Trusts are formed when the legal ownership of an asset is separated from the beneficial ownership, i.e., a legal owner (the trustee) holds it ‘on trust’ for another person (the beneficiary) who benefits from it. The person who establishes the trust is the ‘settlor’.
These trusts are known as ‘express trusts’, i.e., those deliberately created by the settlor in the form of a deed outlining who the parties are and what assets are in the trust; such trusts can also be created by the settlor upon their death, with their will being the constituent document.
Common Types of Trust
The most common trust is a ‘discretionary’ trust, whereby the trustees have total discretion as to what happens with the trust’s income and capital.
Another type is the interest in possession (IIP, or life tenant) trust, whereby usually a single beneficiary (the life tenant) is entitled to utilise the asset or receive the income for the rest of their lives; the capital remains with the trustees, but the life tenant has the right to use it. Upon the life tenant’s death, the trust is dissolved and the trust assets go into the absolute ownership of a ‘remainderman’.
How are they Formed?
To create a trust, there are three ‘certainties’ (laid down in Knight v Knight (1840) 3 Beav 148 by Lord Langdale MR) required to settle an express trust:
- certainty of intention, i.e., the intention to create a trust and not just make an absolute gift; it must be clear that the creation of a trust was intended – ideally using the words ‘in trust’ rather than precatory words such as the donor would ‘hope’ that the donee holds the asset for the benefit of someone else, or that they ‘have confidence’ that they would do so, etc.;
- certainty of subject matter, i.e., it must be clear exactly which assets are being placed into trust; and
- certainty of objects, i.e., precisely who the beneficiaries are. The trust’s deed must be able to clearly identify the relevant people and provide certainty that a given person is a beneficiary, ‘my children and future issue’ or something along those lines means that every potential beneficiary can be traced from that description, whereas ‘my old friends’ was too uncertain conceptually in Brown v Gould [1971] 2 All ER 1505. Discretionary trusts, having a class of beneficiaries, need to be particularly careful with this last criterion and the class of potential beneficiaries must also have some evidential and administrative certainty; settling a trust for the entire population of West Yorkshire is just unworkable (Re. Hays Settlement [1982] 1 WLR 202).
The settlor can create the lifetime (or inter vivos) trust by transferring the legal ownership from themselves to the trustee and beneficial ownership to the beneficiary, or they could simply declare themselves as trustee and pass the beneficial ownership to the beneficiaries. These trusts are usually created by a deed – indeed, transactions of beneficial ownership in land must be in writing; other assets can potentially be conveyed verbally or by physically handing them over. Trusts can also be created upon death via someone’s will – which doubles up as the trust’s constitution.
Tax Basics
Trustees are subject to income tax – discretionary trusts at additional rate, IIPs at basic rate (though discretionary trust beneficiaries receive income with a refundable tax credit of 45% representing that tax paid). Trustees are also subject to capital gains tax at 24% with the benefit of half an annual exemption.
All trusts set up in a settlor’s lifetime are known as ‘relevant property’ trusts, which have their own inheritance tax (IHT) regime of charges every ten years and when assets leave the trust.
Practical Tip
Trusts can be very useful for tax and non-tax purposes, and the concept is relatively simple; but there are some rules that need to be followed for their successful creation. If the settlor wants to create a trust, it must be made abundantly clear that they are doing so, with which assets, and benefitting which people.