divorce settlement, the Court can alter trusts established with a particular marriage in mind.

Trustees’ powers and duties

A considerable body of case law has evolved clarifying trustees’ powers and duties. There is also legislation including the Trustee Act 1925, the Trusts of Land and Appointment of Trustees Act 1996 and the Trustee Act 20DO.

Trustees’ duties

The duties of trustees are imposed by the trust instrument, case law and statute. We shall now consider some of these duties:

  • Reasonable care and diligence– trustees must carry out their duties with reasonable care and diligence and have a fundamental duty to act in the best interests of the beneficiaries.
  • Investment – there is a duty to invest trust funds, maintaining an even balance between income beneficiaries and capital beneficiaries {for example between the life tenant and remainderman of an interest in possession trust). In this case, trustees should avoid investing in assets which produce high income at the expense of capital growth (hence favouring the life tenant) or indeed vice versa.
  • Accounts– trustees are under a duty to maintain accounts, and produce them to the beneficiaries on request.
  • Distributing trust assets – although it may seem obvious, trustees are under a positive duty to distribute trust assets to the correct beneficiaries.
  • Duty not to profit – trustees cannot purchase trust property or derive any benefit from it, unless expressly permitted by the trust instrument. Furthermore, historically trustees were not entitled to be remunerated for their services unless the trust deed specifically provided for such payment. However, this often left professional trustees in a difficult position and so the Trustee Act 2000 introduced a provision to allow professional persons to be reasonably remunerated where no contrary intention is expressed.

If trustees fail to carry out their duties properly, they could be in breach of trust and as a result may be subject to legal action by the beneficiaries.

You should bear in mind that that the above observations are non-exhaustive and legal advice is necessary before implementing and strategy or refraining from taking action based on the contents of the above.

 

Updated 21 February 2019

This publication has been prepared by RRL LLP. It is to be treated as a general guide only and is not intended to be a comprehensive statement of the law or represent specific tax advice. No liability is accepted for the opinions it contains, or for any errors or omissions. All rights reserved.