A trust is an arrangement whereby the owner of assets, who in private trusts, such as those we talk about below, is called the settlor, passes complete legal ownership of the assets in question to a trustee.
The trustee (which can be a company or an individual) then becomes the legal owner of and administrator for the assets.
The trustees must administer, invest, and distribute the assets within the trust according to the terms of a key document known as a trust deed, as well as according to the governing law of the jurisdiction in which the trust is established.
The trustee does so on behalf of the beneficiaries of the trust, who can compel the trustee to comply with the terms of the trust and general law.
These beneficiaries can include the settlor (although this usually reduces or negates any specific tax benefits of establishing a trust.)
In rather more legal language, Sir Arthur Underhill, a barrister at Lincoln’s Inn in London, once provided this definition of a trust:
“An equitable obligation binding a person (who is called a trustee) to deal with property over which he has control (which is called trust property) for the benefit of persons (who are called beneficiaries or cestuis que trust) of whom he may himself be one, and any one of whom may enforce the obligation.”
This definition is useful because it emphasises the point that the trust property is held for the benefit of the beneficiaries.
It is the beneficiaries who hold the equitable interest in the property, subject to the terms of the trust, and it is the trustees who hold the legal interest.
The assets are said to be 'held in trust' for the beneficiaries to one day decide what to do with.
The assets in trust, and any payment received from them, are called the trust fund.
Trusts exist primarily in ‘Common law’ countries (very broadly: the Commonwealth, the USA and Canada), having grown up in England from the time of the Crusades (although the general concept is far older).
In ‘Civil law’ countries (broadly, the rest of the world) the concept is unfamiliar or unknown (although there are similar concepts elsewhere, for example in Islamic law) and in some countries a trust may not be recognised in law.
Trusts are extremely common in all sorts of situations, for example partnerships, pensions and land ownership.
The trusts we talk about here are private family trusts.
Onshore and international trusts are predominantly used to transfer or gift assets, for succession and tax planning, and asset protection purposes.
Since 22 March 2006, private family trusts can be broadly divided between those trusts that come under the mainstream IHT regime for relevant property trusts, and those that do not.
Relevant property trusts are taxed as discretionary trusts (explained below).
The 2006 changes were made to ensure that the IHT treatment of trusts was streamlined, so that all trusts are treated in the same way, with some limited exceptions.
Settlor
The settlor is the person who provides the assets for to be held on the trust.
As stated, the settlor can also be a beneficiary of the trust, although this represents a ‘gift with reservation,’ and therefore generally makes the trust ineffective from an IHT perspective.
Some trusts allow for joint settlors.
This option should only be chosen where both settlors are the providers of the funds, or (for example) joint insurance policy owners to be held in trust, in the case of an existing policy.
Trustees
As the name implies, a trustee should be a person the settlor (and, ideally, the beneficiaries) can trust.
Legally speaking a trustee must be at least 18 years of age, of sound mind and not bankrupt.
Settlors can appoint themselves as a trustee, and additional trustees can include family members or friends, professional advisers or a trust corporation (in theory these can be as many as the settlor wishes, but not commonly more than a handful and often only two; there are disadvantages in having a single trustee other than a trust corporation, since a single trustee cannot give a good receipt for land).
Beneficiaries may also act as trustees, although this gives rise to likely conflicts of interest.
Before accepting the role of trustee, anyone tasked with this role needs to fully understand the terms of the trust deed, the general law principles that govern trusts, and appreciate that being a trustee is a “high duty” – a duty for which law requires the trustees to operate with the highest degree of integrity.
Beneficiaries
Beneficiaries are beneficial owners of the property held in trust, although this will often not provide an immediate right to use of the assets. Beneficiaries benefit according to the terms of the trust, as operated by the trustees.
‘Discretionary trusts’ (also known as ‘flexible trusts’) appoint both discretionary and named beneficiaries.
‘Bare trusts’ (see below) have no discretionary beneficiaries, and instead the settlor appoints one or more absolute beneficiaries.
Trustees have a general duty to operate the trust according to general law and the terms of the trust, and general law sets out the standards.
The core duties of care and skill owed by a trustee are the duties to:
The level of these duties is set out in statute (the Trustee Act 2000) and in common law.
The Trustee Act 2000 imposes a general duty of care and skill on trustees in terms of (for example) operating the power of investment or acquiring land.
Broadly, whenever the duty applies, a trustee must exercise such care and skill as is reasonable in the circumstances, having regard to any special knowledge or experience that he has or holds himself out as having, and acting as a business or professional trustee, to any special knowledge or experience that it is reasonable to expect of him.
Similar statutes apply in Northern Ireland and Scotland.
As regards the duty to act with prudence, general law says that a trustee must “take such care as an ordinary prudent man of business would take in managing his own affairs”, meaning not simply by reference to what the ordinary man of business would do if he had only himself to consider, but what he would do if he was under a moral obligation to provide for others. The standard is set higher for professionals by both the Trustee Act 2000 and general law.
As regards the investment duty, trustees must consider a variety of factors, including:
A named beneficiary typically has an entitlement to income, but not capital.
If the trustees don’t make an appointment (that is: a distribution) of capital during the lifetime of the trust, the trust fund defaults to those named in the trust deed as named beneficiaries, in the percentage shares set out in the trust deed.
This is what beneficiaries of a “bare trust” (see below) are called.
An absolute beneficiary has an absolute entitlement to capital from the trust (subject to its terms), and is able to demand payment of their share of the trust fund, typically once they reach the age of majority.
If an absolute beneficiary dies, the portion of the trust fund belonging to them forms part of their estate for IHT purposes (whether or not it has actually been distributed to them).
After the beneficiary’s death, their share is passed to their estate to be distributed in accordance with the terms of the will, or via the laws of intestacy in their particular jurisdiction.
Once established, a bare trust cannot change the absolute beneficiaries.
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