On 7 November 2018, HMRC finally published its long awaited consultation on the taxation of trusts, first announced in the 2017 Autumn Budget and entitled ‘A review’. As that suggests, there are no specific proposals for reform; instead, this is a high level document explaining the general principles that the government believes should underpin the taxation of trusts and the extent to which the current rules achieve these, with some examples of areas currently thought to fall short.

What are the key principles?

The key principles suggested are transparency, fairness and simplicity, with question 1 asking whether this is a reasonable approach. These principles are not controversial in themselves and sound like a good starting point, albeit that they are not new. The government issued three successive consultations in 2012, 2013 and 2014 on the inheritance tax (IHT) treatment of trusts, the first two entitled ‘simplification’ and the last calling for ‘fairer’ trust charges. (Ultimately, their proposals for a ‘settlement nil rate band’ were abandoned and only minor simplification measures were introduced in 2015, alongside rules to target avoidance through the use of multiple trusts.)

However, each of the three principles is open to interpretation and there may also be difficulties in reconciling them. Take ‘fairness’, for instance: the consultation equates this to neutrality but specifically acknowledges the need to balance fairness with simplicity ‘where the two principles could lead to different outcomes’.


The review suggests that trusts should be sufficiently transparent that the beneficial ownership of funds or assets is not hidden. There are cogent arguments that trusts should be fully transparent to government authorities, such as HMRC, customs and law enforcement agencies, which should be sufficient to prevent individuals ‘hiding’ assets in trusts. But we also need to look further, at what governments do with the information that is given to them. Increasing globalisation has brought with it exchange of information agreements (now about 100), which raise the delicate issue of whether inter-governmental transparency is always a positive measure. For example, there may be concerns about the recipient government using the information in a way that endangers beneficiaries or to confiscate assets held by the trustees, perhaps even for its own (possibly corrupt) purposes.

Attitudes to the provision of information under inter-governmental agreements (IGAs) vary. Some countries, such as the US, seem keen to receive information but slow to provide it; whilst others, such as Switzerland, examine every request in detail before deciding whether or not to provide the precise information requested – a commendable approach, but not one which all jurisdictions follow.

As for any wider publicity, article 8 of the Human Rights Act 1998 (the right to respect for privacy and family life) provides strong and legitimate reasons why details about beneficiaries should not be made available to the general public, as the French government found to its cost. On 21 October 2016, the French Supreme Constitutional Court ruled that its proposed public trust register was in breach of privacy rights because it would disclose to the public details relating to beneficiaries, including information about their respective wealth management decisions. Article 1649 AB section 2 of the French Tax Code, which had introduced the register, was therefore declared unconstitutional with immediate effect. The need to respect the privacy of individuals can easily get lost in the global debate on transparency but should be given proper weight.

Can transparency be enhanced any further?

This is question 2 in the consultation, but it is difficult to see how much more transparent trusts could become before legitimate rights to privacy are completely eroded. There has been a massive increase in compliance over the last few years, both in the UK and worldwide; examples include the Foreign Account Tax Compliance Act (FATCA), the Common Reporting Standard (CRS), the persons with significant control (PSC) and trust register requirements. Much of this was designed to increase transparency and international cooperation.

It is hard to envisage further legislation other than the measures already announced (such as the register of offshore owners of UK property and the widening of the Trust Register requirements following the EU’s fifth Anti-Money Laundering Directive). The latter alone could mean that thousands more trusts need to register, many reflecting standard arrangements to hold life insurance or joint interests in land, where there seems little risk of assets being hidden, if indeed that is the perceived evil.

So there is a strong argument that the existing rules, coupled with the various exchange of information provisions in the treaties between developed countries, already give HMRC enough in its armoury, especially when coupled with the enhanced penalty regime for offshore matters.

Indeed, the existing rules perhaps go further than is ‘fair’. Trust disclosure is already required of all beneficiaries (however small their share), the trustees and any protector. However, is the level of disclosure required proportionate when compared to the PSC register, which uses ‘significant control’ to define who must register (broadly, those with 25% or more shares/votes or a right to appoint directors)? There is no percentage interest definition for trusts but, if ‘fairness’ is the aim, trusts should not be required to be more transparent than companies.

Are any of the proposals specifically concerned with offshore trusts?

All of the proposals concern all types of trusts but HMRC seems reasonably relaxed about UK trusts, noting that reforms in 2005 and 2015 have plugged a number of gaps in the tax rules affecting them. However, there is a clear focus on non-resident trusts, thought to pose a significantly higher risk in terms of criminal exploitation and money laundering. Question 3 in the consultation document is therefore whether to change the definition of resident and non-resident trusts, presumably to make it harder to establish a non-resident trust – although it is difficult to see exactly how this might be achieved. This is then followed by question 4 – a request for views and evidence on the reasons a UK resident and/or domiciled person might choose a non-resident trust rather than a UK resident trust.

