Changes in Tax Law for Trusts.

Trusts and Inheritance Tax

Trusts can be used to hold and manage money, property, investments and other assets for beneficiaries. They are commonly created to protect vulnerable people, provide for children, control when beneficiaries receive assets or manage family wealth across generations. A trust does not necessarily remove assets from Inheritance Tax. The tax treatment depends on the type of trust, when it was created, who can benefit and whether the person creating it retains any benefit from the assets.

How Does a Trust Work?

The main parties to a trust are:

• The settlor: the person who places assets into the trust;
• The trustees: the people or organisation responsible for managing the trust; and
• The beneficiaries: the people or organisations who may receive income or capital from it.

The trust deed sets out the trustees' powers, the beneficiaries and how the assets may be used. Trustees become the legal owners of the trust property, but they must manage it for the beneficiaries and comply with the trust document, tax rules and their wider legal duties.

Why Are Trusts Created?

A trust may be appropriate to:

• Hold assets for children until they reach a specified age;
• Provide for a disabled or vulnerable beneficiary;
• Protect money for someone unable to manage it personally;
• Provide income to one person while preserving capital for another;
• Manage assets following a death;
• Protect family or business assets for future generations;
• Control how and when beneficiaries receive money;
• Provide continuity where property has several owners; or
• Support charitable purposes.

Asset protection may be a consequence of a properly established trust, but a trust cannot safely be used to conceal assets, defeat creditors, avoid care charges or evade tax.

Trusts Are Not Automatically Tax-Free

A trust may be liable for:

• Inheritance Tax;
• Income Tax;
• Capital Gains Tax;
• Stamp Duty Land Tax or another property transaction tax; and
• Administrative and professional costs.

Tax may arise when assets enter the trust, while they remain in it, when income or gains arise and when property is distributed to beneficiaries. The tax treatment varies considerably between discretionary trusts, interest-in-possession trusts, bare trusts, vulnerable beneficiary trusts and trusts created by wills.

Relevant Property Trusts

Many discretionary trusts and some other trusts fall within the relevant property regime. Potential Inheritance Tax charges include:

• A lifetime charge when assets are transferred into the trust;
• A principal charge on each tenth anniversary; and
• An exit charge when assets leave the trust or cease to be relevant property.

The maximum ten-year and exit charge is generally 6%, although the actual rate may be lower depending on the trust's value, available nil-rate band, previous transfers and how long the assets have been held.

Transferring Assets into a Trust

Placing assets into a relevant property trust is usually a chargeable lifetime transfer for Inheritance Tax purposes. Where the transfer, together with other relevant transfers made during the previous seven years, exceeds the available nil-rate band, lifetime Inheritance Tax may be payable. The lifetime rate is generally 20% on the amount above the available threshold, with the trustees paying the tax. The effective cost can be higher where the settlor pays it. If the settlor dies within seven years, the original transfer may need to be reconsidered, and additional tax can arise.

The Inheritance Tax Nil-Rate Band

The standard nil-rate band is currently £325,000. It is not a separate tax-free allowance automatically available to every trust in all circumstances. The calculation can be affected by:

• Other chargeable transfers made by the settlor during the preceding seven years;
• Earlier property added to the same trust;
• Related settlements;
• Property added to several trusts on the same day; and
• Changes in tax law after the trust was created.

The residence nil-rate band that may apply to a home passing on death does not generally provide an additional allowance for lifetime transfers into discretionary trusts.

Multiple Trusts

It was once possible to obtain a more favourable result by creating several trusts on different days, allowing each trust to be assessed separately under the relevant property rules. The Government considered replacing this system with a single settlement nil-rate band, but that particular proposal was not introduced. Instead, anti-avoidance rules apply to certain same-day additions. Broadly, where the same person adds value to two or more trusts on the same day, those additions can be considered together when calculating ten-year and exit charges. Multiple trusts can still exist and may each have separate legal and tax consequences. However, creating several trusts solely to multiply tax allowances is unlikely to produce the result assumed in the original article. < h3> Tenth Anniversary Charges Relevant property trusts are assessed for Inheritance Tax on each tenth anniversary of the date the trust began. The calculation can take account of:

• The value of the relevant property;
• The settlor's earlier chargeable transfers;
• Property previously added to the trust;
• Related trusts and same-day additions;
• Available exemptions and reliefs; and
• The period for which particular assets have been held.

