How to use a trust to cut taxes and stay in control of your assets

If keeping a lid on inheritance taxes is your goal, then trusts can help. However, it may not be the most important reason people avail of these structures, which ultimately give greater control when determining how you want your estate shared out.

As Niall Glynn, a partner with Deloitte notes, trusts are often conflated with a structure designed to offer tax advantages. But depending on how they are structured, they can in fact result in higher taxes.

“There are some different and complex tax rules around trust which can render them complex, and result in additional taxation for the unwary,” he says. “People who do it rarely say it’s for tax purposes; it’s usually for broader purposes”.

With a variety of trusts available to be used in Ireland, if it’s greater control, or lower inheritance tax bills you’re after, here are some estate planning options.

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What is a trust?

At its simplest, a trust is a form of estate planning that allows you to control how and when your assets are passed onto others.

In Ireland, a number of types are used, including discretionary, fixed, bare trust, or a family partnership.

Trusts are typically used for a myriad of reasons: to protect your assets in the event you could be sued; to provide for minors, or children with disabilities, after your death; or to keep assets within a family where parents may have concerns over children’s marriages.

Trusts can also be used where there are illiquid assets, and the trust can be used to care-take those assets so they can be sold at the right time to maximise their value.

“If you didn’t have a trust you might have to sell those assets shortly after someone passes away, and you might not get the maximum price for it,” says Beryl Power, a tax director with PwC.

Different types can convey different advantages, and are treated differently from a tax perspective.

Discretionary/fixed

A fixed trust, for example, conveys a fixed interest in the assets to the beneficiaries.

“It’s a clear interest,” says Glynn, such as “I give my house to X for use during their lifetime, and after their death it can go to Y”.

Alternatively, a discretionary trust can be established. This gives the trustees “absolute flexibility” to apply the assets as they see fit, says Glynn. This means that trustees can adapt what should be appointed to certain family members, should there be a change in circumstances.

In such trusts, often the “settlor”, or creator of the trust, would write a letter of wishes to the trustees, setting out some guidance on how the proceeds of the trust should be shared out.

The key point with such a trust is that the beneficiaries have no legal interest in the assets, rather they have a right to be considered to receive them.

When it comes to taxation, a number of taxes apply. Firstly, the trust itself is subject to discretionary trust tax (DTT).

The reason someone might use a family partnership is because a parent can retain a controlling interest in a partnership

According to Glynn, the rationale for this tax, which was introduced in the 1980s, is that Revenue feared that a beneficiary could have use of assets and never pay CGT or capital acquisitions tax (CAT), hence the introduction of the levy.

It is applied at a rate of 6 per cent initially, and 1 per cent a year subsequently, and generally arises where a person passes away, and the youngest child reaches the age of 21. The 6 per cent can be reduced to 3 per cent if assets are appointed within five years of charge arising, which often happens.

“Certainly in my experience trusts are used for short period of time,” says Power.

Once the assets are disbursed from the trust, the beneficiaries may also face a tax bill, depending on the various CAT thresholds that apply. Such trusts can have a less attractive treatment of CAT than other types of trusts. This is because the trigger date for CAT is when the assets come out of the trust. So if the assets have increased in value during the period, then the ultimate tax bill may also be higher, too.

In addition, disposal of assets within the trust will give rise to a CGT charge, although Power notes this may be offset against a subsequent CAT bill.

On the other hand, if assets are held in a trust for subsequent generations, then double layers of taxation on the same assets can be avoided.

There can be a trade-off with a trust. As Power notes, you’re more likely than not increasing the overall tax liability. However, you are gaining an element of control over how and when they will be disbursed.

“You’d want to be pretty sure that your broader commercial or family requirements warrant the potential additional tax charges,” says Glynn.

When to establish a trust should also be a key consideration. If you set up a trust within your lifetime, then there is the potential for CGT/stamp duty in transferring the assets. No CGT applies, however, when a trust is set up as part of a will.

As Glynn states, when inheritance or gift tax rates are high, there may be an attraction in deferring such taxes and paying DTT. On the other hand, when they are low, such as they were from 1999 until 2008, when CAT was just 20 per cent, then paying 6 and 1 per cent is “quite unattractive”.

Family partnership

Another option in determining how to protect or dispense of assets is a family partnership. According to Glynn, this is useful when someone might want any appreciation in their assets to apply to younger family members.

While one option to achieve this would be to gift the assets outright, such a move would mean giving outright ownership of the assets to the children. A family partnership on the other hand, is a way of retaining control, while mitigating CAT liabilities.

This is because CAT is triggered when the partnership is formed. So, if an asset goes into a family partnership with a valuation of €500,000, upon which CAT is paid, but ultimately is worth €1 million when the partnership is wound up, there will be no further tax liabilities providing the asset is retained. In a discretionary trust on the other hand, CAT would apply to the €1 million. So a potential €165,000 CAT bill (disregarding the impact of tax free thresholds) could otherwise be a €330,000 bill.

“The reason someone might use a family partnership is because a parent can retain a controlling interest in a partnership,” says Power. “Normally with a family partnership, the way it would work is it is set it up, then the parents might gift money to the children, up to the (CAT) threshold, who would use it to invest in the family partnership. That money can be used to buy investment assets.”

“It works well in the context of assets that people want to work long term, as it caps or minimises future inheritance tax,” says Glynn, noting that gifting an asset outright can give “outright, unfettered control”, but with the family partnership, the parents can still exercise some control.

However, while the CAT treatment may be advantageous, it’s not as flexible as a trust arrangement, and won’t protect assets as well.

Bare trust

Another option is a bare trust. In this case, the child is the beneficial owner of the asset, but cannot access it until they turn 18.

Such trusts are easier to arrange then a more complex discretionary trust, and can be an ideal vehicle to hold assets that are likely to grow in value. If timed correctly, the assets could be transferred at a low value, giving rise to a lower CAT bill, and could be worth significantly more with no tax outstanding, when the child takes ownership.

I always say to people, if you're going to give a gift to your children, you need to be sure you've retained sufficient assets to look after yourself

This is because the tax event is triggered on the day the assets are transferred into the trust.

Some families use such a structure to save €3,000 each year, under the small gifts exemption; investing €6,000 each year would give rise to a lump-sum of €108,000 – and potentially more depending on how it’s invested.

The downside of such a structure, however, and a reason perhaps why Power says they are not so common, is that once the child turns 18 they can take ownership of the trust. This means the parent no longer has any control over how the assets are spent.

“That’s why you would typically see people using a family partnership, because the parent has the ability to retain more control over the asset”.

Can you get the assets back?

It’s a consideration that needs careful thought. If you put assets into a trust, are you happy that you won’t be able to get them back again should your circumstances change

“If validly constituted, once the assets go in, then the assets can only be distributed to beneficiaries,” says Glynn.

The trustees, however, may determine that it’s appropriate to wind up the trust and disperse the assets back to the original owner.

In short then, it should be considered as part of a broader financial review.

“I always say to people, if you’re going to give a gift to your children, you need to be sure you’ve retained sufficient assets to look after yourself,” says Power.

Finally, remember that when it comes to estate planning, you don’t need a one-size-fits-all approach. As Glynn notes, you can adopt a combination of the above arrangements to achieve your goals.