What is a US living trust?
A living trust is a common planning vehicle in the US that is typically used for administrative ease. It can work as an alternative to a will, because assets will pass on in line with the trust deed and without being subject to probate after death. This is beneficial as probate is often a process that can take a long period of time.
For US tax purposes, a living trust is known as a revocable trust, which means the person that settles the trust (the grantor) retains certain powers. This will typically include the power to revoke the trust agreement altogether and powers over how the trust is managed. As a result, the trust is not a separate taxable entity for US purposes, and all income or gains are taxed on the settlors US tax filings.
Whilst these trusts can be viable planning options in the US, sometimes they do not travel well if you move or have connections to the UK.
Below we are going to ask Alexa Collis about some of the UK issues to be aware of, if you have or are thinking about creating a living trust for your assets. Alexa is a private client lawyer with more than 10 years’ experience. Alexa joined Harbottle & Lewis two years ago from New Quadrant Partners as part of team led by Zoë Camp. She advises on wealth and succession planning with a particular expertise in assisting families with UK/US connections.
How common are living trusts?
Honestly, I would say that I come across these almost daily! They are such a common planning tool in the US, for the reasons mentioned above and I would say particularly in States such as California where the probate procedure is notoriously nightmarish.
Where we have a US citizen client, who has come to the UK with their estate planning already in place, it is extremely commonplace to find that they will have already set up a living trust and transferred their US assets into it.
How can these trusts be treated in the UK?
The assumption is often that the UK will tax these trusts in the same way as the US does, i.e., effectively treat the assets held in the trust as an extension of the grantor’s estate – the assets are still theirs for all purposes; there is just a different name above the door.
However, we do not have the concept of a living trust in the UK and there is actually some uncertainty over how US living trusts should be categorised.
Broadly, though, a US living trust will be treated as either a nominee arrangement i.e., transparent for tax purposes (and therefore aligned with the treatment in the US) or a substantive trust. If the latter, then the UK taxation becomes more interesting, and can create some real, and unanticipated, complications.
In carrying out an analysis, there are various factors which will weigh in favour, and against, a living trust being viewed as looked through. It is not a case of one size fits all and the terms of each trust must be considered carefully to reach a view.
The grantor having absolute control over the assets helps support the bare trust argument i.e., being able to direct the trustees as to how much they may receive from the trust, including the ability to revoke the trust at any point. Although the trust may be drafted in this way whilst the grantor has capacity, we often see provisions creep in that give the trustee’s discretion if the grantor loses capacity. Clauses which give the trustees power to make decisions on behalf of the grantor make living trusts seem more akin to a substantive trust in the UK.
Does it matter who the trustees are?
This allows me to elaborate on one of the “real complications” mentioned above.
Typically, with living trusts, it is the grantor themselves who is also the sole trustee. If the trust is also substantive then the tax treatment of the trust will follow the residence of the grantor e.g., whilst the grantor is UK resident, the trust will be as well. The flip side is that if the grantor becomes non-resident, then the trust will follow suit and the change could inadvertently trigger a capital gains tax charge on the value of the entire trust fund.
Another point to flag is that while the trust may have started off from a tax transparent standpoint, if the status of the trust changes on, say incapacity, because of the nature of the provisions, then this can likewise trigger a disposal of all the assets of the trust fund for capital gains tax purposes.
Can these trusts be set up whilst living in the UK?
Yes, they can, but they must be approached with care.
If the client is UK domiciled at this point (and a chance to refer to the complications again!), then the bare trust status becomes more crucial.
The reason for this is that, if the trust is treated as a substantive trust, then the grantor will be subject to UK inheritance tax at 20% on the transfer of assets into trust in excess of the tax fee amount. The trust will then itself be subject to a special UK inheritance tax regime for trusts known as the “relevant property regime” which imposes tax charges on the value of the trust every 10 years and on distributions from the trust.
The helpful part of this though is that, if the client is in the UK, the chances are that UK advisers will already be on board flagging the above. Because, of course, it is possible for the client to be UK domiciled whilst not living in the UK, and for this to then go unnoticed.
Can certain types of investments cause issues?
Yes, in particular clients need to watch out if they have investments in US based funds, whether in their own name or held through their living trust.
Investments in non-UK funds that are not on HMRC’s (Her Majesty Revenue & Customs) list of approved non-UK funds can give rise to adverse tax consequences in the UK.
Before making a move to the UK, it is important to have an adviser review your asset holdings to highlight any potential issues and to make sure these are ironed out as far as possible before they become real problems.