The maximum effective rate is generally 6% of the taxable value, but the calculation is technical and professional advice is often required.

Exit Charges

An exit charge may arise when assets are:

• Distributed to a beneficiary;
• Transferred to another trust;
• Appointed out of a discretionary trust;
• Used to create a different interest; or
• No longer treated as relevant property.

The rate depends partly on the rate applicable at the last tenth anniversary and how long the property has remained in the trust. An exit charge can apply even where the beneficiary receives property rather than cash.

Bare Trusts

Under a bare trust, the beneficiary is normally absolutely entitled to the trust assets and income. For many tax purposes, the assets are treated as belonging directly to the beneficiary. Bare trusts are therefore taxed differently from discretionary trusts and are not normally subject to the relevant property ten-year charge regime. They are often used to hold assets for children, although the beneficiary will generally become entitled to control the property at age 18 in England and Wales.

Interest-in-Possession Trusts

An interest-in-possession trust gives a beneficiary an immediate right to trust income or to use particular property. For example, a will may allow a surviving spouse to live in a home or receive investment income during their lifetime, with the capital passing to children afterwards. The Inheritance Tax treatment depends on when and how the interest was created. In some cases, the trust property is treated as part of the life tenant's estate on death. Other interests may fall within the relevant property regime.

Trusts for Disabled or Vulnerable Beneficiaries

Special tax treatment may be available for trusts established for certain disabled or vulnerable beneficiaries. Where the statutory conditions are met, the trust may avoid some of the normal relevant property charges or qualify to be taxed by reference to the beneficiary's personal position. The rules are detailed, and the trust deed must be drafted carefully. A general discretionary trust does not become a qualifying vulnerable beneficiary trust merely because one beneficiary has additional needs.

Gifts Instead of Trusts

Making a direct lifetime gift can be simpler than creating a trust. An outright gift to an individual is generally a potentially exempt transfer for Inheritance Tax purposes. If the donor survives for seven years, it will usually fall outside the donor's estate for IHT. However, an outright gift involves giving up control and ownership. Risks include:

• The recipient spending or losing the money;
• Divorce or relationship breakdown;
• Bankruptcy or creditor claims;
• The recipient dying unexpectedly;
• The loss of means-tested benefits;
• Capital Gains Tax on the gift; and
• The donor later needing the asset or income.

A gift should not be made solely for tax reasons without considering the wider legal and financial consequences.

Gifts with Reservation of Benefit

A person cannot usually remove an asset from their estate for Inheritance Tax while continuing to enjoy it as before. For example, giving a home to children but continuing to live there rent-free may be treated as a gift with reservation of benefit. The property can remain part of the donor's estate on death despite the legal transfer. Similar problems can arise when a settlor places assets into a trust but continues to use or benefit from them. Additional Income Tax rules concerning pre-owned assets may also apply in some circumstances.

Trusts and Care Fees

Creating a trust or giving away property to avoid care charges can be challenged as deliberate deprivation of assets. A local authority may consider:

• Why the transfer was made;
• The pperson'shealth and care needs at the time;
• Whether the need for care was reasonably foreseeable;
• What benefit the person retained; and
• Whether avoiding care charges was a significant motive.

There is no simple seven-year rule for care-fee assessments equivalent to the general Inheritance Tax rule for lifetime gifts.

Trusts and Creditors

A trust should not be treated as a guaranteed method of placing assets beyond the reach of creditors. Transfers may be challenged where they were made:

• To put assets beyond creditors' reach;
• At an undervalue;
• When the settlor was insolvent or facing insolvency;
• To defeat a spouse's financial claim; or
• To conceal criminal property.

