One of the questions that is frequently asked by clients of
Technical Connection relates to the liability to tax of the settlor
of a trust. Many questions appear to stem from a misunderstanding
of the term "settlor". This month we seek to clarify some of the
issues using a case study. It is particularly relevant toUKsettlors
of offshore trusts.
The case study
This is based on a recent enquiry related to an actual
situation. Briefly, the facts were as follows:
Some years ago Mr A, a friend of Mr X, created a discretionary
trust with a sum of £10 in an offshore jurisdiction. Mr A and his
brother (both non-UK resident) were appointed as trustees of the
trust and both were excluded from all benefit under the trust. The
beneficiaries of the trust were the children of Mr X and anybody
else that the trustees appointed as beneficiaries. Neither Mr X nor
his spouse were excluded from benefit under the trust.
Mr X, (UK resident and domiciled at all times), in his quest to
mitigate his potential IHT, income tax and CGT
liabilities, proceeded to transfer several properties to this
trust, including his principal residence and some buy-to-let
The questions posed were: Has Mr X improved his tax position?
Has he achieved his tax objectives in relation to income tax, CGT
and IHT? In other words, did his "planning" work? What were
the tax results of the transfers he had made to the trust and what
were the subsequent income tax and CGT consequences?
The rules and the definitions
First, who is a settlor?
A settlor is a person who 'makes a settlement', that is someone
who puts or gifts money or other assets into a settlement. This is
known as 'settling' property and it can be done directly or
A 'settlor-interested trust' is one where the settlor has an
interest, as defined in s625 of the Income Tax (Trading and Other
Income) Act ('ITTOIA") 2005. A trust will be 'settlor-interested'
if the settlor or his/her spouse (or civil partner) can benefit
from the trust propertyin any way. In practice, this means that the
settlor and spouse are not specifically excluded from all benefit,
even if they are not specificallyincludedas named
The 'settlements' provisions treat trust income of a
settlor-interested trust as belonging to the settlor for
income tax purposes (ITTOIA 2005, s 624).
For CGT purposes, a settlor is treated as having an interest in
a settlement if any of the followingmaybenefit from the trust (TCGA
1992, s 169F)
- The settlor
- The settlor's spouse;
- A "dependent child" (or stepchild) of the settlor (aged under
18 and unmarried and not in a civil partnership).
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, s 169B).
For IHT purposes, if a settlor creates a discretionary trust and
is not specifically excluded from the discretionary class in a way
that they cannot benefit at any time, they would still be able to
benefit from the property given away. This will be regarded as a
gift with reservation of benefit (FA 1986, s 102, Sch
This will be the case regardless of whether the settlor actually
receives any benefit from the discretionary trust - the fact that
the settlor is capable of benefiting means that the gift with
reservation rules will apply
So has Mr X achieved his objectives?
Given the definition of "settlor" for tax purposes, Mr X will
clearly be considered as the settlor in relation to all the assets
he has transferred to the trust. This was everything except the
initial £10 - the settlor of that sum was Mr A.
Let us now look at each tax in turn.
Despite the fact that Mr X is not listed as a beneficiary under
the trust, the fact that he has not been specifically excluded from
all benefit and that the trustees have the power to add any
beneficiary (other than Mr A and his brother) means that any gifts
made by Mr X into this trust would have been gifts with reservation
of benefit (GWR).This means that the value of the trust fund
representing those assets remains in Mr X's estate for IHT
purposes. Of course, the GWR is not the only IHT
Every time Mr X transferred an asset to the trust, he made a
chargeable lifetime transfer for IHT purposes which, depending on
values involved, could have resulted in lifetime charges at 20%
increasing to 40% on death within 7 years. To prevent a double
charge to tax, relief under the Double Charges Regulations may be
available if the original gifts took place less than 7 years
And there are also the periodic and exit charges to
In short, not only did Mr X not achieve any IHT mitigation, he
is potentially in a worse position from a tax point of view than he
would have been had he done nothing.
The settlement made by Mr X clearly falls within the definition
of a 'settlor-interested trust'. This means that all
the trust income as it arises will be taxed on Mr X. But again,
this is not the end of the story. Since 2006 the fact that a trust
is a settlor-interested trust does not absolve the trustees from
paying tax on the trust income (effectively on the settlor's
behalf). In the case of Mr X the trustees are non-UK resident but
the trust income is generated fromUKbuy-to-let properties. This
means that the non-resident landlord rules will apply (broadly
speaking, this requires the tenants to deduct 20% tax from any rent
payments and pay it over to HMRC).
So again Mr X's income tax position has not improved but got
Capital gains tax
Again, the settlor-interested trust provisions will apply. This
means that CGT hold-over relief would not apply to any transfers to
the trust (resulting potentially in immediate CGT liabilities when
the assets were transferred to the trust). There could also be
potential complications with claiming principal residence relief
(PPR) on the property occupied by Mr X on any subsequent disposal
given that to qualify for the PPR exemption S225 TCGA1992 requires
that the property is occupied by a person entitled to occupy it
under the terms of the settlement. As Mr. X is not actually listed
as a trust beneficiary, that could be difficult to argue.
As can be seen from the above, there are various potentially
adverse tax implications where an individual settles cash or other
assets on trust but is capable of benefiting under the trust.
Various anti-avoidance rules exist for income tax, capital gains
tax and inheritance tax purposes, which can give rise to unforeseen
tax problems for the unwary.
In the above case study Mr X has unfortunately only made his tax
position more complicated and quite possibly incurred unnecessary
tax liabilities. And it's not like he could just pretend that none
of these transactions ever happened. To unscramble the arrangement
there will potentially be further tax consequences depending on the
Of course, professional advisers should be able to point out
these potential problems and ensure that any planning that may be
implemented avoids them.