Mark McLaughlin highlights a selection of capital gains tax issues involving trusts.
Trusts can be used for a wide variety of purposes, such as asset protection or passing family wealth down generations. From a tax perspective, trusts need to be handled carefully to prevent unexpected and unwelcome consequences.
This article highlights a selection of capital gains tax (CGT) issues. However, remember to also consider other potentially relevant taxes (e.g., inheritance tax (IHT) and income tax) in advance of any events or transactions involving trusts.
Give it away…properly!
If the trust’s creator (settlor) gifts an asset to the trust (e.g., an investment property), this will be a deemed disposal at market value for CGT purposes. This could result in a chargeable gain for the settlor, even though no proceeds are received for the property. A form of CGT relief (holdover relief) generally applies to defer gains on transfers of assets on which IHT is immediately chargeable, such as the gift of a property to a discretionary trust (TCGA 1992, s 260(2)(d)).
However, this relief is subject to various conditions and exceptions, including that the trust must not be ‘settlor interested’, such as where a ‘dependent child’ of the settlor (i.e., a child, including a stepchild, who is under 18 years old, unmarried and does not have a civil partner) can benefit from the trust. Thus, when setting up a trust, consider the trust’s potential beneficiaries carefully.
Sharp claws
A separate form of holdover relief is potentially available for gifts of business assets (TCGA 1992, s 165). However, the held-over gain on the disposal may be ‘clawed back’ from the transferor in certain circumstances. For example, this can arise if during the ‘clawback period’ (i.e., up to six years after the end of the tax year of disposal) the trust becomes settlor-interested.
There are only limited exceptions to this anti-avoidance rule, so it would be prudent to keep a close eye on events involving the trust during the clawback period.
Timing is everything!
If seeking to rely on holdover relief under TCGA 1992, s 260 on the basis that a transfer out of the trust to a beneficiary results in an immediate IHT charge, the timing of the transfer may be critical to the availability of that holdover relief.
For example, no IHT is chargeable (so no CGT holdover relief is available) on a transfer which occurs within three months of the day on which the trust commenced, or within three months following a ten-year anniversary of the trust. In other words, if no IHT is chargeable on the transfer, no holdover relief under section 260 is available either.
Practical tip
A holdover relief claim under TCGA 1992, s 260 can have unfortunate implications where the asset transferred is a house. For example, a parent may wish to gift a buy-to-let property into trust, which subsequently becomes the main residence of their adult child as a trust beneficiary. The parent might intend holding over any gain on the property disposal for CGT purposes (under section 260), and the trustees may intend claiming principal private residence (PPR) relief on a subsequent disposal of the property.
However, PPR relief may be restricted or denied on the disposal of a dwelling by an individual or settlement trustees in such circumstances, if the property’s base cost has been reduced following one or more section 260 holdover claims on its earlier disposal (TCGA 1992, s 226A).
