HM Revenue & Customs’ (HMRC) recent, wide-ranging consultation asked Professional Advisors for their thoughts on how the taxation of trusts in the UK could be simpler, fairer and more transparent. We welcomed this opportunity to contribute towards HMRC’ findings and the opportunity to apply our Brighter Thinking approach.
In our submission, we wanted to highlight the important role that trusts can play – particularly through their ability to protect the vulnerable – both as legally defined but also those at risk of exploitation should they hold the funds personally.
We also wanted to highlight the negative impact that the current tax regime of trusts is having on this. The amount of complex compliance needed in respect of trusts (even if there is little or no tax at stake) acts as a deterrent to people creating them and can make small trusts unviable, preventing those who need them most from benefiting.
How can Trusts be beneficial?
Trusts can be hugely beneficial to all sorts of people and we feel that it is unfair that the complexity of the tax regime and the inherent costs involved with compliance should be dissuading or preventing a section of society from benefiting from them – in particular, those who may stand to benefit the most from having a trust in place.
How do headline rates impacts trusts?
We have also found that people avoid trusts purely because the headline rates are so high. This not only goes against HMRC’s stated aim that trusts should be tax neutral but is in fact not entirely true. While some areas suffer higher tax, particularly initially, other areas can have quite beneficial regimes and even where the headline rates are high, beneficiaries will only ever suffer tax at their marginal rate meaning refunds are often received from HMRC in the end.
Unnecessarily complex compliance
There are certain areas in particular where compliance is unnecessarily complex: trusts for vulnerable beneficiaries and settlor-interested trusts are prime examples. Broadly speaking, these are designed to be tax neutral. However, the method of compliance that has been employed to achieve this is hugely complex and often requires tax to be paid by the trust, refunded to the beneficiary or the settlor, and then in certain circumstances, refunded back to the trust. Surely a simpler solution would be to make trusts in these circumstances look-through. To tax the individual immediately ensures that the correct tax is paid in the first place while potentially saving significant compliance costs within the trust.
Inheritance tax in respect of trusts is also particularly complex. While we appreciate some of HMRC’s reasons for this, we feel that the issues surrounding inheritance tax are both amplified and evidenced by the time it takes HMRC to process inheritance tax returns, often taking well in excess of a year to send a response. A simplification of the process should aid both the taxpayer and HMRC.
Small trusts, particularly life interest trusts, have been negatively impacted by the recent changes to taxation of dividends and interest. Unlike individuals, life interest trusts are unable to benefit from the dividend allowance and the personal savings allowance. Therefore, a small life interest trust, which a few years ago would likely have had very little income tax to pay due to the notional tax credit on dividends and the basic rate withholding tax on interest, now faces an additional compliance burden.
Usage of trusts summary
We also took the opportunity to defend the usage of trusts more generally. Trusts, and in particular heavily regulated and monitored offshore trusts and by extension those who use them, are often used as a scapegoat by both the government and the opposition when looking to highlight tax evasion. The reality these days is that the majority of trusts are entirely compliant and the severe penalties placed on advisors for marketing any sort of avoidance or evasion schemes deters development almost entirely.
Indeed, it should also be remembered that many examples of non-compliance stem from incorrect application of the existing complex rules rather than deliberate avoidance of tax. The level of scrutiny placed on the offshore community and their trusts is grossly disproportionate to the level of avoidance taking place, but of course, non-voters are a rather easy target!
In conclusion, we welcome the government’s willingness to conduct such a thorough review of the taxation regime faced by trusts. We feel that the position would be improved by simplifying certain areas of trust taxation, both helping to ensure that trusts are easily able to accurately comply with the legislation and reducing the burdensome cost of doing so, therefore opening the valuable usage of trusts to a wider audience.