An optimised approach to asset protection will consider a wide range of tools and structures potentially at your disposal. One item for consideration in this toolkit will be the trust.
Trusts have for centuries been used for asset protection purposes. However, trusts have also been synonymous with tax planning and avoidance. For better or for worse, the latter approach is unlikely to be effective as any tax benefits for UK resident and domiciled individuals have almost been totally eroded.
However, rather than being a dinosaur facing extinction, the use of trusts has continued to evolve. As a device for protecting assets from spendthrift children, poor marriages in the family or commercial creditors, trusts still have a lot to offer.
Today, trusts are often used for the purposes of gifting cash, shares and other assets while applying certain conditions. The donor has probably already decided he wants to bequeath assets to a donor (and as such this gift will trigger tax consequences) but it is the thought of the donee having unfettered access to the underlying capital which makes them use a trust.
For example, by settling an asset – e.g. shares – on to a trust a beneficiary may enjoy the economic benefits of ownership such as the dividends that might be payable on the shares. However, the trustees will prevent the sale of the shares by the beneficiary or potentially protect the asset from a creditor, for example, on bankruptcy. A trust could even protect wealth from the tax.
It should be noted that a trust will not help in a situation where a creditor has already arisen. So one cannot deprive a creditor by transferring assets to a trust. That horse has bolted.
How does a trust protect personal assets: Tax issues on transferring assets on to trust
As mentioned above, the making of an outright gift will usually have tax consequences. Where the asset is a chargeable asset (so not cash and some other exempt assets) and it stands at a gain then this will be a disposal for capital gains tax purposes. This will be the case even where there is no cash.
Certain transfers of business assets might qualify for holdover relief. This means that as long as the recipient is happy to sign a joint election with the donor to take on this historic gain – which will crystallise when the recipient sells the asset – there is no tax to pay.
Where the asset is transferred to a trust then, as long as the trust is UK resident, is not settlor interested and the settlor’s minor children cannot benefit, then usually the gain on any asset can be held over in this way.
So, for instance, where a property is being transferred a trust can help defer a gain. The trustees would take over the gain and they would pay tax if they sell to a third party or, if the asset is appointed to a beneficiary, then the trustee and the beneficiary might enter into a similar election.
For inheritance tax purposes, an outright gift is usually more straightforward. In the absence of any reliefs then the donor will escape IHT if they survive the gift by seven years. If they die within this period, the gift is added back to their estate on death.
However, where the asset is transferred to a trust – but not a bare trust, see below – then the transfer is what is known as a Chargeable Lifetime Transfer (CLT). In the absence of any reliefs, and where the value exceeds the available nil rate band, then the excess is subject to IHT immediately at 20%. If the donor dies within seven years then there will be further tax to pay of 20%.
How does a trust protect personal assets: Different types of trust
There are different types of trust available, each with different characteristics. It is therefore crucial to ensure you understand and consider all options to meet your specific personal circumstances and objectives.
We take a brief look at some of the most commonly used trust types, although many more exist and should be considered in line with your requirements:
Known as the most straightforward of trusts, and in effect a basic nominee arrangement, a bare trust is structured at the outset with a definitive list of (living) beneficiaries and set distribution of capital and income.
The position at the time the trust is created is then fixed. There is no flexibility to for example include additional beneficiaries.
While trustees are required to meet regularly to discuss the investment of the funds, they have no discretion as to distribution, meaning overall administration of the trust is relatively simple.
Bare trusts generally offer low appeal for asset protection since the beneficiaries own the capital and assets in trust, including gains and income arising. At 18, the beneficiary is entitled to assume control of their asset.
There are however a number of benefits to this structure. For example, gifts made under a bare trust are known as ‘potentially exempt transfers’ (PETs). Provided the settlor lives at least seven years after making a PET, the assets in the trust will no longer count as part of the estate, beyond the reach of IHT.
As the name suggests, discretion is the key characteristic of this type of trust.
At any point, changes can be made to the trust set-up including adding beneficiaries and changing distribution of income arising. The prevailing rule is that any change must be in the beneficiaries’ best interest, making this type of trust attractive in asset protection terms.
Discretionary trusts are typically inefficient in income tax terms, which is to be balanced against the primary driver for asset protection.
A common use of the discretionary trust is in the family business context. A trust is used to hold shares in a family business, with the trustees controlling succession to the next generation, while importantly – providing protection from external financial threats such as creditors or ex-spouses.
As a more flexible type of trust, however, discretionary trusts will demand more proactive management on the trustees’ parts, which, as you might expect, could lead to higher running costs.
How does a trust protect personal assets: Offshore trusts
In the same way that UK trusts have undergone a transformation in their potential tax benefits, so too have offshore trusts.
In tax-efficient terms, significant change has been effected through anti-avoidance rules governing the use of offshore trusts, effectively rendering offshore trusts of little taxable benefit to UK resident and domiciled individuals.
For non UK domiciled individuals and non UK residents however, the tax position of offshore trusts does continue to present more favourable efficiencies. But the coast is far from clear, and you are advised to tread carefully.
Looking specifically at the question of ‘how does a trust protect personal assets’, however, these changes will be of less concern.
Offshore trusts generally enjoy enhanced protection from creditors, given the added complications of multiple legal regimes in addition to the UK element, before they are able to gain access to trust assets.
The rules in this area are however sensitive, and care must be taken to ensure use of offshore trusts, including how they are structured and how income and gains are distributed, do not satisfy proximity to the UK regime. For example, in the instance of a non resident trustee, where a settlor or a beneficiary is closely connected to the UK, income and /or gains liability will generally be triggered.
If you have an existing structure, or are considering setting up a structure, we would recommend you obtain and continue to obtain proper professional advice.
How does a trust protect personal assets?
Asset protection is a highly complex area of tax planning, particularly where issues of residence and domicile are involved.
In all cases, the use of trusts for asset protection purposes will also need to take into account wider taxation implications – transfers for example potentially triggering capital gains tax liability, which will need to be balanced against the value assigned to the protection of assets.