Upcoming Budget could trigger a steep decline in new trusts

During the last Labour government, Gordon Brown as chancellor introduced extensive changes in 2006 to the taxation of UK trusts. Subsequently, the number of trusts submitting self-assessment tax returns has fallen from 210,000 in the 2005/06 tax year to 141,500 in the 2021/22 tax year, a drop of almost one-third. 

Transfers of assets to or from most new lifetime trusts are subject to inheritance tax (IHT) charges at:

• Up to 20% when assets are transferred to the trust (entry charges).
• Up to 6% when assets are distributed from the trust (exit charges).
• Up to 6% at every ten-year anniversary of the trust’s creation. 

These charges can be perceived as barriers to establishing trusts but still represent IHT savings compared to the IHT charge on assets held personally which can suffer death taxes at a flat 40% on value above the available allowances.

The latest inheritance tax (IHT) statistics indicate that the actual tax paid as a result of trust IHT charges may be less than initially expected based on headline rates. For example, in the 2021/22 tax year, HMRC’s latest estimates show that only 48 chargeable events, with a combined chargeable value of £42m were subject to entry charges. These entry charges generated just £2m of IHT, giving an effective entry charge rate of less than 5%.

The total of IHT receipts from trusts in the 2021/22 tax year is estimated at just £52m, of which the bulk – £42m – came from 10-year charges. The total IHT receipts from trusts is less than 1% of the almost £6bn of IHT liabilities in that year, a drop in the ocean when compared to the IHT assessed on deaths.

The falling number of trusts may indicate that many taxpayers do not understand how they operate. However, trusts have a history of protecting assets for the vulnerable and provide flexibility and control on how assets pass to the next generation. The fact that the majority of IHT on trusts appears to be collected from 10-year charges suggests that long-established trusts are valued by taxpayers.

Effective IHT rates on trusts are likely to be heavily impacted by claims for agricultural relief (AR) and business relief (BR) which can reduce IHT on qualifying assets by 50% or 100%. The 2021/22 statistics show an overall net increase in such claims on death, when compared to the prior year. Where AR and BR are available, trusts are useful for preserving and maximising these reliefs. Other taxes such as property stamp taxes, capital gains tax and income tax should be considered when assets are transferred into trusts, and taxpayers should take advice on how trusts can be beneficial for families.

There are rumours that restrictions to AR and BR may feature in the upcoming, first Budget of the new Labour government. Such a move may be one more step towards the demise of trusts, given that it appears that a large proportion of assets contributed into trusts now benefit from these reliefs. However, if valuable IHT reliefs are restricted or withdrawn, assets already held in relevant property trusts, benefitting from lower, ongoing, IHT rates may remain the ideal home for valuable and relatively illiquid assets.

Trusts have an important place in modern society, just as they did for the knights in the 12th century, but the rumoured potential changes to the tax system could accelerate the decline in their use even further. Trusts should not be the preserve of a select few and if reform is coming, then there may be opportunity to consult and expand the opportunity for their use by families.