This is the first in a series where Richard Ballard,  Managing Director of Ryefield Accountants and Tax Consultants, discusses settlements and trusts and some of the potential pitfalls.

No1 Why Settlements and Trusts?

Some definitions

A trust is the relationship which exists where a person or persons (trustees) hold property for the benefit of others (beneficiaries).  A trust is usually created by a written document, possibly during an individual’s lifetime or perhaps by a will upon death.

A settlement is sometimes referred to as a trust, suggesting that they mean the same thing.  However, a settlement can include any disposition, trust, covenant, agreement, arrangement or transfer of assets.

A settlor is a person who, in relation to a settlement, made (or is treated as having made) the settlement directly or indirectly, or if it arose on his or her death.  This includes any person who has provided, or has undertaken to supply property directly or indirectly for the settlement.

Settled property is any property held in trust other than property held as nominee, bare trustee for a person absolutely entitled, an infant or disabled person.

Settlements legislation is contained in Income Tax (Trading and Other Income) Act 2005 Part 5 Chapter 5 (ITTOIA 2005 Pt 5 Ch 5) and Case Law.

Why would an individual or group of individuals set up a Settlement?

  • Settlements can be used to hold assets or the income from those assets for the benefit of a person or persons who may be considered by the settlor to be too young, too immature or too reckless to have power over the assets and sometimes over all the income from a gift or bequest. 
  • The Settlor may want a beneficiary to be able to use an asset or the income from an asset during the beneficiary’s lifetime but thereafter they want the asset to go to some other beneficiary or group of beneficiaries. 
  • The settlor may want an asset to be kept available for a large number of beneficiaries.
  •  An individual or group of people may wish to donate to and administer money and assets for charitable purposes.
  • Settlements can be used to reduce a settlor’s estate for Inheritance Tax purposes.  Providing the settlor nor his spouse or civil partner can benefit from the settled property in any way, the settlement will normally be effective for Inheritance tax purposes.  This means that if the assets are put into the settlement over 7 years before the death of the settlor then the value of the assets transferred to the settlement will not count as part of the settlor’s estate.

The Settlements legislation is complex and if a settlement is something you are considering setting up, it is essential to take sound legal and taxation advice.  Why not make use of Ryefield’s expertise and use the contacts page to arrange an initial free consultation.

Pitfall 1   Where the settlor or his spouse or civil partner can benefit in any way from the settlements assets or income of the settlement, the ‘settlements’ provisions treat trust income as belonging to the settlor for income tax purposes (ITTOIA 2005, s624).

Pitfall 2   Capital gains tax holdover relief is not available on a transfer of chargeable assets to the trustees if the settlor has an interest in the settlement (TCGA 1992, s169B).

Pitfall 3   The ‘gifts with reservation’ provisions can treat property transferred into trust as remaining within the transferor’s estate for inheritance tax purposes (e.g. if the settlor transfers a property into trust and occupies it rent-free as a beneficiary)(FA 1986, s102, Sch 20)

Pitfall 4   The settlements legislation can apply if an individual enters into an arrangement to divert income to someone else, resulting in a tax saving.  If those arrangements are bounteous, or un-commercial, or not at arm’s length or (for gifts between spouses or civil partners) wholly or substantially a right to income, the settlement rules can apply to cancel the income tax advantage.

There are many more pitfalls to watch out for!  Take Advice