This is the first of two articles that seek to provide an overview of the taxation of family trusts in Ireland. By the nature of the topic, the articles are not all encompassing and my best advice to those wishing to consult with professionals over trusts is to go with an open mind and speak plainly about your wishes, desires and what it is you want to achieve for your family. The articles also assume that the reader has a small knowledge of trusts and certain terminology associated with them. I can recommend anyone requiring further practical advice on trusts to look at the blog section of this website.
Though not used as much as they should be in Ireland (but changing as of the time of writing) trusts can assist greatly in succession planning for the family business and protecting family wealth for future generations, as well as offering a large degree of flexibility in providing for young children, beneficiaries with disabilities or vulnerable adult beneficiaries. This article focuses on trusts and the family business. The second article will deal with disability trusts and the taxation issues associated with them.
Overview
There are three broad categories of trusts for Irish tax purposes being Bare, Fixed or Discretionary trusts.
Bare Trust
A bare trust (sometimes known as a simple trust or nomineeship), is one where the beneficiary(s) has an immediate and absolute right to both the capital and income of the trust and the Trustee(s) has no discretion over the assets held in trust. The trustee of a bare trust is a mere nominee in whose name the property is held and must follow the (lawful) instructions of the beneficiary(s) in relation to the assets held in trust. Bare trusts are ‘look through’ for tax purposes, and the beneficiary, rather than the trustee, remains liable for any taxes which arise.
Fixed Trust
In a fixed trust, each beneficiary has a fixed entitlement to a specific share or interest in the trust property. The entitlement may not necessarily be immediate but rather the beneficiary may be entitled to the property after a specific time period (known as “a period certain” ) has passed, such as on the death of a person who has an interest in the property for the duration of their lifetime or otherwise.
Discretionary Trust
A discretionary trust is one where the Trustees are responsible for the administration of a trust and its assets for the benefit of one or more of the trust’s beneficiaries. Unlike other types of settlement, the Trustees have the absolute discretion as to how to use the trust’s income and to utilise (i.e. provide benefits) or distribute (appoint) the trust’s capital and income to beneficiaries and the conditions, if any, they may impose on the recipients.
It is important to understand the concept and differences between each type of trust above as the tax treatment and the tax implications for all the parties involved in a trust can vary.
Taxation of Trusts
Income Tax
The Trustees
The income tax (“IT”) position regarding a trust is determined by the tax residence of the trustee(s), such that:
(a) If all of the Trustee(s) are Irish resident, then any worldwide income of the Trust will be liable to IT1*; and
(b) If all the Trustee(s) are not resident in Ireland, then the Trustee(s) will only be liable to IT on any Irish sourced income.
Trustees will pay IT at the Irish Standard Rate of 20% and have no entitlement to credits, reliefs or allowances as apply to individuals. However, Trustees are not subject to USC2* or PRSI3* in relation to trust income. Where Trustees make a payment from capital funds that is treated as income in the hands of a beneficiary the Trustees have withholding tax obligations.
Irish tax law provides for a surcharge on undistributed income of certain accumulation and\or discretionary trusts. If income arising to a discretionary trust has not been distributed within 18 months of the end of the year of assessment in which it arises, to a person who receives it, as income, it will be subject to a surcharge of 20%. Income which has been treated as income of any person other than the Trustees is excluded from the surcharge. The usual income tax return deadlines and filing requirements that apply to individuals apply equally to Trustees.
The Beneficiaries
Case law has established a principle that a beneficiary who has a vested interest in possession in a trust asset is subject to tax on any income that asset generates as if he had received the income himself when it arose. If a beneficiary of a trust is absolutely entitled to the income then the Trustees are not assessable to IT and Irish Revenue will assess the beneficiary on the income directly. Where a beneficiary is absolutely entitled to income as it arises, a trustee’s expenses are not deductible against the income of the beneficiary.
Capital Gains Tax
The Disponer
When a person creating a trust, known as a “Disponer” in Ireland (“Settlor” in the UK) creates a trust during their lifetime, he/she will transfer assets to the trust and these will form the basis of the trust’s “Trust Fund”.
