Tax-free gifts: Using a discretionary trust

Chris Thorpe outlines how discretionary trusts can be used to gift assets tax-free. A trust is essentially an arrangement whereby the legal ownership is in the hands of one person, with beneficial ownership in the hands of another; the legal owner (the trustee) holds that asset as custodian for the beneficial owner (beneficiary).

What is a discretionary trust?

In the case of a discretionary trust, the discretionary trustee, as the name implies, has complete discretion as to the trust asset and any income arising therefrom; the beneficiaries are often a class of people, such as the grandchildren of the ‘settlor’ (the person who set up the trust) or the ‘future issue’ of a specific beneficiary, as long as they are a defined and ascertainable class.

Income arising within a discretionary trust is subject to income tax at additional rates, with no personal allowance; any capital gains from disposals to third parties are subject to capital gains tax (CGT) at 24% with a £1,500 annual exemption (for 2026/27).

It is with inheritance tax (IHT) that discretionary trusts (indeed all ‘relevant property’ trusts) take on a unique identity, with their own IHT regime; there is an IHT charge of 20% when assets go into a trust, also when assets go out of a trust (an ‘exit charge’), plus every ten years at a maximum 6% charge. However, these IHT charges only apply when the assets in question exceed the settlor’s or trust’s ‘nil-rate band’ (NRB – currently £325,000 with a single settlor, and will remain such until 2031).

Lifetime gifting

If a lifetime gift is to be made, it can be to an individual directly, but there are several issues. Firstly, there is potentially CGT for the donor and, unless the asset is one used in the donor’s trade, no holdover relief, so CGT will be charged at 18% or 24% despite having no proceeds out of which to pay it.

Secondly, once gifted, the asset is in the donee’s estate for tax and other purposes – if that individual goes bankrupt or gets divorced, the asset may well be lost, though if that individual has spendthrift tendencies or cannot be trusted with the safekeeping of the asset, it might also be lost in any event. This might be reason enough to place assets into trust instead.

If the asset goes into a trust for the benefit of that same individual (or their family), there is no CGT to worry about, as TCGA 1992, s 260 holdover relief is available; this provision allows relief for any type of assets, whether trading or not. This is by virtue of the IHT charge upon placing the asset into the discretionary trust, even if no tax is payable because the value is below the settlor and trust’s own NRB (having its own NRB based on the number of settlors, a discretionary trust is essentially another person for IHT purposes).

Another benefit of the trust, as alluded to above, is that the asset is protected from the beneficiary and dangers associated with ownership; assets within a discretionary trust are not in any beneficiary’s personal estate, and any income, capital or use of the asset is entirely within the gift of the trustees.

APR or BPR

Whilst discretionary trusts are subject to IHT, they are also eligible for agricultural property relief (APR) and business property relief (BPR) for qualifying assets. Trusts can hold assets within
their own NRB tax-free, but for qualifying assets, APR or BPR unlimited relief was available prior to 6 April 2026; thereafter, 100% relief is limited to £2.5m per settlor and per trust (though shared amongst trusts settled on/after 30 October 2024) with 50% relief thereafter.

Whilst placing an asset into trust before 6 April 2026 would give unlimited 100% relief for the
settlor, entry, 10-year charge and exit charges will henceforth be subject to the £2.5m limit.

Practical tip

Placing an asset into a discretionary trust provides for a CGT-free gift, but it can also be free of IHT if the value is below the trust’s NRB and the APR or BPR 100% allowance of £2.5m.

Disclaimer: The information provided on AccountingFirms.co.uk is for informational purposes only and should not be considered as financial advice. Always consult with a professional accountant to ensure compliance with UK laws and regulations.