A trust is the separation of legal and beneficial ownership. The trustees legally hold assets for the benefit of others.
Two main types of trusts exists:
- An interest in possession trust: provides entitlement to the income of the trust as it arises along with a potential to benefit from the capital.
- A discretionary trust: provides the trustees with discretion over what and how to distribute or benefit beneficiaries.
A seriously ill person may wish to take measures to ensure they are looked after as their health deteriorates. This may include passing the ownership of assets to trustees who will legally hold and manage those assets for the benefit of the beneficiaries. They will also look to spend and/or distribute funds in a manner for the beneficiary’s benefit. The trust does not have to be established by the person affected by a serious illness and may instead be created by another person. For example, if a child is affected by a serious illness it may be that a parent or grandparent wishes to provide for them.
There are special rules for trusts established for the benefit of vulnerable persons. The trustees of a qualifying trust for vulnerable persons may claim special income tax and capital gains tax (CGT) treatment.
A vulnerable person is a ‘disabled person’ or a ‘relevant minor’ (under 18 years old and one of the parents has died). A disabled person includes one who is eligible for any of the following benefits:
- attendance allowance (either the care component at the middle or highest rate, or the mobility component at the highest rate)
- personal independence allowance
- an increased disablement pension
- constant attendance allowance
- armed forces independence payment
A vulnerable beneficiary includes someone who is unable to manage their own affairs because of their mental health condition.
A qualifying trust is one that, during the lifetime of the disabled person or trust satisfies the following conditions:
- the property is applied for the benefit of a disabled person
- either the disabled person is entitled to all the income or it is applied for the benefit of a disabled person
To obtain the special tax treatment, the trustees and a beneficiary jointly make a vulnerable person election. The election is irrevocable.
Vulnerable Trusts: Income Tax
The trustees’ income tax liability may be reduced by reference to a formula:
Step 1: Calculate what the trustees income tax would be.
Step 2: Calculate the vulnerable persons’ income tax as if the income had been paid directly to them as an individual.
Step 3: Reduce the income tax liability by the difference between step 1 and 2.
Vulnerable Trusts: Capital Gains Tax
The trustees’ CGT liability may be reduced by reference to a formula:
Step 1: Calculate the CGT the trustees would be liable for on qualifying trust gains.
Step 2: Calculate the CGT the vulnerable person would be liable for.
Step 3: Calculate the CGT as if the gains accrued to the vulnerable person instead of the trustees without relief for allowable losses.
Vulnerable Trusts: Inheritance Tax
Trusts for vulnerable people also receive special IHT treatment. When these conditions are met there is no IHT:
- if the settlor survives seven years, from establishing or contributing to the trust
- on distributions to a vulnerable beneficiary
- on each tenth anniversary (i.e. no principal charge)
On the death of a beneficiary, assets held on trust on their behalf are included in their estate for IHT purposes.
For trusts established on or after 8 April 2013, the treatment may be received where:
- all payments except for £3,000 per annum (or 3% of assets if lower) must go to the vulnerable person
- a person suffering a condition that is expected to result in them being a vulnerable person sets up a trust for themselves
- a trust is established for a bereaved minor and they must become entitled to the assets and income at age 18