Courts, insolvency practitioners and enforcement authorities have powers to investigate and reverse improper transactions.

Moving Abroad and Overseas Trusts

Leaving the UK does not automatically remove a person or trust from UK Inheritance Tax. From 6 April 2025, the former domicile- and deemed-residence-based system was replaced by the domicile rules. Long-term UK residents may remain within the scope of Inheritance Tax on overseas assets, including in some circumstances after leaving the UK. The treatment of non-UK assets held in trust can depend on:

• When the trust was created;
• The settlor's UK residence history;
• When the assets entered the trust;
• Where the property is situated;
• The type of trust; and
• Transitional and anti-avoidance rules.

Changing residence solely to avoid Inheritance Tax is unlikely to be a simple or immediate solution and can create tax liabilities in several countries.

Trust Registration Service

Many UK trusts and some non-UK trusts must register with HMRC through the Trust Registration Service, even where no tax is currently payable. Trustees may need to provide details of:

• The settlor;
• The trustees;
• The beneficiaries or classes of beneficiary;
• People exercising control over the trust;
• The trust assets; and
• The trust's tax liabilities.

Registrable changes generally need to be reported within the applicable deadline. Trustees may also have annual declaration and tax-return responsibilities. Some trusts are excluded from registration, but the exclusions are specific and should not be assumed.

Trustees’ Responsibilities

Trustees must:

• Follow the trust deed;
• Act in the beneficiaries’ interests;
• Invest and manage assets appropriately;
• Keep trust money separate from their own;
• Maintain accounts and records;
• Deal with tax returns and payments;
• Register and update the trust where required;
• Consider beneficiaries fairly; and
• Avoid unauthorised benefits or conflicts of interest.

Trustees may become personally liable for losses, unpaid tax or improper distributions if they fail to comply with their duties.

Business and Agricultural Assets in Trust

Business Property Relief and Agricultural Property Relief may reduce Inheritance Tax on qualifying assets held in or transferred to a trust. These reliefs are subject to detailed ownership, occupation and qualifying-use requirements. The availability and amount of relief can also be affected by legislative changes. A trust holding a farm, a family company, or a trading business should be reviewed regularly, rather than assuming that the relief available when the trust was created will continue indefinitely.

Reviewing an Existing Trust

Older trusts should be reviewed periodically, particularly where:

• A ten-year anniversary is approaching;
• The settlor or beneficiary has moved country;
• The value or type of assets has changed;
• A beneficiary has died, divorced or lost capacity;
• Trustees need to be replaced;
• Business or agricultural relief is being relied upon;
• The trust has not been registered with HMRC;
• Income or capital is due to be distributed; or
• The original tax planning may no longer be effective.

A trust should not be altered, wound up or distributed without considering Inheritance Tax, Capital Gains Tax and the trustees' legal powers.

Are Trusts Still Worthwhile?

Trusts remain useful legal arrangements. Their value is not limited to avoiding Inheritance Tax. They can provide protection, continuity and control that cannot be achieved through an outright gift. However, they may involve:

• Immediate and ongoing taxation;
• Professional and administration costs;
• Registration and reporting duties;
• Loss of direct ownership by the settlor;
• Complex rules for trustees; and
• Restrictions on how beneficiaries access assets.

Whether a trust is appropriate depends on the family circumstances, purpose, assets and likely future needs.

Obtaining Trust and Tax Advice

Specialist advice should be obtained before:

• Transferring property or investments into trust;
• Creating several trusts;
• Making a substantial lifetime gift;
• Moving overseas;
• Distributing trust property;
• Changing trustees or beneficiaries;
• Approaching a tenth anniversary;
• Using a trust for a vulnerable person; or
• Relying on Business or Agricultural Property Relief.

A solicitor can advise on the trust's terms, trustees' duties and succession objectives. A specialist tax adviser can calculate the likely tax charges and reporting requirements. To find a Trusts or Inheritance Tax Solicitor, use the search facility at the top of this page. We recommend contacting several firms to compare their relevant experience, proposed structure and fees.