How should trusts be taxed?
By Donald Drysdale for ICAS
14 December 2018
As a chartered accountant, chartered tax adviser and trust and estate practitioner, Donald Drysdale encourages practitioners to provide input to HMRC’s current consultation on the taxation of trusts.
An ill-timed consultation
Typically, practitioners who deal with trusts specialise predominantly in personal taxes. For them, therefore, the quarter from November through January is hectic as they face the pressures of the 31 January tax filing deadlines for individuals and trusts, and the need to ensure compliance with the new requirements to register trusts with HMRC.
One has to wonder, therefore, why HMRC chose November to launch their current consultation on the taxation of trusts, with a closing date of 30 January 2019. A cynical observer might be forgiven for thinking they wanted to limit the number of responses. However, the questions raised are potentially far-reaching and should not be ignored.
The use of trusts
Alongside the consultation document, HMRC published a research report by Ipsos MORI on a survey of settlors of trusts and their professional advisers. Its aim was to understand motives people had for using both UK and offshore trusts, and to explore the extent to which tax planning influences or drives those behaviours.
The survey revealed that settlors generally had very limited knowledge of trusts, and relied heavily on advice from their agents. UK trusts were used to protect assets from people, to protect assets from taxes and other costs, and to retain control and flexibility. The same reasons applied in a wider sphere to offshore trusts, with privacy an added attraction.
Discretionary and interest in possession (IIP) trusts are widely used in the UK and serve a variety of purposes. Personal factors, and reducing inheritance tax (IHT), were commonly key drivers for establishing trusts. Settlors’ views on the tax efficiency of trusts were often difficult to decipher because of the complexity of factors such as the 10-year periodic charge.
Policy principles
Previous tax reforms have reduced the scope for using trusts to avoid or evade tax. The Government now wants to address any such opportunities which still exist, eliminating unfairness and unintended consequences, whilst also facilitating the straightforward use of trusts where they are the appropriate legal mechanism.
HMRC suggest that the correct approach should be based on three policy principles. Trusts should be sufficiently transparent to prevent their use for tax avoidance or evasion. Trust taxation should be fair and neutral – neither encouraging nor discouraging the use of trusts. It should also not be so complex as to discourage the use of trusts where they are the most suitable legal arrangement to achieve legitimate goals.
Transparency
Following revelations such as those that were contained in the Panama and Paradise Papers, the Government sees transparency as a key requirement – but recognises the need to balance it with legitimate concerns about privacy, especially for vulnerable beneficiaries.
Transparency of trusts is already encouraged by existing measures, including the OECD Common Reporting Standard (CRS), implementation of the Money Laundering, Terrorist Financing and Transfer of Funds (Information on the Payer) Regulations 2017 (MLRs) and, as a result of the latter, the Trusts Registration Service (TRS). The Government invites views and evidence on whether there are other measures it could take to enhance transparency still further.
In considering transparency, the consultation focuses particularly on whether any changes might be needed to the definitions which differentiate between UK-resident and non-resident trusts. It questions why UK resident and/or domiciled persons might choose to use a non-resident trust rather than a UK resident trust, and what ways non-resident trusts are being used for tax avoidance and evasion.
Fairness and neutrality
In considering the neutrality of trust taxation, the consultation paper suggests that it may be necessary to compare the tax outcome with that which could arise in any one of three different hypothetical circumstances, viz: the trust property still being owned by the settlor, or the property being owned by the beneficiaries; or it belonging only to the trustees.
The consultation asks whether there is a need for targeted reform of the IHT regime as it applies to trusts. Specific strategies mentioned are the ability to make repeated lifetime transfers of the nil rate band into relevant property trusts every seven years; the suitability of existing trust IHT charges in the form of entry charges and periodic charges; and the treatment of will trusts.
The Government believes that the current trust tax regimes for income tax and capital gains tax (CGT) are broadly appropriate, but raises some detailed questions. These relate to CGT private residence relief, income tax relief on trust management expenses, the distinction between income and capital receipts in trust law, and tax consequences where trusts and transactions are declared void by the courts.
Simplicity
In searching for simplicity, the Government sees much of the trust tax regime as unavoidably complex and the consultation offers few suggestions for improvement.
It invites views on how the income tax and CGT treatment of ‘vulnerable beneficiary trusts’
(trusts for beneficiaries with a disability or for bereaved minors) might be simplified, alongside their interaction with ‘age 18 to 25 trusts’ (a continuation of bereaved minor trusts used in some circumstances).
It also asks whether existing tax compliance procedures, which require trustees to liaise with settlors or beneficiaries (as the case may be), might be replaced by a standalone or simplified regime – either for all trusts, or for those trusts whose settlors or trustees would welcome a reduction in administrative burdens.
A chance to respond
Under the Government’s Tax Consultation Framework, this consultation on the taxation of trusts is at Stage 1 of the process. In other words, its purpose is to seek views on the policy design and any possible alternatives, before HMRC consults later on specific proposals for reform.
If you have views which you would like to share with ICAS to inform its response, please email the ICAS tax team.
Article supplied by Taxing Words Ltd