It is worth remembering that the UK has used private trusts as vehicles to protect vulnerable beneficiaries, or to protect assets from improvident beneficiaries and claims by creditors, since the 12th century. (They were originally developed during the Crusades.) Indeed, the review acknowledges that trusts are an intrinsic part of the UK’s legal system and that ‘there are many circumstances throughout UK society in which trusts play a valuable role’, which are certainly welcome statements from HMRC. But we do not all live, work and own assets only in the UK nowadays: families are increasingly international and may hold assets in several different jurisdictions, each with its own succession regimes, conferring different rights on family members and with the potential for tricky conflict of law and/or double tax treaty issues on death. Some family members may be tax resident in the UK, with the potential to become deemed domiciled in future, whilst others may be and remain resident elsewhere. In those circumstances, trusts (created either inter vivos or by will) can dramatically simplify and streamline how assets are held during the owner’s lifetime and how they will devolve upon death. However, using a UK resident trust may increase the overall tax burden or be inappropriate from the perspective of the intended beneficiaries and the underlying assets. By contrast, a non-resident trust might meet the owner’s legitimate succession and asset protection needs perfectly.

The UK has historically taken the view that offering a beneficial taxation regime helps to attract international individuals, giving the UK a competitive edge. Trusts used by non-doms are part of that package. The treatment of offshore trusts should not therefore be considered in isolation, but as part of whatever general approach the government wishes to take to the taxation of non-domiciliaries.

It will be interesting to see what responses emerge to question 5, which seeks views and evidence on any current use of non-resident trusts for avoidance and evasion, and how to address this in future. Note, though, the eliding of ‘avoidance’ (which, as a matter of law, is still legal albeit a moral ‘hot potato’) and ‘evasion’ (which is clearly illegal). This occurs throughout the document, as it does in other HMRC publications. No one can sensibly argue against the proposition that taxpayers should pay whatever the law demands, but we need legal certainty about what exactly is and is not taxable. It is hard to defend the lack of certainty that this implies.

How should fairness be assessed?

The government’s approach is to equate fairness with neutrality, so the tax treatment of trusts should be fair in the sense of fiscally neutral. It should neither encourage nor discourage their use. It is worth remembering the 2006 changes to the taxation of trusts; in particular, the introduction of the relevant property regime with an upfront 20% IHT charge for new lifetime trusts. Additionally, trusts pay the highest rates of income and capital gains tax. We are not therefore starting on a level playing field.

However, as the consultation freely admits, assessing fairness and neutrality depends on what comparisons are being made. Possible suggestions are:

  • to approach trust taxation as though the property and/or income of the trust still belong to the settlor (because the property has not been given outright to the beneficiaries);
  • to compare trusts with the position where property and/or income have been given free and clear to the beneficiaries (so treating the trust as transparent); or
  • to view the income and assets as belonging to the trustees themselves.

These different viewpoints seem surprising. In the IHT context, the most appropriate approach would be to compare a gift into trust to an outright gift, since a transfer into trust is fundamentally about making a gift for the benefit of the beneficiaries (not the trustees) and divesting oneself of the assets. On that analysis, the current rules do not achieve parity. This leads straight to the conclusion that if the government’s aims are indeed fairness and neutrality, it should re-introduce the ability to create inter vivos qualifying interest in possession trusts without immediate entry charges. This would immediately put the IHT taxation of trusts on a much more neutral footing, both with outright gifts and trusts created by will, although it would not itself level the income tax and CGT playing field.

What IHT measures are proposed to make the tax regime fairer?

The consultation lists various aspects of the current regime which may not meet the fairness and neutrality criteria, seeking views in question 6 on the case for and against a targeted reform to the IHT regime for trusts. The research mentioned below found that settlors choose to place their wealth into trusts up to the value of the nil rate band every seven years, in order to create trusts without incurring a lifetime IHT charge of 20%. Such arrangements can be beneficial in comparison with holding those assets outright until death because the assets would normally no longer be part of the settlor’s or a beneficiary’s estate. This is argued to be a means of obtaining additional nil rate bands, and in that sense is unfair. However, it is equally possible to argue that an individual can give away unlimited assets to another individual via a potentially exempt transfer (PET) on which no immediate IHT charge would arise and which could escape IHT altogether, putting them in a better position than if they had made gifts into trust. If the ability to make PETs to interest in possession trusts was reinstated, the assets would also be in the recipient’s IHT estate – and the playing field levelled.

When releasing this consultation, HMRC also published the results of some independent research, ‘Exploring the use of trusts’, aimed at understanding the reasons why settlors use trusts. This was based on a very small sample (from interviews with only 40 advisers and a mere 20 settlors). While most advisers did not see tax as a predominant motivator for the use of trusts, settlors believed that saving IHT was one of the main reasons to set up a trust. This perception, however, was based on a lack of understanding, particularly of the ongoing IHT charges on trusts (many settlors were completely unaware of these) and so unfortunately is not a very reliable indicator.

There is also a suggestion that the IHT trust charging regime results in less tax being paid during the lifespan of a settlor than if he or she had retained the assets outright, suffering the 40% charge on death. This must depend on the methodology used, however, as there are several possible approaches. Meanwhile ‘tax deferred is tax saved’ and the earlier payment of IHT ten year charges, whilst welcome from the government’s perspective, is arguably more expensive to trustees, who are unable to invest and grow the value of the tax funds paid away.

