This article was originally published in EPrivateClient and can be accessed here.
Vulnerable beneficiary trusts
Readers will remember the government’s 2018 consultation inviting views on the principles that should underpin trust taxation. The focus of the government’s consultation was primarily the tax treatment of private trusts for individuals, including vulnerable beneficiary trusts.
The principles which the government believed should underline the approach to trust taxation were transparency, fairness, simplicity – fairness being taken to mean ensuring that tax considerations neither incentivise nor disincentivise the use of trusts. This author argued at the time that the taxation of trusts has in some cases become so unduly onerous and complex that such taxation can in fact disincentivise their use.
The scope of the government’s consultation was wide-ranging, and resulted in a large number of responses. The government published a response to the consultation in March 2021 which concluded that:
“The responses did not indicate a desire for comprehensive reform of trusts at this stage… the government will continue to review specific areas of trust taxation on a case-by-case basis, with responses relating to those areas forming part of the consideration”
This was a welcome response, given that many in the industry did not suggest that an extensive reform to the taxation of trusts was necessary. And while many practitioners agreed that no comprehensive reform may be required, it is positive to see the government stating that targeted reform may be pursued where required.
One area that is ripe for reform is the rules on trusts for vulnerable beneficiaries (particularly disabled person trusts or ‘DPTs’), which are arguably too complex and can produce unfair results.
A DPT is a trust for a person who, by reason of mental disorder, is incapable of administering his or her property or managing his or her affairs; or is in receipt of a qualifying disability benefit. To qualify as a DPT, during the lifetime of the disabled beneficiary, the trust property may in general only be applied for the benefit of that person in order to qualify as a DPT.
There are income tax, capital gains tax and inheritance tax advantages for DPTs. They are generally taxed to an amount which equates to what a beneficiary would have paid if they owned the property outright.
However, the statutory definition of ‘vulnerable person’ is so narrow that it can prevent some clearly vulnerable people, often with some form of disability, from qualifying. On top of this, considerable work is required to ensure that such trusts benefit from the favourable tax treatment, often resulting in higher accountancy and legal fees. The costs involved can in some cases be considered too high and too onerous and therefore dissuasive for those who might otherwise wish to use them.
A simpler and wider definition of ‘vulnerable person’ might promote greater fairness. A regime that is easier to understand and use would make access to DBTs easier.
An extension of the definition of vulnerable person might also allow those who wish to self-settle in order to provide for future, anticipated vulnerability (which might not currently meet the statutory definition for a DPT) to qualify as a DPT for tax purposes.
It is positive to see that, following the government’s consultation response, CIOT has also called for the tax regime for DPTs to be reformed, citing its complexity and inconsistency. CIOT call for a simpler, bespoke regime, with precedent online forms being available to use online (which might avoid the often high fees which accompany setting up a DPT).
Separately, the Law Commission’s 14th Programme has confirmed that a project on modernising trust law, included in the 13th Programme, will roll over into the 14th Programme. It is hoped that the issues raised above in relation to DPTs might be included within this programme with a view to effecting the changes suggested above.
Finally, one positive outcome in recent months is contained in the final version of the regulations implementing the changes to the Trusts Register required by the Fifth Anti-Money Laundering Directive. The regulations confirm that certain trusts will remain outside of the scope of the registration requirements due to their low risk of being used for money laundering or terrorist financing. DPT are considered to fall within this category, and therefore will not need to register with the Trusts Registration Service – surely welcome news for all involved, in view of the otherwise onerous burden that registration would have otherwise imposed on DPTs (although it should be noted that a trust that is otherwise excluded from registration is still required to register if it has a liability to UK tax.)