Depending on the type of assets transferred to the Trustees, capital gains tax (“CGT”) may arise. CGT is assessed on the market value of the asset(s) transferred (gifted) to the trust. If the market value of the asset gifted is greater than the original acquisition cost (value) to the Disponer, then CGT could arise. No CGT will arise, however, where cash (euro currency) is transferred to the trust by the Disponer.
If the trust is created by a Will, becoming operational on death, then no CGT arises on the initial creation of the trust as the Trustees will inherit the assets at their open market value at the date of death of the Disponer. This is the base cost for any future disposal of the trust asset(s) concerned.
The Trustees
Whether CGT arises on the trust assets depends on the residence and ordinary residence status of the Trustees. In the event that the majority of the Trustees are resident and ordinary resident in Ireland and the general administration of the trust is carried out in Ireland, then the Trustees will be liable to CGT on the trust’s worldwide gains.
If the majority of the Trustees are not resident or ordinarily resident in Ireland, then the Trustees will only be liable to Irish CGT on gains arising on the disposal of specified Irish assets, namely:
(a) Land and buildings in Ireland;
(b) Minerals in Ireland including related rights such as exploration and exploitation; and
(c) Unquoted shares in Ireland deriving their value or the greater part of their value from (a) and (b) above.
However, special rules apply for professional Trustees or trust companies. If the Trustee is a professional trustee and the settlor is neither Irish resident nor ordinarily resident in Ireland when the assets were settled on trust, the professional trustee is deemed non-Irish resident and is therefore not Irish resident for CGT purposes.
The Beneficiaries
If CGT arises then it may be credited against any capital acquisitions tax which may be payable by the beneficiaries of the trust who inherit the assets on cessation of the trust.
Stamp Duty
The Trustees
Stamp duty (“SD”) may be payable on the lifetime transfer by a Disponer of assets into a trust. If the transfer comprises residential property then SD will be payable on the value of the asset transferred. The first €1 million will be subject to SD at a rate of 1% and thereafter at a rate of 2% on any balance. If the transfer is of commercial property then the rate is 7.5%. If cash is transferred (gifted), no SD duty arises.
However property can lawfully be vested in Trustees without the need for a written instrument (e.g. paintings, jewellery) and in which case no SD will arise nor will there be any liability to SD arise where assets are transferred to a trust under a Will.
The Beneficiaries
Where correctly structured appointments of assets to beneficiaries in accordance with the terms of the trust should not give rise to SD.
Capital Acquisitions Tax
The Disponer
For the Disponer, capital acquisitions tax (“CAT”) applies to gifts and inheritances. There is no CAT on the transfer of assets to a trust by a Disponer as the legal title to the assets vested into the trust have not yet passed to the beneficiaries.
The Beneficiaries
Where a beneficiary receives assets/benefits from the Trustees, they are taxed as if the transfer/benefit had been given to them by the Disponer/the deceased.
It should be noted that CAT is a lifetime tax, so any previous gifts or inheritances received since the 5th December 1991 may reduce or “consume” the entire tax-free threshold.
Assets appointed out of a trust settled on or after 5 December 1999 will be within the charge to CAT:
(a) If the recipient beneficiary is resident or ordinarily resident in Ireland on the date the benefit is received;
(b) The donee or successor is resident or ordinarily resident in Ireland;
(c) Where the Disponer is resident/ordinarily resident at the date of death, CAT will arise on any benefit taken on his/her death; and
(d) Where assets are situated in Ireland.
A foreign domiciled4* person will not be deemed resident for CAT until they have been resident in Ireland for five continuous tax years5*.
In some circumstances distributions from a trust can give rise to both an IT and CAT liability in the hands of a beneficiary. Distributions can be classed as capital or income in nature and it is the character of the payments in the hands of the beneficiary that will determine the tax consequences. The nature of distributions has been the subject of case law in the past. Regular or periodic distributions to a beneficiary can be both subject to IT and CAT. A revenue concession exists where CAT is chargeable on the net benefit received (i.e. the net after tax amount).
