This article was first published in the October 2012 Irish edition of Accounting and Business magazine.
Trusts are generally used where confidentiality is at issue for holding, preserving and transmitting wealth. Trusts are also useful where beneficiaries may be financially naive or imprudent and, therefore, the disponer is hesitant to transfer assets to them or where the owners of assets do not wish to be identified.
Even where trusts may be the most appropriate choice for clients, many advisers are faced with skepticism whenever the trust concept is broached. It is a misconception that only wealthy individuals establish trusts or that trusts are used to hide assets offshore or avoid tax. The most common types of trusts are bare trusts and discretionary trusts. The use of bare trusts is often necessary for minor beneficiaries who have an entitlement to assets but who are not permitted under law to hold the legal title to those assets in their own name.
The main advantage of acquiring assets in the name of minor children is that any capital acquisitions tax is based on the market value of the assets at the date of the acquisition (or on the underlying cash gift used to fund the purchase) so advantage can be taken of current low market values. Any growth in value accrues in the child’s hands. Discretionary trusts are often of a type that give the trustees discretion as to how they deal with assets. Discretionary trusts are useful in holding property in limbo to see how circumstances turn out in the future and can also be used to protect young children while giving the trustees flexibility in providing for the children of the trust. Discretionary trust taxes are often seen as harsh and carry a huge administrative burden between filing returns and paying taxes annually. However, these costs should not be the determining factor in whether to set up a discretionary trust. For instance, while discretionary trust tax may arise in the future, it will not arise until the youngest child reaches the age of 21. It may be possible to appoint the trust assets or change the terms of the trust in advance of the youngest child’s 21st birthday to avoid the charge arising. In addition, even though discretionary trust may arise where children are over the age of 21, where there is a significant amount of valuable assets involved, the discretionary trust tax may be a worthwhile cost when compared with inheritance tax or gift-tax saved.
In the case of most capital gains and capital acquisition tax reliefs, certain conditions must be fulfilled before reliefs can be availed of. The advantages of using discretionary trusts are that it allows trustees and the beneficiaries to plan their affairs so that they are in a position to quality for relevant reliefs. Where a disposal gives rise to a charge to capital acquisitions tax in respect of any property and the same event constitutes a disposal for capitals gains tax of the same property (or part of it) then, insofar as the capital gains tax has been paid, it may be deducted as a credit against the net capital acquisitions tax due (up to the maximum amount of the capital acquisitions tax due). In other words, where the same event gives rise to a charge in respect of capital gains tax and capital acquisitions tax, the capital gains tax paid may be credited against any capital acquisitions tax due. As both capital gains tax and capital acquisitions tax are currently charged at the rate of 30%, this can be a very valuable relief which, if properly utilised, can effectively eliminate a charge to capital acquisitions tax. In the event of trustees wishing to appoint assets, which would give rise to capital gains tax, with careful tax planning, a substantial reduction in the overall charge to tax can be obtained. Where income of a discretionary trust is payable to a child beneficiary for the purpose of the child’s university education, the child would be taxed on the income, presumably the child’s tax rate would be lower than that of the parent, resulting in a savings of tax. If the child were 18 years of age or over, the trust could be funded directly by the parent without triggering the income attribution rules under income tax rules.
Asset protection trusts can be used to protect assets in the event of a bankruptcy. Funds are generally held in trust for a specific beneficiary followed, on determination of that interest, by a discretionary trust in favour of a class of beneficiaries for the remainder of the trust period. The trust is usually determinable in the event of bankruptcy, an attempt to alienate the property or in other similar specified events. Where an asset protection trust is set up to defeat creditors, the court will generally set aside the trust in case of bankruptcy. There are also a number of commercial uses for a trust such as employee incentive schemes, unit trusts and the issue of a number of debt instruments. Businesses, for example, utilise the trust because of the flexibility it provides when structuring deals. Also, the fact the trust separates the benefits of ownership from the burden of ownership minimises risk with respect to liability and provides for increased investment opportunities.
Trusts are flexible and versatile, but they are also complex legal tools that may give rise to unintended tax consequences if not structured carefully. Therefore, it is recommended that the services of a professional are retained while giving effect to the actual intention of the trust. This article is only a general discussion and does not deal with all the issues and tax analysis of same. When claiming any of these savings, it is important to do so carefully and seek tax advice where necessary.
Crona Brady is tax manager and Úna Ryan is tax senior, Grant Thornton.