Perhaps the principle reason behind the development of trusts in common law was not tax savings, but the delivery of family money to those who could not manage it effectively. Many trusts in the past were small family trusts set up to look after a particular individual after the death of their parents. The Inheritance Tax Act 1984 resulted in the fairly abrupt end of such onshore trusts and accelerated the move offshore. However, whilst maintaining trust assets is obviously essential, the perceived distance between trustees and beneficiaries can lead to problems. Recent changes in taxation legislation have sought to encourage the use of onshore trusts, where vulnerable beneficiaries need active support. It is therefore, appropriate to consider whether there is a growing role for onshore trusts.
Some trusts can also have the benefit of supplying funds without depriving vulnerable persons of the means tested benefits on which they are reliant. This was the problem that so troubled the Court Appeal in Ilott v Mitson  EWCA Civ 797. In that case Lady Justice Arden said the District Judge at first instance was wrong to make a lump sum award that took no real consideration of the applicant’s means tested benefits. The Court of Appeal went on make a judgment that did do that, although at a significantly higher price. The proposed purchase of Mrs Ilott’s council house and the £20,000 additional sum, amounted to an award of over three times the need of £50,000 that the District Judge found (in a somewhat opaque manner) was reasonable.
When the Supreme Court in Ilott (Respondent) v The Blue Cross and others (Appellants)  UKSC 17 reverted back to the District Judge’s award, they somewhat skirted around the means testing issue. At paragraph 44 they did point out the Court of Appeal’s solution itself disentitled Mrs Ilott to Housing Benefit :-
“It also seems likely that in the absence of a discretionary trust the additional “option” to draw down £20,000 at will would fall foul of exactly the same capital disqualification rules as to benefits, because those rules treat capital which is available to the claimant, but of which he has deprived himself, as being in his possession: see Housing Benefit Regulations 2006, SI 213/2006, regulations 49 & 50, (consolidated with the Council Tax Benefit Regulations SI 215/2006), together with the Guidance Manual issued to officers by the Department of Work and Pensions BW1 (13 September 2013), to which it does not seem the Court of Appeal was referred.”
However, that point seems difficult as Lady Justice Arden’s proposal was that she buy her property and hence not require Housing Benefit. As her Tax Credits where not capital means tested, it was in that way a creative, albeit expensive, solution to the problem.
The Supreme Court nevertheless restored the District Judge’s award of £50,000 and at paragraph 41 commented that in relation to benefits:
“The Court of Appeal rightly said that the 1975 Act is not designed to provide for a claimant to be gifted a “spending spree”. But this kind of necessary replacement of essential household items is not such an indulgence; rather it is the maintenance of daily living. Moreover, how the claimant might use the award of £50,000 was of course up to her, but if a substantial part of it were spent in this way, the impact on the family’s benefits would be minimised, because she could put the household onto a much sounder footing without for long retaining capital beyond the £16,000 ceiling at which entitlement to Housing and Council Tax Benefits is lost.”
Leaving aside that on applying for Leave to Appeal to the Supreme Court the charities agreed to the purchase of the house in any event – this case had long since ceased to be about Mrs Ilott – many benefits lawyers would be puzzled by this. The benefits regulations have specific provisions to prevent a spending spree, so as to drop down below the capital threshold. For example, the Housing Benefit Regulations 2006 (HBR), at regulations 49 and 50, sets out how capital – other than that in personal injury or discretionary trusts – are treated as notional capital and that capital is only to diminish by the weekly rate that benefits would have been awarded. Whilst there is some discretion by the assessor to ignore some expenditures for essential items, it is doubtful that the holidays the Supreme Court suggested be taken would be exempt.
This does suggest that the Supreme Court decision did not turn on issues of what actually was provided by the award, but – partly due to the publicity it attracted – was a reinstatement of orthodoxy. It stressed the principle of testamentary freedom and the importance of charities, whilst reinstating the District Judge’s rather unclear award against them.
What the Supreme Court did in obiter touch upon, was the possibility of the use of discretionary trusts to effect the desired result in an economic manner. Many of us have been achieving this in settlements, which courts have readily approved. However, this was not really an option to the court after the contested hearing. This was partly owing to a prerequisite for an agreed trust deed and willing and qualified trustees.
