In this article, we look at different types of vehicles which can help you preserve wealth for future generations: trust and foundations.
What is a trust?
A trust is a legal relationship created by an individual or individuals (a settlor or settlors) when assets are placed under the control of one or more individuals or companies (the trustee/s) for the benefit of one or more individuals (beneficiary/s).
Trusts allow the legal ownership (held by the trustees) to be separated from the beneficial interest (held by the beneficiaries) ie the right to enjoy income earned from the assets and their capital value.
Types of trust
Different types of trust can be used depending on what you are aiming to achieve. For example, trusts can be drafted so that one or more people are entitled to receive the income earned on the assets during their lifetime but are not entitled to the capital value, which can be useful if you want your partner to maintain a certain standard of living, but the assets themselves to be passed down to the next generation. Alternatively, you can give your trustees complete discretion about when and to whom (among a class of beneficiaries) to distribute income or capital, which preserves flexibility so that the trustees can consider the relevant circumstances (including any unexpected circumstances) and decide how, when and to what extent the beneficiaries should benefit.
As with Family Investment Companies (FICs) and Family Limited Partnerships (FLPs) (see parts 1 and 2 of this series), trusts can help to protect assets from creditors (because the settlor no longer holds the legal title to the assets (nor in most cases the beneficial interest). Trusts can also be used to preserve assets for future generations and prevent them being dissipated by less responsible beneficiaries or accessed by the spouse of a family member going through a divorce.
Because a trust is not a legal entity, the trust does not pay tax itself. Instead, depending on where the trust is tax resident (for example in the UK or elsewhere) and the nature of the trust, tax can be charged to:
- The trustees. Trustees may be liable for tax when they receive income or sell trust assets on which there is a chargeable gain, on every ten-year anniversary of the trust's creation, and when assets are distributed to beneficiaries.
- The settlor. A settlor may be charged when they transfer assets into the trust, if the value transferred is over their inheritance tax nil rate band (currently £325,000), or the assets are standing at a gain. If the settlor or their family has an interest in the trust, the settlor may also be charged on the income arising in the trust.
- The beneficiaries. Beneficiaries may be charged when they receive income or capital from the trust in some circumstances.
From a UK tax perspective, UK resident trusts offer more limited advantages, although trusts which are resident outside of the UK can be highly tax efficient for those who are non-UK domiciled.
What is a foundation?
A foundation is a standalone entity with its own legal personality but it does not have shareholders or partners. Foundations are set up by "Founders", and effectively they own themselves and own assets in their own names. They are run by councils, in accordance with their by-laws and charters, which will vary depending on your aims in setting up the foundation and are run for the benefit of one or more beneficiaries or for a specific purpose.
Foundations are typically seen in civil law jurisdictions (which often do not recognise trusts), such as continental Europe and in the Middle East. They are not recognised under common law, so for UK tax purposes a foundation will be treated as a trust or a company and taxed accordingly.
Foundations can be used in a similar way to trusts, even though they are corporate bodies. You can use family foundations to protect assets from creditors and they can also prevent individual family members and later generations from gaining control over assets held by the foundation, as family members cannot dissolve the foundation, transfer assets to third parties, or exercise voting rights.