The income received by a trust is broken down into the actual sources from which it has arisen. Thus, Irish rental income would be taxed in the individual’s name under Schedule D Case V, foreign rental income under Schedule D Case III, etc.
If the beneficiary has a contingent interest in the income (i.e. no right to the income until a future event) or the Trustees have the power to accumulate income, the Trustees are subject to IT while the income remains within the trust. The additional 20% surcharge may arise on any undistributed income.
If income is passed to a beneficiary upon which IT tax has already been assessed on the Trustees, the beneficiary can claim a credit for the tax already paid by the Trustees and the income is grossed up in the hands of the beneficiary and assessed in the normal manner. The Trustees should provide the beneficiary with a Revenue Form R185 (which shows the 20% tax paid by them) and the beneficiary will then receive a credit for the tax paid.
If the income is not paid to the beneficiary, but is applied for his or her benefit by the Trustee e.g. for maintenance, education etc., then an amount equal to the financial benefit is treated as the beneficiary’s income.
Specific Tax Rules for Discretionary Trusts
In a discretionary trust, those persons the Disponer wishes the trust to benefit (the “class of beneficiaries”) is set out in the trust deed. The Trustees then have the discretion to distribute the trust property between those beneficiaries as they see fit. A discretionary trust also exists where property is held on trust to accumulate income or part of the income from that property. For further information on the trust law aspects of discretionary trusts please refer to the article on the website of UHY Trust and Corporate Services Limited entitled “Types of Trust and Whose Involved”.
From a tax perspective, discretionary trusts can potentially allow a situation to arise in which no beneficiary ever becomes “beneficially entitled in possession” to a trust asset thereby resulting in a potentially indefinite deferral of a CAT charge. To address this, discretionary trust tax in the form of a one off initial levy of 6% and thereafter an annual levy of 1% of the value of the assets in the trust, was introduced (see DTT section below for further details).
These discretionary trust charges, as well as the surcharge imposed on undistributed trust income, can often dissuade people from using discretionary trusts on the basis that they are not tax efficient and erode the value of the trust property. However, a one off levy coupled with an annual 1% levy is a cost that a Disponer may be willing to bear if the trust otherwise meets the Disponer’s commercial/personal objectives (i.e. to protect family assets and to ensure flexibility in terms of who gets what and when).
The flexibility inherent in a discretionary trust may, in appropriate cases, also be utilised to allow time to pass and a benefit be deferred until such time as all necessary conditions have been met for a tax relief to apply, such as agricultural relief or business property relief.
Discretionary Trust Tax (“DTT”)
Discretionary trusts are subject to a one off charge of 6% of the capital value held in a trust, followed by an annual charge of 1% arising on 31 December in every subsequent year (except the year in which the 6% is paid). The initial DTT charge of 6% is generally payable on the later of the death of the Disponer or on the date on which the last principal object of the trust (if any) reaches the age of 21. The 1% charge will not arise within 12 months of the initial 6% charge. If the trust is wound up such that the entire property within the trust is appointed out of the trust within five years of the initial 6% charge a refund of 50% is repayable to the trust.
If the trust is created under a Will, and all of the beneficiaries are over 21, then the liability to DTT arises on the later of either the date of death or the date the property becomes subject to the trust. The estate of the deceased has four months to settle the DTT payable.
There are a number of exemptions from the DTT tax. These include trusts that are set up exclusively for:
(a) People with certain disabilities;
(b) Public or charitable purposes; and
(c) Approved superannuation schemes.
Specific Tax Rules for Fixed Trusts
Another way to pass wealth to the next generation is through the use of a fixed trust. In a fixed trust, the entitlement of the beneficiaries to the income or capital of the trust is fixed by the Disponer.
However, just because the share or interest taken by the beneficiary is fixed, the Disponer still has some flexibility as to what should happen and when. For example, the beneficiary may be entitled to the property;
(a) Immediately;
(b) After a specific time period (“a period certain”) has passed; or
(c) On the death of a person who has an interest in the property for the duration of their life (i.e. on the death of a life tenant), or otherwise.
