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Trust planning - the good, the bad and the ugly

So, what’s good about trusts, where can things go bad and where do ugly situations arise that were never considered or anticipated at outset?

When trust planning is being considered by advisers and their clients, sometimes the potential tax benefits can blur the actual necessity of the planning or the actual requirements/circumstances of the client.


In certain situations, tax mitigation may be the fundamental driver for the planning and the client will be aware of the associated restrictions going forward. However, in other cases, all a client may actually require is a very simple unrestricted type of trust to avoid probate.


The Good


Where a policy is assigned to a trust and the original owner of that policy dies, the deceased’s estate does not have to provide any documentation to the policy provider to enable them to release the policy proceeds. This is because the trustees are the legal owner.


Probate avoidance demonstrates the effectiveness of trusts at their most simple level, but usually they are used for tax mitigation strategies by transferring assets outside of an estate or for succession planning.


But (and this is a really big but!) they only work if they are set up correctly, the right trust wording is used and all involved know what they can or can’t do. All too often, trust planning can become a millstone around the neck of those involved as it doesn’t work out as expected.


So what type of things can go wrong?


The Bad


Settlor Domicile and residence

Overlooked, these two factors alone can have significant implications on the effectiveness of the trust going forward. For example, if the client is UK domiciled, the creation of the trust can result in a charge to UK Inheritance Tax (UK IHT) and, furthermore, there would have to be some restriction as to how much they can benefit from the trust in order for it to be effective from an IHT point of view.


Alternatively, if they are not UK domiciled, the last thing they probably need are access restrictions if UK IHT planning is not their objective.


Have the succession laws in the client’s country of residence been considered?

For example, if the client is resident in a civil law jurisdiction, trusts can be ‘looked through’ where they seek to deprive heirs from inheriting property under local succession laws, or where taxes can be avoided due to the assets being held in trust. France has recently made its views very clear in these areas in that, although it officially acknowledges the existence of trusts, it doesn’t like them at all.


Selecting the correct trust provisions

If a client only wanted to avoid probate, then it would be overkill to set up a trust where they were excluded from accessing the trust capital. Alternatively, a simple probate trust is useless where IHT planning is concerned as the assets never leave their assessable estate.


Fixed or Flexible Beneficiaries

If the client is UK Domiciled, then their choice of beneficiaries can impact on the taxation of the trust.


Fixed beneficiaries = Potentially Exempt Transfer whereas:


Flexible = Chargeable Lifetime Transfer.


The question is then whether the client wants flexibility over tax, or vice versa?


Whilst having fixed beneficiaries does make the tax side of things easier (in the UK), it does also create an absolute right for the beneficiary and, as such, should the Settlor fall out with them or the beneficiary ‘goes off the rails’, there is nothing they can do to deprive that beneficiary of their share.


Therefore, although potentially more complex with regard to tax, having the flexibility to select beneficiaries can be very useful where there are concerns over a beneficiary’s capability to spend their inheritance wisely or where there are concerns about a beneficiary being involved in an unsuitable marriage or failed business venture.


Access

To be effective from an IHT and creditor protection point of view, there must be some restriction placed on the amount of access the Settlor has to the property placed in trust.


If there is unrestricted access, the IHT planning will fail (as nothing has been given away) and as the Settlor would be a beneficiary, a creditor could try to claim their interest in the trust.


Where IHT planning and access are required, a Loan Trust or Discounted Gift Trust (DGT) can be useful, but they are both totally different. The Loan Trust allows unrestricted access to the original loan and any outstanding amount can be recalled by the Settlor at any time. The DGT on the other hand creates an income for life which cannot be changed. Therefore, if income is not required, needs to be reduced or cannot be spent, DGTs may not be the right option.


The Ugly


At the start of this article we looked at areas which make trusts such good structures for planning etc. However, things can go terribly wrong and, where they do, the courts usually get involved.


Trustees not acting in the best interests of the beneficiaries

In Cowan v Scargill and others (yes, Arthur Scargill) the trustees of the National Union of Miners pension scheme had political motives which did not lead them to want to invest in certain countries. The court ruled that the trustees could not make a decision based on their own political agenda and that they had a duty to the beneficiaries to obtain the best return possible, irrespective of whether or not it was against the personal morals of the trustees.


Beneficiaries enforcing the trust

In Saunders v Vautier, assets were placed in trust for Vautier with the intention that he would not receive them until he was 25. Vautier was not particularly happy about this and, at 21, suggested that the trustees should wind up the trust and give the assets to him now.


The court decided that although he was only 21, as he was the only beneficiary, he was going to get everything anyway and therefore agreed with his suggested course of action. Clearly situations like this can be the last thing that concerned grandparents/parents would want where they had concerns over a beneficiary’s ability to use the trust fund wisely or as they had intended.


Trustee mistake

There has been a longstanding rule called the ‘Hastings Bass Principle’ which was, until recently, a ‘get out of jail free card’ if trustees undertook a particular course of action, and that action has unintended consequences – usually tax.


This was demonstrated recently in ‘Futter v Futter’ and ‘Pitt v Holt’. In both cases, the trustees took professional advice which led them to undertake a particular course of action. However, the advice was wrong and a significant tax charge arose. Trustee mistake and thus relief under the Hastings Bass rule wad claimed, and they were initially successful.


However, HMRC appealed the decisions and they won.


HMRC had, over the years, become incredibly frustrated at trustees claiming relief under Hastings Bass. They successfully argued that where trustees have taken advice prior to exercising their powers, they could not claim ignorance of the consequences irrespective of whether the advice was right or wrong.


As such the application of claiming trustee mistake has been significantly reduced and where any advice has been taken, rendered practically obsolete altogether.


In summary

It’s important that the right trust wording is selected for the right client objective, and that everyone is aware of what they can or cannot do.


RL360° has a number of tools available that can help you and your client select the most suitable trust, and all our draft trusts contain comprehensive guidance notes and case studies.