We frequently hear from individuals who would like to make financial provision for the care of family members who lack the capacity to care and provide for themselves. Trusts can be effective vehicles for such provision: they are flexible and the legislation offers tax concessions for some such trusts (referred to as ‘trusts for disabled persons’).
Who qualifies as a ‘disabled person’?
A person is a ‘disabled person’ for tax purposes if they are:
- incapable of managing his affairs because of a mental disorder (e.g. dementia; schizophrenia and autistic spectrum disorders)
- receiving certain allowances/payments, including: attendance allowance, disability living allowance and personal independence payments.
What type of trust might be suitable?
A discretionary trust
This is a trust which names a class of individuals and gives the trustees the power to decide how to distribute the funds between the individuals.
An interest in possession trust
Under an interest in possession trust, there are one or more individuals who have the
right to the income from the funds held in trust.
What tax charges will apply?
In order to qualify for the advantageous tax treatment available, a trust for a ‘disabled person’ could be either:
- a discretionary trust under which a disabled person is within the class of beneficiaries and any income and/or capital distributions from the trust are applied for his benefit during their lifetime
- a trust under which the disabled person has an interest in possession (a right to income from the assets).
If a trust meets the requirements for a disabled person’s trust, it will qualify for special treatment, not available for trusts that do not qualify as disabled persons’ trusts:
- there will be no immediate charge on the transfer of assets to the trust but the transfer will be a potentially exempt transfer so that an inheritance tax charge will arise if the person making the transfer fails to survive seven years from the date of the gift
- there will be no 10 year anniversary tax charges
- there will be no exit tax charges
- the disabled person will be treated for inheritance tax purposes as if they had an interest in possession in the funds: they will be taxed as part of his estate on their death (assuming that the trust lasts throughout his lifetime). If the trust is set up by an individual in their will, the transfer of assets to the trust on death will be chargeable to inheritance tax at the usual death rate, currently 40%.
The trust could be either:
- a discretionary trust under which a disabled person is within the class of beneficiaries; or
- a trust under which the disabled person has an interest in possession.
Capital gains tax
A transfer of assets to a disabled person’s trust is treated as a disposal of those assets at market value. There will be a capital gains tax charge if the assets are standing at a gain. It will only be possible to hold-over (i.e. defer) the charge if the assets qualify as business assets.
If the disabled person has an interest in possession, the income will be paid to them as of right and they will be taxed on that income at his marginal rate of tax (with the benefit of his personal allowance).
If the trust is a discretionary trust, the income will be taxed at the special trust rate (currently 45%) but a beneficiary who receives a distribution of income from the trust should get credit for the tax paid by the trustees.
Are there any disadvantages?
The asset protection opportunities and the availability of special tax treatment for disabled person’s trusts mean that such trusts can be an extremely useful vehicle for individuals seeking to provide for and to protect disabled family members.
The tax implications, the tax situation of the disabled person himself and any impact on his entitlement to state benefits should be considered. The cost of setting up and administering a trust should also be taken into consideration.
The content of this article is for general information only. For further information on this topic, please contact Catherine Bacon. Law covered as at August 2015.