STEP report reviews the social and economic benefits of trusts
This article was first published by Trusts & Estates Law & Tax Journal in September 2021.
Trusts are often misunderstood in the UK with the perception that they are a tool to evade tax and that their use is limited to the highest echelons of society. This reputation is damaging and threatens the continuing existence and use of trusts in the UK. As a result of this public perception, STEP commissioned a report to review the social and economic benefits of trusts. STEP’s aim is to ‘open the curtains’ by addressing common misconceptions and highlighting the positive benefits of trusts. While their report had a worldwide focus, this article will review and summarise the UK perspective.
Use of trusts
The report emphasises that trusts were created to meet the needs of families and that in the modern ages this differentiation between legal and beneficial ownership stemmed from the requirements of the Crusaders in the Middle Ages travelling to battle and their need to ensure that their families were provided for in their absence. The origin of trusts is therefore intrinsically linked to distinction between the concepts of legal and equitable ownership and the moral obligations of the church during this period.
The use of trusts over history evolved from largely holding land to holding cash, shares and securities. This evolution allowed those other than the landed gentry to benefit, demonstrating how trusts have changed with society to become more socially inclusive.
STEP aims to demonstrate that the use of trusts can benefit an individual throughout the course of their life and that their use is much more widespread than public perception would suggest. STEP has outlined this through the following examples.
Families and succession planning
At the heart of trusts is the desire to provide for families. Often those creating trusts wish to ensure that funds are maintained for future generations of the family. Settling assets in trust allows them to be ring fenced for this purpose and a key selling point of trusts is the certainty that this provides families.
Trusts created by Wills are especially common and their use can allow the testator the comfort that any minor children would be provided for and that they would not receive potentially large sums of money at a young and impressionable age.
Trusts also allow families to provide for their unique circumstances and their use is more common place as the traditional nuclear family becomes less common. A common use of trusts, especially those created in Wills, is to provide for ‘blended’ families, where the testator wishes to ensure that their spouse from a later relationship is provided for but that their estate will eventually be held for their children. This use of trust helps to avoid arguments and acrimonious relationships upon the death of a family member.
Until the recent changes in law to allow same sex couples the same rights as opposite sex couples, trusts could be used to help bridge the gap in rights afforded by law.
Trusts are also a useful tool in divorce settlements to allow children to remain in the family home until they are of age, avoiding the need to force a sale of the property.
A highly common but perhaps less well known use of trusts in succession planning is to hold a life insurance policy or death in service benefit. Many individuals may not realise that by nominating a work place death in service benefit that they are essentially creating a trust.
While a trust may be set up to provide for the educational needs of family members, a less reported use of trusts in education is a scholarship trust to assist those that are disadvantaged. STEP notes that it is a scholarship trust for Cambridge University that currently provides the largest number of international scholarships for the university.
In the UK in particular, there are further educational uses for trusts through the development of schools supported by charitable foundations and trusts. These forms of trust allow communities to flexibly support their local schools and allows donors more control over how their donations are used to benefit the school and pupils.
While trusts and homeownership may more commonly be associated with assisting the stereotypical trust fund beneficiaries to purchase a home, they have a more widespread use in home ownership. Many homeowners who own their property jointly may be surprised to learn that they are party to a form of trust. This increasingly common use of trusts allows co-owners, generally a cohabiting couple, to protect their individual investment into the property by holding their shares as governed by a declaration of trust.
The concept of a community land trust was also introduced to the UK in 2016 which assists individuals in achieving home ownership that may not otherwise be available to them. The basic premise is that the trust buys land and a family or individual then contributes to the trust in exchange for assistance with their deposit and low interest rate mortgages. The trust then appoints a board which acts democratically. These trusts have been lauded as a possible solution to the housing crisis.
Building a business
Employee-owned businesses are increasing in use throughout the UK. These models allow employees to share the profits and have been demonstrated to increase productivity and performance. STEP comments that the employee ownership trust was created by the UK government to encourage this model. These trusts can provide capital gains tax relief and allow the payment of income tax free bonuses to employees. This form of trust therefore allows employees to be rewarded for a business’ success in a way that a traditional employee may not.
Protecting the vulnerable
A key use of trusts in the UK is to provide for those that are vulnerable or disabled. The UK government has recognised this with tax benefits for trusts for the vulnerable. There are strict requirements which must be met so as to ensure that this tax relief is not exploited.
STEP reports that as of August 2018 UK Ministry of Justice’s Court Funds Office has around £2.4 billion of funds under management and over 185,000 accounts – many of them belonging to vulnerable clients, such as young children that have been awarded damages in civil actions or persons under a medical vulnerability.
Trusts are a common tool to hold occupational pensions. The trust is established to hold the pension fund and all members of the pension scheme are beneficiaries. Trustees are appointed to manage the fund and monitor the investments. STEP reports that the overwhelming majority of occupational pensions in the UK are held in such a trust, meaning that many Britons may be surprised to learn that they are already a beneficiary of a form of trust.