So what in practice would a discretionary trust have offered in the Ilott case? Firstly, the Inheritance (Provision for Family and Dependants) Act 1975 provides that any legacy award is in effect backdated to the date of death. As such Mrs Ilott would not have ever received the money for means testing purposes. It would be as if her mother had set up a Will Trust. Such Will Trusts can be exempt from means testing if they do not give the beneficiary an absolute interest.
The regulations dealing with means testing, such as regulation 49 HBR and The Care and Support (Charging and Assessment of Resources) Regulations 2014 (CSCAR) do exclude discretionary trusts. For example regulation 22 of the CSCAR at sub-paragraph 2 states:
“The adult may be treated as possessing any payment of capital which would be treated as capital possessed by a claimant of income support under regulation 51 of the Income Support Regulations (Notional Capital).” This is a reference to the Income Support (General) Regulations 1987. At regulation 51(2) of those Regulations, again under the heading “Notional Capital”, set out a series of exceptions to nominal capital are set out. Those include, as well as a personal injury trust, a discretionary trust.
As such it would be possible to put a legacy into a discretionary trust, which would allow for benefit to be given to the client, and still have that money ring-fenced for means testing.
This does return us to the issue raised at the outset, which is tax. The tax treatment for such trust would not be as onerous as one might think. Firstly, there would be no immediate inheritance tax charge or periodic charges as the trust would be under the nil rate band of £325,000. Will trusts are in any event not subject to an immediate charge.
The HMRC would of course have to be notified of the trust and income tax returns filed. However, it is unlikely that this trust’s income would exceed the £1,000 at basic rate band. Furthermore, for a trust such as this it is unlikely that there would be any substantial capital gains – certainly not beyond the trust allowance.
Importantly, if the trust were drafted so as to allow full capital advancement, then such a trust might be short lived. The capital items needed might be acquired within the first tax year. Monies up to the capital allowances could be paid direct to the beneficiary. As such the trust might only last one year. Whilst there would be some costs in this process, if the trustees knew what they were doing, it would not be to the extent of the value lost by means testing.
If Mrs Ilott had been severely disabled then the tax position might be mitigated further by an election under s89 of the Inheritance Tax Act 1984 for Vulnerable Persons Trust status. The rules in relation to this tax status was made more attractive in the Finance Act 2014. However, they are still not without their issues, not least that entitlement might lapse as one qualification is entitlement to various disability benefits. Furthermore, as specific trust deed is required. Such trusts are certainly advisable for larger trust funds.
For such very disabled beneficiaries, applying the trust monies so as to set up an effective care plan is challenging and specialist work. In those cases a trustee must have knowledge of the statutory services and work with a Court appointed Deputy or the Local Authority. The powers and obligations of a trustee are in many ways substantially different and a trustee should be wary of overstepping his role. An example of the pitfalls in doing so is illustrated by the recent case of Staffordshire County Council v SRK  EWCOP 27, where a Deputy was held liable to having deprived the client of their liberty through putting in place a comprehensive care plan.
Nevertheless, if a good working relationship is established between the two bodies, a real improvement in the quality of life can be delivered to the beneficiary. Indeed, most Social Workers and Deputies are happy to work constructively with Trustees, although it is fair to say that they are not all consistent.
The complexities of setting up and administering the trusts can lead to expense, which has to be balanced against the benefit delivered. Whilst costs are a major concern to all beneficiaries, in smaller trusts proportionality comes more into play. However, if the alternative is that trust funds are only used as a substitute means tested benefits, then trusts are attractive to beneficiaries, if there is a clear plan agreed from the outset.
As to the reasons why trustees and executors should and indeed often do consider such arrangements when dealing with disappointed beneficiaries, one only has to look the Ilott case. Whilst most cases do not have so many parties and do not involve two trips to the Court of Appeal and then the Supreme Court, beneficiaries with little to lose will litigate. In this case it is hard to see how the charities could have received anything after the £50,000 award.
In conclusion, trusts do offer real benefits for some vulnerable persons. The use of such trusts are not however without problems. Trustees’ personal liability for tax understandably makes many nervous to take on the tax issues. The complexities above do limit the number of lawyers who can deliver cost effective benefit. Nevertheless, the complexity of using trusts does lead the client to lawyers and as such it is something that we should embrace.