Broadly speaking, a Trust is an arrangement under which property i.e. land, cash, investments, or some sort of rights such as copyrights, is held by a person or organisation on behalf of one or more people. The people holding the property are called “the Trustees” and the people on whose behalf the property is held are called “the Beneficiaries”. The Trustees can sometimes also be Beneficiaries.
Trusts are unique to the legal systems derived from the English Common law and are found in most Commonwealth countries and in the USA. Other legal systems do not have trusts and struggle to understand the concept. There are some legal structures that sound like trusts but are not. The most well-known is the “Usufruct” which features in many European systems of law.
The majority of trusts arise automatically under English law. When a house is owned jointly by a husband and wife, there is a joint ownership trust that automatically arises. The same applies to all jointly owned assets. Similarly, a child cannot have legal ownership of most assets, so in theory anything belonging to a child is held in trust. So if a child inherits from their parents, while under the age of 18, the inheritance is automatically held in trust.
As becomes apparent from the above, trusts are in our life much more than we realise. For example, your pension fund, whether an Employers pension fund, or a Self-Invested Pension Plan (SIPP) is held by Trustees on your behalf. Another example of such a trust arrangement is when you hold an investment portfolio which is held by a third party in a wrapper or as nominees on your behalf. This is called a Bare Trust.
Most of the time, when people talk about trusts, they are in fact thinking of Trusts which have been created by some sort of Trust Deed document, sometimes these are called “Express Trusts”.
What is the purpose of trusts?
In very simple terms, they are all about protecting property. A common example of this is when a trust is used to protect family wealth from a spendthrift. Trusts were very popular in Victorian and Edwardian times to protect the family wealth against the excesses of the spendthrift son, thereby ensuring something was available to be passed to the next generation. It is likely that the same principle was behind the popularity of “Marriage Settlements”, whereby a Victorian or Edwardian daughter’s inheritance was put into trust for her benefit during her lifetime and then for her children.
Trusts are often created in Wills when a couple are in a second marriage and wish to benefit their new spouse during their life, to ensure that their own children benefit. Another common use is to try and avoid nursing home fees.
The way in which someone can benefit under a trust is twofold. Either they have what is called a “life interest”, which is a right to benefit from the income derived from an asset, or they have “interest in possession” which is the occupation of property during their lifetime. The second way you can benefit is as a discretionary beneficiary, which means you have no right to income, but the trustees have the right to decide whether or not to make payments to you. While this may sound daunting, it is usual that the Trustees will have been given clear instructions as to what to do.
One of the most important features of express trusts is that they have a separate legal existence. They can almost be regarded as a separate person, and this is central to their existence. The property held by the Trustees belongs to the Trustees and not to the Beneficiaries. Someone who is a beneficiary of a trust may be able to get some sort of benefit from the trust, but they do not own the property. This means they cannot sell the property of the trust, and therefore the property is not going to be vulnerable to creditors. The separate existence of trusts means that the Trust is subject to separate systems of taxation. The way someone is entitled to benefit under a trust can have a very important effect on the way the trust is taxed.
Trusts can be very popular in tax planning because of the unique separate existence feature. And carefully used, certain trusts can be part of a family’s tax planning. But this attraction has a further consequence, as it makes these trusts very interesting to our friends at HM Revenue and Customs.
The rules surrounding both the taxation of trusts and their use and management is extremely complex. At Herrington Carmichael we have a wealth of experience dealing with trusts and will happily advise on when they can be used, to assist with the protection of your wealth. However, we should warn you in advance that trusts cannot always help and some of the stories about how a trust can be Miracle X do have to be taken with a pinch of salt.
For further advice, please do contact a member of the Private Wealth Team using the contact form below. Or you can book a place at one of our Inheritance Tax Planning Clinics, which include a free 15-minute consultation with a solicitor.
This reflects the law at the date of publication and is written as a general guide. It does not contain definitive legal advice, which should be sought as appropriate in relation to your own particular matter before action is taken.