These pension trusts are strictly regulated and are subject to specific legislation. The rules ensure that a company’s pension funds are kept separate to the other company assets and are protected in the event of bankruptcy.
Individuals can also separately set up trusts to set aside assets for retirement or increase their retirement fund through investments.
The use of charitable trusts in the UK is longstanding, with STEP pointing out that the National Trust is one of the UK’s most famous charities. The UK government encourages charitable giving through tax reliefs and in the UK charitable trusts are highly governed and regulated.
Challenging public perception
Despite the above examples, STEP reports that is clear that the perception in the UK is that trusts are the purview of the rich and famous. It is suggested that this is in part due to many people being introduced to the concept of trusts through literature focusing on the elite. Highly publicised scandals, such as the Panama Papers, do not assist the public perception.
STEP suggests that recent media coverage, however, has been more favourable, such as the reporting on charitable trusts like the Bill and Melinda Gates Foundation and its assistance in the battle against Covid-19.
STEP concludes that there is a clear disconnect in public perception between these widely reported charitable trusts and the other benefits as outlined above and the view that they are mere vehicles to provide tax loopholes for the wealthy.
The perception that trusts are only available to the wealthy is challenged by STEP. They review the standard costs to establish a trust in the UK and, while they note that costs will increase as complexity increases, they find that the general starting price of a trust is £500. While this is not an insignificant amount, it demonstrates that for many ordinary people it is affordable to create a trust.
The increased global transparency in relation to the ownership of assets also challenges the view that trusts are used to hide funds from the tax man. There is ever increased worldwide scrutiny of beneficial ownership and countries such as the UK are now requiring registration of the beneficial ownership of assets, rather than merely the legal ownership.
The UK recently introduced a trust registration service which requires trusts which meet certain criteria to be registered with HMRC. Registration details include the identity of the settlor, trustees and beneficiaries and information about the trust assets, meaning that more information is required about the beneficial ownership of trusts than companies. The criteria for registration is due to be expanded soon, requiring more trusts to now register.
In addition, there is increasing exchange of information between countries, allowing authorities to identify assets placed in trusts offshore.
Further, while the public perception is that trusts are used to evade tax, trusts have increasingly been subject to tax in the UK, with trustees often being taxed at a higher than individuals. The commonly held view is that trusts are used to avoid inheritance tax but that view does not stack up against the 2006 changes to the taxation of trusts in the UK. It is now no longer possible for a UK resident domiciliary to settle funds in excess of the nil rate band in their lifetime without incurring inheritance tax at 20%. This is in addition to the periodic charges to inheritance tax in the trust’s lifetime.
Over the initial 30 years of assets being gifted to trust the tax position is largely neutral to that if they had been gifted absolutely upon death. Although STEP do note that this tax neutrality fades the longer assets are held in trust. In addition to this, trustees are subject to income tax and capital gains at higher rates than many individuals, without the same annual exemptions.
STEP has advised that ensuring that the taxation of trusts is largely neutral to the taxation of individuals is a key component in challenging their public perception.
There are also widespread reports linking trusts to financial crime which sully their public perception. STEP reports that the UK’s 2017 National Risk Assessment of Money Laundering and Terrorist Financing found that there is ‘very little evidence of UK trusts … being abused for money laundering purposes. The risk of criminals exploiting UK trusts to launder money is therefore assessed to be low.’
Regulatory and political response
The key concern with an overwhelmingly negative public perception of trusts is that this will lead to pressure on politicians to draft harsher legislation, making trusts unviable in many circumstances. STEP reports a concern that there is the general public perception that it is worth making trusts unviable in order to target the few ‘bad apples’ who actually do abuse trusts.
It is fair to say that policy makers are often responsive to public perception and STEP reports that this response can be seen in recent regulatory changes, such as the UK’s Register of Beneficial Ownership, the OECD’s Common Reporting Standard and the EU’s Anti-Money Laundering Directives. The Register of Beneficial Ownership in particular represents a shift in the UK government’s attitude to the concept of the separation of legal and beneficial ownership.
This is despite the fact that there is no clear evidence that trusts are inherently more subject to abuse than other financial vehicles, especially worldwide.
STEP reports that in the 2018 consultation ‘The Taxation of Trusts: A Review’, the UK government held a robust line on trusts and the view that they do not facilitate tax evasion or avoidance. There is therefore currently little appetite among UK politicians for wholescale reform of trusts but it is not impossible that this will change in the future.
It is clear from STEP’s report that the common public perception of trusts risks there being a movement for the reform or even the abolishment of trusts. Any highly publicised report of the misuse of a trust therefore risks creating a groundswell in public opinion. It is apparent from the report that this perception is incorrect that that there are real social and economic benefits to the use of trusts. The issue is how to publicise this and change perception. While STEP’s report is a helpful summary of the issue to assist in countering these perceptions, this message needs to be communicated to the public at large.
This briefing is for guidance purposes only. RadcliffesLeBrasseur LLP accepts no responsibility or liability whatsoever for any action taken or not taken in relation to this note and recommends that appropriate legal advice be taken having regard to a client's own particular circumstances.