The previous article in this series on Trusts ended with the tax planning suggestion for the rearrangement of investments. But doing so will not necessarily mean that there will be no tax due - just no income tax. This article covers the instances where Capital Gains Tax (CGT) is charged on Trusts.
Trusts have been recognised in English law since at least the 13th Century and were supposed to have come into being when the crusader knights went off to the Holy Land as a way of protecting what they owned when they were not there to protect it themselves.
The mechanics of the setting up of a trust have not changed, being that a trust is created when a person (a ‘settlor’) transfers assets to people whom they ‘trust’ (‘trustees’) to hold them on behalf of others (‘beneficiaries’). The trustees are treated as one single and continuing body as distinct from the persons individually such that, for example, the retirement of one UK resident trustee does not, in itself, give rise to a chargeable disposal for the trust.
To be caught under UK CGT rules, either the trust has to be administered in the UK or at least half of the trustees be resident and ordinarily resident in the UK (the rule is slightly different where professional trust managers act as trustees).
When and Who Pays CGT
If a trust is resident in the UK then CGT is charged in the following scenarios, the exact circumstances of which determine who is liable for the CGT, if due:
• Creation of the trust and /or transfer of assets (including property) into the trust –the settlor is treated as having disposed of property into the trust at market value. The market value rule applies because the settlor and trust are deemed to be ‘connected’ as at the exact moment that the trust comes into existence. If the property transferred has increased in value since the date of acquisition by the settlor, then the settlor will have a chargeable gain and possibly CGT to pay.
However, all is not lost as it may be possible for the settlor to defer (‘Hold over’ )the charge (see ‘Getting out of paying CGT’).
• Sale or transfer of property out of the trust – the trust is liable to CGT under the usual CGT rules subject to the annual exemption for trustees (see ’Getting out of paying CGT’).
• Emigration of the trust so that the trustees are no longer UK taxpayers – the trust is liable to CGT based on the market value of the assets at the date of transfer or emigration.
Getting Out of Paying CGT
• Use of losses - losses incurred on the sale of assets held by the trust can be offset against any gains made thereby reducing the CGT due. However, there are anti avoidance rules which prevent offset in certain circumstances.
• A qualifying ‘interest in possession’ ends such that the beneficiary becomes ‘absolutely entitled’ to the trust assets; this will either be on death or when some special condition is met (e.g. upon reaching a specified age, say, 18 years). Being ‘absolutely entitled’ means that the beneficiary can direct the trustees what to do and how to deal with the property; he may even require the property to be transferred to him. This type of trust is used where someone has a right to the income from the trust property but not the capital. On the death of someone who has such an ‘interest in possession’, the ‘interest’ comes to an end, the beneficiary becomes absolutely entitled to the trust property but no CGT is due (but neither are any capital losses allowable).
The trust is deemed to dispose of the property held and immediately reacquire it again at market value but may continue to hold the property as nominees or ‘Bare trustees’ until subsequently sold or finally transferred to the beneficiary. A subsequent disposal is treated as being a disposal by the beneficiary. A chargeable gain will only arise to the trust if the cost of the asset had been reduced by ‘hold over’ relief on transfer into the trust and the gain will equal this ‘hold over’ amount (see ‘Hold over’ relief claim).
• ‘Hold over’ relief claim – this claim allows the transfer of property into the trust without the payment of CGT on the gain at the date of transfer. Instead, the CGT charge is deferred to be paid when the asset is eventually sold, being taxed on the increase in value from the date at which the trust acquired the property and the final sale plus the CGT ‘hold over’ amount.
• A life interest terminates other than on death (e.g. because a widow remarries or the interest is transferred to someone else) - as the property itself remains in trust there is normally neither a chargeable gain nor a change in the base value of the property for future CGT disposals.
Amount of CGT Due and When
After the deduction of the annual exempt amount from the gain calculated, the CGT charge is 18% for disposals before 23 June 2010 and 28% thereafter. The tax is payable by 31 January following the tax year of the event.
Problem with Principal Private Residence (PPR) Relief
A beneficiary can occupy a residence held in a trust as their main PPR and the future disposal of the property by the trustees may qualify for PPR relief. However, generally, trusts and PPR do not work well together because once a transfer into a trust (whether ‘settlor interested’ or not) has occurred and a ‘hold-over’ election made, PPR is denied on any subsequent sale.
This holds true whether the trust sells the property or the property is transferred out of the trust and the transferee then sells. Where a property has been subject to a ‘hold over’ election after 10 December 2003 PPR relief is no longer available, until after it has been sold to a third party. If the original transfer took place before 10 December 2003, PPR relief is only available on the proportion of gain arising before that date.
So the choice is broadly between paying CGT at the date of transfer of the property into the trust based on the market value, and claiming PPR relief on the future sale if a property has been lived in as the main PPR at some time.
Consider not electing for ‘hold’ over’ relief into the trust but opting to pay CGT sooner rather than later, especially if it is thought that CGT rates are likely to rise in the future. The tax and law issues affecting trusts are potentially complex, and specific professional advice should be considered.
This is a sample article from the monthly Property Tax Insider magazine. Go here to get your first free issue of Property Tax Insider.