Posted by Simon Misiewicz on 1st March 2014
Are you “pained” to be paying more tax on your property income than your spouse?
Do you feel “ill” for having a good job when you pay so much tax as a high tax rate earner?
In this series of articles we are going to focus on “Deed of trust”
• Deed of trust to minimise your tax – Part 1 Income Tax
• Deed of trust to minimise your tax – Part 2 Capital Gains Tax
• Deed of trust to minimise your tax – Part 3 Inheritance tax
Tax issues need to be diagnosed in order to be understood for a remedy to be implemented.
If you own property and are a high tax earner through employment or through your own business then you could be paying between 40-45% in tax per year.
If you put properties into a deed of trust you can then reduce the tax liability from 40-45% to 20%.
Applying the treatment
Now we have identified the treatment here are a few ways that you can apply it to your “tax pains”.
There are many ways to minimise your tax and they are:
- Using Limited companies to pay just 20% corporation tax
- Using your spouse, family and friends to do some work which then utilises their personal allowance
- Amend the legal documentation when you purchased the property from Joint Tenants to Tenants In Common. This allows you to split the income and ownership of the property
- A deed of trust transferring the money from property into a trust
So, let us get into the detail
What is a trust?
A trust is a legal arrangement where one or more ‘trustees’ are made legally responsible for holding assets. The assets – such as land, money, buildings, shares or even antiques – are placed in trust for the benefit of one or more ‘beneficiaries’.
The trustees are responsible for managing the trust and carrying out the wishes of the person who has put the assets into trust (the ‘settlor’). The settlor’s wishes for the trust are usually written in their will or set out in a legal document called ‘the trust deed.’ (3)
In general law there are two types of ownership – legal and beneficial. If the legal owner and the beneficial owner are not the same person, the legal owner holds the property on trust for the beneficial owner. Where there is joint ownership of property, there is always a trust (7).
The beneficial owner is the person for whose benefit the property is held. It is distinguished from the person in whose name the property is held (the legal owner). [beneficial ownership] means ownership for your own benefit as opposed to ownership as trustee for another.’ (J Sainsbury plc v O’Connor 64 TC 208)
The beneficial owner is sometimes referred to as having a ‘beneficial interest’ in the property.
A settlor is a person who has put assets into the trust. This is known as ‘settling’ property. Assets are normally put into the trust when it’s created, but they can also be added at a later date. The settlor decides how the assets in the trust and any income received from it should be used. This is usually set out in the trust deed.
In some trusts, the settlor can also benefit from the assets they’ve put in. These types of trust are known as ‘settlor-interested’ trusts and they have their own tax rules. (3) (4)
A beneficiary is anyone who benefits from the assets held in the trust. There can be one or more beneficiary, such as a whole family or a defined group of people. Each beneficiary may benefit from the trust in a different way.
For example, a beneficiary may benefit from (1):
- the income only – for example, they might get income from letting a house or flat held in a trust
- the capital only – for example, they might get shares held on trust when they reach a certain age
- both the income and capital of the trust – for example they might be entitled to the trust income and have a discretionary interest in trust capital
Once you have a deed of trust set up it is very important that you notify HMRC. The type of information that you will need to supply to HMRC is as follows (1):
- the name of the trust
- the names and addresses of all of the trustees
- the contact details of any professional agent, or a trustee’s telephone number if there is no professional agent
- whether the trust is governed by UK law, Scots law or another country’s law
- whether the trust is employment related
- whether the trust is for a vulnerable beneficiary
- details of how the trust was created – for example this could be the deceased person’s details if the trust is created by a will, or a settlor’s details for a trust created during their lifetime
- the date the trust started
- whether the trust was created by a Deed of Variation or family arrangement
To make life a little easier HMRC have designed a form for you to complete your deed of trust. The form 41G may be found on their website. (2)
It is advisable that you speak with your solicitor to see how you can take things forward to put in a deed of trust and to discuss any implications it has on your estate.
Interest in possession trusts
For Income Tax purposes, an ‘interest in possession’ trust is one where the beneficiary is entitled to trust income as it arises.
From an Income Tax perspective, an interest in possession trust is one where the beneficiary has an immediate and automatic right to the income from the trust after expenses. The trustee (the person running the trust) must pass all of the income received, less any trustees’ expenses, to the beneficiary.
The beneficiary who receives income (the ‘income beneficiary’) often doesn’t have any rights over the capital held in such a trust. The capital will normally pass to a different beneficiary or beneficiaries in the future. The trustees might have the power to pay capital to a beneficiary even though that beneficiary only has a right to receive income. However, this will depend on the terms of the trust.
Stanley is married to Kathleen. On his death, Stanley’s will creates a trust and all the shares he owned are to be held in that trust. The dividends (income) earned on the shares are to go to Kathleen for the rest of her life. When she dies the shares pass to the children.
Kathleen is the income beneficiary. She has an ‘interest in possession’ in the trust as she is entitled to the dividend income from the trust assets for the rest of her life. Kathleen has no right to the capital. When she dies the trust ceases and all the capital (the shares) passes to the children. (5)
With bare trusts the beneficiary (the person who benefits from the trust) has an immediate and absolute right to both the capital and income in the trust. Beneficiaries will have to pay Income Tax on income that the trust receives. They might also have to pay Capital Gains Tax and Inheritance Tax. (6)
Gary leaves his sister Juliet some money in his will. The money is to be held in trust. Juliet is the beneficiary and is entitled to the money and any income (such as interest) it earns. She also has a right to take possession of any of the money at any time.
This is a bare trust because Juliet is absolutely entitled to both the capital (the original money put into the trust) and the income (any interest earned).
Tax on Bare Trusts & Interest in possession trusts. (5) (6)
Tax on rental income is the same as income tax rules. At the time of writing, basic tax earners would be taxed at 20% of the income from the deed of trust. The income can be reduced by the following costs:
- Trust management expenses of someone running the trust
- preparing a tax return for income received (this doesn’t cover the cost of preparing capital gains pages – which must be excluded from the expenses claimed)
- deciding which beneficiaries to pay and how much
- paying income to beneficiaries
A flat is rented out and the rents are paid to A. “A” claims that the rent from the flat should be taxed half and half between A and her husband B. “A” says she has transferred the flat into joint names with B. However, the Land Registry record clearly shows that A is the sole owner. It is also established that she was the sole borrower of the loan from the building society.
There is no evidence that the beneficial ownership of the property or the income is held to any extent by B.
Joint ownership is not in point here. The property is not held ‘in joint names’, so ITA/S836 is not relevant. That section refers to ‘property held in the names of a husband and wife etc’.
A is taxable on all the income. (7)
For the trust to work please ensure that:
- The property is bought in joint names under “tenants in common”
- A deed of trust is formed to allocate the money in accordance of the split you desire
- Complete Form 17 to notify HMRC that the income is to be split (8)
Preventing “tax pains” through precautionary methods. Here are a few suggestions.
Always plan your strategy before buying properties. If you know that you are going to set up the property into a trust then be sure to buy the property “tenants in common” and get the deed set up soon after purchase (or better still at the same time).
If you are looking for an accountant or thinking of changing your current accountant because they do not understand property investing and tax implications then please Click Here To Book an “Initial Free Consultation”.
1. Notifying HMRC About A New Trust
2. Trust Details Form
3. Trusts: The Basics
4. Settlor-Interested Trusts
5. Interest In Possession Trusts
7. HMRC Income Tax Guidance
8. Declaration Of Deneficial Interests – Form 17