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Breaking of discreationary trust

Breaking up Discreationary Trust and transfer investment property to limited company or settler

Hi

I have a client who had settled an investment property into a discretionary trust around 10 years ago. The trust receives rental income. Beneficiaries of the trust are two unmarried children and they are high bracket taxpayers. Due to this reason, no income was distributed to children up to date. The trustee pay income tax at 45% on trust income. The current value of the trust property is around 1. 6 Millian. At the time property transferred it was around  £900K.

Settler is worried, that he has to pay ten-year anniversary charge sooner and income tax at 45% on trust income. He was thinking either to break up the trust and transfer the property into a limited company.  Appreciate, if somebody can advice what is the tax implication of breaking up the tax and then transfer into a limited company.

As an alternative, he was thinking to transfer to beneficiaries. What tax implications to the trustees and beneficiary?

Other than the above options, has trustee got any better options?

Any advice will be greatly appreciated.

Thanks in advance.

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21st Mar 2019 13:10

If by “breaking the trust“ you mean “taking the assets back out” then either 1) he can’t legally do that or 2) the tax has been dealt with incorrectly for nearly ten years.

But it is obvious that there is potentially a considerable amount of tax in play. Why not buy in some advice/pass the query to another advisor?

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to Tax Dragon
21st Mar 2019 13:18

It's actually a little know feature of a discreationary trust, that it can, in fact, be discreated.

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By maxaca
21st Mar 2019 14:36

With a value of 900k when the trust was created there would have been IHT to pay on set up and any subsequent exits of capital from the trust will carry an IHT exit charge at that effective rate. The first and subsequent 10 year anniversaries simply reset the rate that will be used then for the principle charge and also for the next 10 years. Also any undistributed income accumulated during the first 5 years will be treated as capital for the purpose of this calculation.

Unless the property is sold at arms length (perhaps to a company), he can only transfer the property to beneficiaries in accordance with the trust deed - the discretionary class of beneficiaries is unlikely to contain a company. Also, whether selling property or transferring in-specie on breaking the trust will be a capital gains tax event, with CGT at 28% (if the property is residential rather than commercial), although hold-over relief may be available because of the IHT.

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21st Mar 2019 14:38

45% income tax on the rental income might seem cheap when you crunch the numbers... The significant value of trust property means there will be significant tax due when it is distributed (namely IHT and potentially CGT).

The fact the beneficiaries are HR taxpayers is no reason why the rent shouldn't be distributed... they get a tax credit of 45% and pay tax at 40%.

No one here could offer advice specific to your client's position without making a number of assumptions.

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to Adam12345
21st Mar 2019 15:05

Adam12345 wrote:

No one here could offer advice specific to your client's position without making a number of assumptions.

Spot on.

Mine would include that you were right to ignore the reference to "the settler" in the subtitle, else the tax changes completely, as I have already intimated.

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