Election pledges could spell trouble for family trusts

03 November 2023

HMRC has published its latest statistics on the number of taxpaying trusts in the UK and the figures make for depressing reading for advocates of the legal arrangement. 

For the tax year to 5 April 2022, a total of 141,500 trusts and estates submitted a self-assessment tax return. That represents a 3% reduction from the previous year, and is the latest fall in a longer-term decline. In 2005, the number of trusts and estates that submitted a tax return totalled 220,500 and over the last 17 years, that number has fallen by over 35%.

The UK family trust can trace its roots back to the 12th century, so what is causing this sudden decline over the last 20 years or so? Part of the problem is that the decline could be self-perpetuating. With fewer trusts in existence each year, there is a corresponding decline in how many people understand them and their benefits.

That declining knowledge base is arguably being reflected in the professional services industry as well, with it becoming more of a specialist area, which can lead to higher running costs. That in turn can put trusts out of reach for some and the statistics suggest that the number of trusts with higher levels of income are broadly static and that it is the smaller trusts that are being wound up.

The family trust is an important legal concept and should not solely be the preserve of the wealthy. It can play an important role in helping with the transfer of assets between generations. For example, it effectively allows someone to give the benefit of an asset away, whilst retaining control of that asset during their lifetime. 

A potential barrier to more family trusts being established is inheritance tax (IHT). During the last Labour government in 2006, Gordon Brown in his time as chancellor, introduced significant changes to the IHT rules and how they apply to trusts. As a result, the vast majority of new trusts created were potentially subject to an upfront inheritance tax charge of 20% if the amounts settled exceeded the IHT nil rate band, currently £325,000.

Since that date, many new trusts that have been established have been funded with assets that qualify for IHT reliefs such as business relief (BR) and agricultural relief (AR). This can allow for the trust to be funded with assets with value in excess of the £325,000 nil rate band and potentially prevent an upfront 20% IHT liability from arising.

With reports that the current shadow chancellor, Rachel Reeves, is considering a pledge to scrap BR and AR in Labour’s election manifesto pledges, the future looks bleak for the family trust. Such a move would further decrease the number of new trusts being established and likely limit them to smaller trusts with value within the nil rate band, which may not be cost effective to run long term.

Similarly, the move may lead to the winding up of many existing trusts where they currently hold assets qualifying for BR and AR, as they may then be subject to periodic IHT charges. In particular, an IHT cost of up to 6% could arise every ten years on the value of such BR and AR qualifying assets, which may not arise at the moment. 

The year ahead may be a pivotal one for the future of the family trust, and an unintended consequence of the contest for the keys at Downing Street is that it accelerates its demise.