This article is relevant to ATX-IRL candidates and is based on the legislation in force as at 30 September 2022
Confession time.
Hello. My name is Paula and I LOVE trusts.
But what’s not to love?? It brings in all the capital taxes, capital gains tax (CGT), stamp duty and capital acquisitions tax (CAT). The rules are the exact same, (with a very slight twist on stamp duty), that we have already gone to the pain of learning in other parts of the ATX syllabus. Then we have the add-in of a couple of extra rules and hey presto that’s Trusts almost covered.
A trust exists where the settlor, (the person who owns the assets and who is now transferring them into the trust), transfers the control of these assets to trustees, (another person who holds the assets for the benefit of the beneficiaries). By settling property on a trust, (transferring assets into a trust), the assets or the income from the assets can be used by persons other than the legal owner.
The trust provides a structure whereby the assets of an estate can be transferred from one generation to the next where minor children are involved, or allows trustees to determine the needs and requirements of potential beneficiaries in the future through a discretionary trust.
Trusts can be created during a person’s lifetime, or they can be created by way of a will, taking effect after a person’s death. Tax implications can arise on set up of the trust; during the life of the trust and when appointments are made from the trust.
They manage the trust assets on day-to-day basis and pay tax on any profits that arise in the process. When they take over the trust assets, they must notify Revenue of the trust, using Form 1 return, due 31 Oct /15 Nov.
There are various types of trusts. In ATX we are concerned with two types:
- Fixed trusts
The trust document sets out who the beneficiaries are and exactly how income and capital of the trust are to be dealt with.
- Discretionary trusts
The trust document sets out who the beneficiaries are but gives the trustees absolute discretion as to how income and capital of trust are to be dealt with.
The trustees have a wide discretion to apply income or capital for the benefit of the beneficiaries. The beneficiary of a discretionary trust does not have the right to receive any benefit from the trust unless and until the trustees make an appointment to that beneficiary.
Let’s consider the life of trust under three headings:
The settlor can set up a trust during their lifetime or on their death. Effectively, they are disposing of assets and therefore the usual CGT rules will apply.
If it’s a lifetime transfer, we must test for the usual CGT reliefs – eg entrepreneur relief, retirement relief and principal private residence relief. (It’s useful to remember that there is no CGT on cash or Government securities as these often feature in an exam question).
If the trust is set up on the taxpayer’s death, there is no CGT because there is no CGT on death.
From the trust point of view, if the trust is set up when the settlor is alive, the usual stamp duty rules and rates apply. For example, if a house under the value of €1m is transferred, then 1% of the market value of the house is owing. If the trust is set up on a death, then of course there is no stamp duty liability, (usual stamp duty rules).
There is no CAT liability at this stage as the assets are yet to be appointed to the beneficiaries.
(‘Appointed’ in this context simply means that legal ownership is passed over to the beneficiaries.)
Income during the life of the trust
Any income coming into the trust – eg dividends or rental income will be subject to income tax (IT), payable by the trustees on behalf of the trust. The usual IT rules apply except that its easier to calculate. There’s no standard rate cut-off or any tax credits or allowances available. Therefore, a simple 20% calculation is all that is called for.
The beneficiaries, upon whom any income has been settled, (given to them), will also have an income tax liability under schedule D case IV. This will be taxed in the usual way with cut-offs and tax credits, with a discount taken for the tax already paid on this same income by the trustees.
However, if this income is not settled (given) to the beneficiaries within 18 months there will be a further surcharge on the income for the trustees to pay.
In the case of a fixed trust – ie where the beneficiary is entitled, under the trust documents, to the income of the trust, and where income is settled on a minor (under 18 and unmarried) and the settlor is alive, the settlor will continue to be assessed on the income arising to the trustees until the minor attains the age of 18.
Disposing and acquiring assets during life of the trust
During the life of a trust, the trustees may decide to sell and reacquire different assets. Again, the usual CGT and stamp duty rules apply. Note that as with all of the trust taxes, the trustees have this liability on behalf of the trust. Annual exemptions and reliefs are NOT available to the trust.
For example, the trustees sell some shares that were settled in the trust. CGT at 33% is payable, on the difference between the disposal proceeds and the market value at the time the shares where settled into the trust. There are no reliefs and no annual exemption available.
Then let’s say the trustees now decide to acquire agricultural property. There will be a stamp duty liability at 7.5% payable by the trustees on behalf of the trust. Again, there are no reliefs or exemptions available to Trustees.
The trustees will have a CGT liability if the assets have increased in value from the time of being placed into trust to date of sale. Remember, trustees get no annual exemption or any CGT reliefs so its quite straight forward to calculate.
The beneficiaries have NO stamp duty liability on appointment. This is the only departure from our usual capital tax rules. However, the usual CAT rules, rates and reliefs apply. The CAT will be based on the market value as at the time of appointment. We test for CAT reliefs such as agricultural, business or indeed dwelling house relief. The current CAT thresholds will apply and the remainder will be taxed at the CAT rate of 33%.
(To summarise here, the settlor and the beneficiaries are entitled to claim reliefs. The trustees are not.)
The CGT offset will also apply as this CGT and CAT are the same event.
That’s the straightforward rules. Very much in line with the rest of the ATX syllabus.
Now on to the tricky bits:
There was a view held, that it was unfair that assets in trusts could avoid any CAT, by never being appointed (and the beneficiaries could live off the income). Therefore, discretionary trust tax (DTT), (an initial levy (IL) and an annual levy (AL)), was introduced to make trusts less attractive from a tax perspective.
Initial levy (IL)
There is a once off IL of 6% on the market value of the assets within the trust that becomes payable – when ALL the beneficiaries of the trust are aged 21 AND the Settlor is deceased.
(Note that this IL does not apply if the trust is for the SOLE benefit of an incapacitated person).
Once this IL is triggered, then an AL becomes payable the following year at 1% of the market value of the assets within the trust.
To further encourage the assets to be appointed, so that a CAT payment can be potentially collected by Revenue, there is a further rule that if the assets are appointed within five years of the IL being triggered, then half of the IL, 3%, is refunded to the trust.
Many taxpayers, contemplating setting up a trust for their children are surprised to discover that DTT is charged when the youngest principal object, usually a child, is 21. Many parents do not feel that their children are mature enough to receive the trust property at that age. In addition to a fear of alcohol or drugs, there is also a fear that access to such wealth will diminish their children’s ambition. However, neither the courts nor the Revenue Commissioners see it as their function to protect wealthy young adults.
The trustees of a discretionary trust are then faced with the difficult choice between distributing assets to children prior to their 21st birthday if the settlor is deceased, to avoid tax or retaining assets in the trust and suffering DTT.
There have been petitions to increase the age limit from 21 to 25 to reduce the pressure on trustees to distribute before beneficiaries are ready to deal with assets responsibly. Conversely, there have been rumours that it will actually be reduced to 18, the age of majority, in line with other legislation.
For further information and reading on trusts, including past ATX IRL trust questions updated for the current examinable Finance Act, refer to the ACCA recognised ATX IRL textbook and Q & A pack, available from Griffith College. Contact ann.donegan@griffith.ie
Written by Paula Byrne FCCA MBA, ATX lecturer, Griffith College