Trusts: Tax Implications
In this article we will discuss and explore the main tax heads of relevance to the creation of trusts and their operation. Trusts are an arrangement whereby a person (a trustee) holds property as its nominal owner for the good of one or more beneficiaries. A trust can be created during one’s lifetime or through a will to take effect on death. Trusts are created for a variety of reasons:- for minor beneficiaries, beneficiaries with disabilities or as asset protection trusts. Once a trust is set up, the trustees hold the trust assets for the benefit of the beneficiaries. The trustees should register the trust for tax and have a unique tax number assigned to the trust, which is separate from the trustees’ own personal tax affairs.
Capital Gains Tax (CGT)
When a disponer creates a trust during his lifetime, he/she will transfer assets into the trust fund. Depending on the type of assets transferred to the trustees, CGT may arise. CGT is assessed on the market value of the asset transferred to the trust. If the market value is greater than its acquisition value, then CGT will arise. No CGT will arise where cash (Euro currency) is transferred to the trust.
If the trust is created by a will, becoming operational on death, then no CGT arises on the initial creation of the trust as the trustees will inherit the assets at their market value at date of death. This is the base cost for any future disposal of trust assets.
Whether Irish CGT arises on the trust assets depends on the residence and ordinary residence status of the trustees. Generally if the majority of the trustees are resident and ordinary resident in Ireland, and the general administration of the trust is carried out in Ireland, they will be liable to CGT on their worldwide gains.
If the majority are not so resident or ordinarily resident in Ireland, then the trustees will only be liable to Irish CGT on gains arising on the disposal of specified assets, namely:-
- Land and buildings in Ireland;
- Minerals in Ireland including related rights such as exploration and exploitation; and
- Unquoted shares deriving their value or the greater part of their value from such assets at 1) or 2) above.
Apart from selling or disposing of assets, trustees will be deemed to have disposed of assets for CGT purposes in the following scenarios:-
- Trustees subsequently cease to be resident or ordinary resident in Ireland (migration);
- Where a life interest ends and trust continues to remain in the trust. No CGT applies where the trust ends on cessation of a life interest and the beneficiary becomes absolutely entitled, such as “to A to life remainder to B”. On A’s death, the trust assets belong to B, and trustees must vest the assets in B, but this does not trigger a CGT event.
- Where a beneficiary becomes absolutely entitled to trust assets save on cessation of a life interest as above, for example “to B on reaching 25”, when B reaches 25, the trust may be liable to CGT on the rise in value of the trust assets during the intervening years.
If any of these events occur, then market value is imposed and the trustees are deemed to have disposed of and reacquired the assets at market value.
If CGT arises, then it may be credited against any Capital Acquisitions Tax which may be payable by the beneficiaries of the trust, who inherit the assets on cessation of the trust.
It is important to appreciate that trustees do not qualify for the annual CGT exemption of €1,270.
Again the tax residence of the trustees is crucial to determine if the trust is liable to Irish income tax. If all of the trustees are Irish resident, then trustees have a liability to Irish income tax on worldwide income. If all are not resident, then trustees are only liable to Irish Income tax on Irish source income only.
Trustees will pay income tax at the standard rate of 20% and have no entitlement to credits, reliefs or allowances as apply to individuals.
In addition a surcharge of 20% applies to any income accumulated in the trust which has not been distributed within 18 months of the tax year in which the income arose.
If a trust beneficiary is absolutely entitled to the income (such a life tenant), then the trustees are not assessable to income tax on those funds. Revenue will assess the beneficiary directly.
The usual tax return deadlines and filing requirements that apply to individuals apply equally to trustees.
On the transfer of assets into a trust created while the disponer is alive, stamp duty may apply. If it is residential property then stamp duty of 1% applies. If it is commercial property then a rate of 2% applies.
If cash is transferred, no stamp duty applies. No stamp duty applies to assets transferred to a trust created under a Will.
When assets are transferred to beneficiaries in accordance with the terms of the trust, no stamp duty arises.
Capital Acquisitions Tax (CAT)
CAT applies to gifts and inheritances. No CAT arises on the transfer of assets to a trust, as the beneficiaries are not yet beneficially entitled in possession to the assets. Where a beneficiary receives an asset from the trustees, they are taxed as if the benefit was taken by the settlor/deceased.
The normal CAT thresholds apply as follows:-
- Group A: children, minor children of predeceased child, parents inheriting absolute interest from child: €310,000;
- Group B: Grandchildren, brothers, sisters, nieces and nephews: €32,500;
- Group C: Everyone else: €16,250; and
- Where the threshold is exceeded, CAT at 33% is levied on the excess. The threshold is a lifetime threshold, so any previous gifts or inheritances received since the 5th December 1991 may reduce or consume the entire threshold.
CAT will arise in the following situations:-
- If the beneficiary is resident or ordinarily resident in Ireland on the date the benefit is received;
- If settlor is resident/ordinarily resident either at i) at the date of setting up the trust or ii) on the date the beneficiary receives the benefit;
- Where the settlor is resident/ordinarily resident at the date of death, CAT will arise on any benefit taken on his/her death; and
- Where assets are situated in Ireland.
A foreign domiciled person will not be deemed resident for CAT until they have been an Irish resident for five continuous years.
Distributions from a trust can give rise to both income tax and CAT. If income is passed to a beneficiary upon which income tax has already been assessed on the trustees, then a From R185 should be given to the beneficiary to claim a credit for the tax already paid by the trustees and the income is regressed up in the hands of the beneficiary and assessed in the normal manner. Distributions from the trust may be from capital or income and the character of the payments in the hands of the beneficiary will determine the tax consequences. The case of The Trustees of the Will of HK Brodie (Deceased) v CIR determined that payment of capital can be treated as income, if they come into the hands of beneficiary as income.
Regular or periodic distributions to a beneficiary can be both subject to income tax and CAT. A revenue concession exists where CAT is chargeable on the net benefit.
Discretionary Trust Tax
Discretionary trust tax only applies where the settlor is dead and the principal objects (children of the settlor or children of predeceased child of settlor) are over 21.
There is an initial charge of 6% payable where the settlor is dead and on occasion that last principal object attains 21 years of age. If the trust is wound up within five years, a refund of 50% of the initial charge is available. If the trust is created by Will, and all of the beneficiaries are over 21, then the liability to discretionary trust tax arises on date of death, and the estate has four months to discharge this tax.
There is an annual charge of 1% per annum thereafter where the trust remains extant chargeable on the value of the trust on the 31st December each year. The charge will not arise on any assets vested in the beneficiaries, absolutely, for life or for a period of five years or more.
The legal and taxation implications of trusts must be clearly understood before being set up. The taxation of trusts are complex and proper taxation advice must be taken by settlors and trustees. Members of our probate team would be happy to assist with any queries.