Another paragraph focuses on whether the current regime for taxing will trusts is the right framework for taxing trustees and beneficiaries to IHT in the future. This is surely an area that is ripe for review. The 2006 changes, in particular the introduction of a complex tax charging regime for those who choose (as most do) to leave assets to children at 25 rather than 18, make little sense to most clients, let alone the still more complex regime for gifts to grandchildren and other minors.

Are other measures proposed to make the tax regime fairer?

The consultation then poses some specific questions about income tax and CGT on trusts, culminating in question 7, which rather bravely seeks views on those points and ‘any other areas of trust taxation not mentioned that would benefit from reform in line with the fairness and neutrality principle’. Again, a critical question is what comparators to use.

The first specific suggestion is that it is unfair to allow trustees to claim main residence relief on a property occupied by a beneficiary because that beneficiary might not benefit from any proceeds of the sale (they might benefit other beneficiaries), which suggests that the comparator here is an individual. In that case, surely giving the relief to trustees and outright owners alike makes the position tax neutral, and so to withdraw it from trustees would do the very opposite of what the review is advocating? On the factual hypothesis, the more likely scenario is surely that the trustees will either use the proceeds for a new property to which that beneficiary moves or pay him outright, so that he can buy the replacement. Does this therefore imply that the relief is likely to be narrowed or withdrawn? Given that no one can have more than one main home at any one time, and that even an outright owner might choose not to apply the proceeds of his home in the purchase of a new one, it is not really clear exactly what ‘mischief’ the government has in mind here.

The next specific topic is trust management expenses. HMRC suggests that the tax treatment for trusts is more generous than it is for individuals, who cannot deduct income expenses of managing their own affairs, and therefore does not produce a neutral outcome. This, however, fails to take into account that beneficiaries of trusts cannot claim the assets in the same way as outright owners, nor can they control what expenses are incurred by the trustees.

Third comes the taxation of income and capital receipts, as classified under trust law, where the consultation flags up that some receipts are not being taxed at either the special trust tax rates or the marginal rates of the income beneficiary, putting beneficiaries in a better position than other taxpayers. What this example again ignores is that an income beneficiary cannot claim capital, so it would be unfair for them to pay the same rate of tax as an outright owner who can.

Even these few examples demonstrate, therefore, that the current system is not achieving the aims of fairness and neutrality and a few small changes will struggle to make it do so. If we really want a level playing field, a wider and more radical reform seems necessary.

Last but not least, views are sought on whether it is fair that transactions by trustees can sometimes be declared void by the courts, particularly in circumstances which produce an unfair tax outcome. This is clearly a reference to HMRC’s dislike of Hastings-Bass type proceedings, where it can lose out when the adverse tax consequences of trustees’ mistakes are reversed.

Simplicity – how to achieve it?

The aim is for trust taxation and administration to be sufficiently straightforward so that the tax system does not disincentivise the use of trusts where appropriate; and minimises the likelihood of error. It is, however, acknowledged that trust taxation is necessarily complex, due to:

  • the wide ranging effects that setting up and running a trust can have;
  • the variety of different types of trust that must be accommodated by the tax system;
  • the range of taxes involved; and
  • the need to ensure fairness of tax treatment between trust users and those who decide to manage their wealth and assets outside a trust.

Question 8 focuses on whether the income tax and CGT rules applying to vulnerable beneficiary trusts (for beneficiaries with a disability or bereaved minors) could be simplified and the reliefs made more effective, as well as their interaction with ‘age 18 to 25’ trusts. It is difficult to see much justification for a distinction between bereaved minors and 18 to 25 trusts: it would be much simpler for them to be aligned.

A further concern is that many small trusts find income tax administrative requirements unduly onerous, especially where the tax due is low. The government’s research found that the cost of employing an agent to calculate the IHT periodic charges for a trust can outweigh the cost of the tax itself. The request is therefore for ideas to ease the administrative burden on trusts.

Finally comes an appeal for views and evidence on other causes of excessive complexity in the trust taxation system, with a view to completely changing the current basis for trust taxation if this would produce a significant improvement. The review highlights the difficulties caused by the need for trustees to liaise with the settlor or beneficiaries to ensure that all parties pay the correct amount of tax, rather than there being a standalone or simplified regime either for all trusts, or for those trusts whose settlors or trustees would welcome a reduction in administrative burdens.

The consultation is open for comment until 30 January 2019. The government will then decide whether to proceed with any specific reforms based on the suggestions received, after which further consultations will be issued on any detailed proposals (assuming that it has the time and resources to take matters forward). Any radical change would be a huge task, so will not be imminent. Meanwhile, the Office of Tax Simplification’s review of IHT is also due any day now.

It is too early to tell what the future direction of travel will be, but I encourage you to respond to this review. It’s a numbers game, so the number of responses matters.

This article first appeared in the Tax Journal on 30th November 2018.