Common examples of fixed trusts are:
(a) A trust for a minor (“e.g. until they reach the age of 21”);
(b) A life interest (“e.g. to pay an annual income for a beneficiary’s lifetime”); or
(c) A remainder interest (“e.g. to transfer the asset to the beneficiary after another person’s death”).
For example, a Disponer may ultimately want his assets to pass to his children but a fixed trust gives him the option of first allowing his wife to enjoy the income of those assets during her lifetime.
Appointing a life interest rather than an absolute interest can make sense in the case of older beneficiaries. Apart from the CAT cost being much less (with the possibility of a CAT refund if the life tenant dies within five years) using a life interest ensures that the underlying capital is protected for the benefit of the next beneficiary(s).
A Life Interest/Tenancy
A life tenant is a person who currently holds a life interest in trust property. In other words, he or she currently has a present right to the income or enjoyment of some or all of the trust assets (for example, the right to live in a house owned by the trust) but has no interest in the underlying asset)
CAT arises when a beneficiary becomes “beneficially entitled in possession” to property. This means in the case of a trust that any present rights to the enjoyment of property to a life tenant are liable to CAT immediately. The CAT liability is based on a multiplying factor related to the beneficiary’s age and gender6* at the time they become beneficially entitled in possession to the property.
In contrast, a future interest to trust property is not liable to CAT until an event happens (such as the death of another person) whereby this future interest becomes a present interest.
As set out above, income that the beneficiaries of a trust are entitled to receive as it arises and which is mandated and paid directly to those beneficiaries (rather than accumulated within the trust) is not assessable on the Trustees; it is taxed in the beneficiaries’ hands and can be subject to both IT and CAT depending on the nature of the payment.
It is common, where a beneficiary has an interest in possession in a fixed interest trust, that the Trustees may have a discretionary power to appoint capital from the trust fund to the life tenant.
For CAT purposes, the power to appoint capital is treated as a contingency. Until the trustees exercise their discretion to make a capital appointment no CAT liability will arise. Therefore, the life tenant is taxed on what he or she receives during their lifetime. In the event the trustees make a capital appointment then the CAT position of the life tenant or other beneficiary needs to be reconsidered as a liability to CAT may arise.
Summary
It is important that the legal and taxation implications of establishing a trust, of whatever nature, are understood before one it is established. The taxation of trusts is complex and proper taxation advice must be taken by both Disponers and Trustees.
If you would like to know more about the points raised in this Article then please contact me or one of my colleagues.
Niall Donnelly
I am a Qualified Chartered Tax Advisor, working in public practice and currently Head of Corporate Tax Structuring at UHY Farrelly Dawe White Limited. I am actively involved in advising domestic businesses, private companies and high net worth individuals on a range of taxation issues. I have extensive experience dealing with family business succession, business exit, tax efficient investment structures, corporate reorganisations, property transactions and tax matters surrounding privately held wealth.
UHY Farrelly Dawe White Limited
FDW House
Blackthorn Business Park
Coes Rd
Dundalk
Co. Louth
T: +353 42 9339955
E: nialldonnelly@fdw.ie
Disclaimer
This overview of the Irish tax implications of trusts is for guidance purposes and given on the assumption that any interested party is fully aware of the classification of trust in which they are involved or contemplating establishing. Any definitive advice can be provided after review and due consideration of any trust deed and ancillary documents and any other pertinent documentation.
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1Save for where the Disponer of the trust and its beneficiaries are not resident in Ireland and the income is “mandated” to the non-resident beneficiaries.
2USC being the Universal Socia Charge which is levied on annual income in excess of €13,000.
3PRSI being Pay Related Social Insurance.
4Determining an individuals domicile is not straight-forward, especially where a person has become resident in Ireland and suitable advice should be obtained if the domicile status is not “cear cut”.
5A tax year in Ireland being a calendar year beginning on 1 January and ending on the following 31 December.
6The gender of the beneficiary is important as the multiplying factor takes into consideration that females, on average, live longer than males.