Discretionary Trusts – Can you have your cake and eat it?
Updated: Apr 17, 2020
Discretionary trusts appoint a number of beneficiaries, which gives them the potential to benefit from the assets held in the trust. Potential beneficiaries will often include family groups like the settlor’s (the person who creates the trust) children and grandchildren. It can also include groups like charities but is it possible for the settlor to include themselves as a beneficiary too?
The answer is yes they can, however, there are consequences to including yourself as a beneficiary and it is important to make sure that you are aware of these and are comfortable with them, before you decide to include yourself as a beneficiary.
If you add yourself as a potential beneficiary of a discretionary trust you will have created a ‘settlor-interested’ trust. A settlor-interested trust has different tax rules attached to them. These tax rules differ to the usual trust taxation rules and they have been put in place primarily to ensure that the settlor gains no tax advantage when creating a trust which they can also benefit from.
These different taxation rules relate to the treatment and liability of all the main taxes, Income Tax, Capital Gains Tax and Inheritance Tax. The rules relating to taxation of a settlor-interested trust can be lengthy and complex to discuss in detail, but we have summarised some main points below;
Income Tax – With settlor-interested trusts (where the settlor can benefit from either the trust income or trust capital), the whole of the trust income is taxable in the hands of the settlor, even if they do not actually receive the income.
Capital Gains Tax (CGT) – If the settlor places assets into a settlor-interested trust, the settlor will have a chargeable gain on the settlement, which cannot be deferred, resulting potentially in immediate CGT liabilities when the assets are transferred into the trust.
Inheritance Tax (IHT) - If a settlor creates a trust from which he is still able to benefit from the property given away, this will be a gift with reservation of benefit (GROB) for IHT purposes. This will also be the case if a settlor has not specifically excluded himself from all benefit under the trust and if the trustees have the power to add any beneficiary. This means that the value of the trust fund representing those assets will remain in the settlor’s estate for IHT purposes, s.102. Finance Act 1986 (FA 1986). So, on the death of the settlor, the assets of the trust will therefore be deemed to form part of his estate.
It may surprise you to read that the rules relating to Capital Gains Tax and Income Tax will also class trusts where a settlor includes their spouse or minor children as potential beneficiaries, as a settlor-interested trust, not just when a settlor includes themselves as a potential beneficiary. Again, this will be the case even if the settlor, their minor children or spouse never actually receive any benefit from the trust.
The effect of these rules can vary depending on individual circumstances, including what type of assets are placed in the trust and their values. If anyone is considering creating a discretionary trust and they still wish to have the potential to benefit from the assets themselves in the future, it is always advisable to discuss this with a professional, who can give specific advice on the effect of this, especially on your ongoing tax affairs.
It may seem strange to put property into a trust if the settlor still wants to retain an interest in it, however, there may be situations where this is beneficial. For example, if the settlor has become ill and is now unable to work, he may create a discretionary trust to ensure that there is sufficient provision for his future should his condition get worse. As well as being the settlor, he is also the beneficiary as the trustees will be able to make payments of either capital or income to him.
It is also important to remember that the appointment of the settlor as a trustee only would not have the same effect. Owning assets as a trustee does not give you a beneficial interest (unless this is specifically given in the trust deed) so this would not cause the trust to be classed as settlor-interested.
Settlor-interested trusts can be beneficial for many reasons, but a great deal of effort has been made to ensure that tax advantages are not one of these benefits. HMRC make sure that if you want the advantages of trusts but still want to retain a benefit, then you will have to pay for it.