Interest in possession trust
| Interest in possession trust |
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| See also |
The interest in possession trust from an Income Tax perspective is that where the beneficiary of a trust has an automatic right and an immediate to the income from the trust as it occurs. The person running the trust (the trustee) have to pass all of the income received which is less any trustees’ expenses, to the beneficiary.
The beneficiary who is enabled to the income of the trust for life is noted as:
- having a life interest or
- a life tenant.
A beneficiary who is enabled to the trust capital is noted as:
- capital beneficiary or
- the remainderman.
The beneficiary who receives income ("the income beneficiary") frequently does not have any rights about the capital of such a trust. However, the capital will usually pass to various beneficiary or beneficiaries in the future. Considering the terms of the trust, the trustees can have the power to shell out capital to a beneficiary even though that beneficiary just has a right to obtain income[1].
Inheritance Tax of an interest in possession trust
The interest in possession from an Inheritance Tax perspective can also contain the right to possess a non-income producing asset (for example - the right to reside in a house). There can be an Inheritance Tax charge when:
- wealth is distributed from an interest in possession trust,
- an interest in possession trust extents a ten-year anniversary,
- wealth (property or money) are put into an interest in possession trust.
The Inheritance Tax regime sometimes take advantage of its own classification for trusts. The interest in possession trusts can fall within what is known as "relevant property" trusts[2].
Capital Gains Tax and Income Tax
Capital Gains Tax and Income Tax on accumulation and maintenance trusts are generally the same as for discretionary trusts. Nevertheless, there is some except that if a beneficiary becomes enabled to income, that share of the trust's income becomes taxed as the interest in possession trust. Therefore, the settlor can be tempted to put money into maintenance trust and accumulation for the benefit of children and paid out to them. However, every income of the trust exceeding during a year £100 paid out to an unmarried under the age of 18 children is treated as the settlor's own income[3].
Examples of Interest in possession trust
- A life interest trust is an example of an interest in possession trust. This type of trust allows a beneficiary to have access to the income generated by the trust during their lifetime. The beneficiary has an immediate right to the income generated by the trust and the trustees must pass this income to the beneficiary as it arises.
- A qualifying disability trust is another example of an interest in possession trust. This type of trust is set up to provide an income to a beneficiary who is disabled or suffers from a long-term illness, and is unable to work. The beneficiary has an immediate right to the income generated by the trust, and the trustees must pass this income to the beneficiary as it arises.
- A discretionary trust is another type of interest in possession trust. This type of trust allows the trustees to decide how and when the income generated by the trust is distributed to the beneficiaries. The trustees have discretion over how the income is distributed, and can decide to pass some or all of the income to the beneficiaries as it arises.
Advantages of Interest in possession trust
Interest in Possession trusts offer several advantages, including:
- The primary benefit is that the beneficiary of the trust has immediate and automatic access to the income generated by the trust, with the trustee being responsible for passing this income on to the beneficiary after any expenses have been deducted.
- The trust also offers tax efficiency, in that the trust will receive a tax credit for any income tax paid, which can be passed on to the beneficiary.
- Another advantage is that the trust can be used to protect the beneficiary's assets from creditors, as the beneficiary does not have direct control over the trust's assets.
- The trust also allows for the flexibility of being able to change the beneficiary at any time, which can be beneficial for those looking to protect their wealth for future generations.
- Finally, the trust can be used to minimize the capital gains tax liability of the beneficiary.
Limitations of Interest in possession trust
The interest in possession trust has a few limitations. These include:
- The beneficiary of the trust must be an individual and cannot be a charity or non-profit organisation.
- The trust can only have a single individual as the beneficiary, and the beneficiary cannot be changed without the permission of the trustee.
- The beneficiary must receive all of the income from the trust, less any trustee’s expenses.
- The trust is not entitled to any capital gains tax relief and the trustee is liable for any capital gains made by the trust.
- The trust is not eligible for any inheritance tax relief.
- The trust must be maintained in accordance with the terms of the trust deed, and any changes to the trust must be approved by the trustee.
- The trust must be reported to HMRC annually and any income tax owed must be paid by the beneficiary.
Interest in possession trust is an arrangement whereby the trust's income is paid directly to the beneficiary of the trust, as and when it is generated, allowing the beneficiary to benefit from the trust's income. Other approaches to managing trusts include:
- Discretionary trusts - These trusts give the trustees discretion to decide how to distribute the income generated from the trust. This gives the trustees flexibility to adjust the income distribution between beneficiaries as circumstances change over time.
- Accumulation trusts - This type of trust allows the trustees to accumulate the income generated from the trust and reinvest it for the benefit of the beneficiaries. This type of trust is most suitable for long-term investments, as the trust can continue to grow over time and provide a larger benefit to the beneficiaries.
- Protective trusts - This type of trust is designed to protect the assets of the trust from creditors. It is typically used by people with high-risk assets who want to ensure that the assets are safe from creditors.
In summary, interest in possession trusts are one option for managing trusts, but there are a variety of other approaches available to trustees, depending on the needs of the beneficiaries. Discretionary, accumulation and protective trusts are all options that trustees can consider when managing a trust.
Footnotes
References
- Barton M., Road H., Wheatons P., (2011)., Acca P6 advanced Taxation FA2012 - Study text 2013, Bpp Learning Media
- Bohan B., McCarthy F., McLoughlin A., (2013)., Bohan and McCarthy - Capital Acquisitions Tax, A and C Black
- Goel S., (2009)., Wealth Management: The new business model, Global India Publications
- Hughes P., (2006)., Tax Planning for Businesses and Their Owners: A Specially Commissioned Report, Thorogood Publishing
- Moffat G., (2005)., Trusts Law: text and materials, Cambridge University Press
Author: Klaudia Święs
