UK IHT issues for US revocable trusts

This article was origionally published in Tax Journal.

Question:

My clients are a married couple who are US citizens and residents. They have
put in place US wills, together with a revocable trust in order to avoid costly
probate on their deaths. They are the only trustees and have assigned all
their current and future assets to the trust. Until recently, all their assets were in the
US, but they are planning on moving to the UK shortly for work and have bought an
English home. Does this trust have any IHT consequences in the UK?

Answer:

US revocable trusts (or ‘living trusts’) are standard estate planning tools used throughout many US states. However, while convenient and tax-efficient in the US, the UK consequences of such trusts can be complex.

What is a US revocable trust?

Typically, the settlors (or grantors) are entitled to income during their lifetime and can direct distributions from their respective portion of trust principal. The settlors also have power to amend and revoke the trust. Usually, other beneficiaries can only benefit after the death of one or both settlors.

Many US states have laws (mirroring the US Uniform Trust Code) simplifying trustee duties for revocable trusts – effectively trustees owe no duties other than to the settlor during his/her lifetime, while the settlor retains mental capacity.

How are revocable trusts treated in the UK?

Where a US trust has UK resident trustees, a UK resident, domiciled (or deemed domiciled) settlor, or UK situated assets, it is essential to consider the UK position.

In your clients’ situation, the trust will shortly have UK resident trustees and settlors, and likely already holds a UK property. It is questionable whether a prior assignment of future-acquired assets into trust is effective under English law, but in all likelihood the property was acquired using US funds which were undoubtedly held within the trust, so the point is moot.

As is often the case when attempting to interpret a foreign entity through a UK lens, a number of complexities and uncertainties may arise including:

Is it a trust under English law?

A person cannot hold assets on trust for himself alone under English law; instead, there is no trust at all, no matter what label is used. Where a single settlor who is also sole trustee, retains total control over trust assets including power to revoke, and owes no fiduciary trustee duties to others, there is probably no trust under English law.

Your clients trust has two settlors/ trustees so at the very least there is a trust under English law as your clients hold assets for one another.

Is it a bare trust or a settlement?

Bare trusts are transparent for UK IHT and the beneficiary is taxed as though they owned the trust assets and income. By contrast, settlements are subject to a special tax regime.

The tax consequences of this distinction are significant. If the trust is an IHT settlement then adding UK property triggered an immediate 20% IHT charge (and future periodic and exit charges), whereas if the trust is a bare trust, then no IHT charge arose. In contrast, IHT settlements created
before a settlor becomes UK domiciled can shield offshore assets from IHT permanently, whereas bare trusts cannot.

For IHT purposes, trust property is not settled property unless it meets certain criteria, the most relevant being that it is ‘held in trust for persons in succession or for any person subject to
a contingency’ (IHTA 1984 s 43(2)).

Arguably many revocable trusts are more akin to wills since only on death does the settlor’s ability to revoke the trust and control and enjoy the trust assets cease (see the Bermuda law case of Re the AQ Revocable Trust [2010] SC (Bda) 40 Civ).

Unfortunately, this question cannot be answered definitively without full examination of the trust’s terms and governing law to establish the extent of the settlors’ powers and the fiduciary duties owed by the trustees to other beneficiaries (if any).

Could it become a settlement in future?

If the trust is not currently a settlement it may become so (in whole or in part) on the death of either of your clients if there are ongoing trusts thereafter. If the surviving spouse benefits, that portion of the fund may become a ‘qualifying interest in possession’ if the trust provides them with an immediate right to present enjoyment of the fund.

Either of your clients’ incapacity may also cause the trust (or part of it) to convert from a bare trust to a settlement. At this point, the incapable settlor will be unable to revoke or direct the exercise
of trustee powers and the trustee may be empowered to benefit a wider class of beneficiaries. An immediate IHT entry charge at 20% of the value of UK assets in trust (or worldwide assets if the incapable settlor is then UK domiciled) would then arise. This risk is often a surprise since
incapacity is not ordinarily a tax-trigger in the UK. Your clients should check with their US advisers whether attorneys acting under US durable powers of attorney could exercise their powers under the trust which may serve to prevent this outcome.

Trust registration

Since 1 September 2022, even bare trusts and trusts without a UK tax liability must register with HMRC’s trust registration service if they (a) hold UK land or (b) have at least one UK resident trustee
and enter into a business relationship with an entity in the UK, unless an express exemption applies. However, if the trust is a simple bare trust in which the entire legal and beneficial interest is held by your clients, the joint ownership exemption should apply.

HMRC’s view

HMRC have so far declined to publish their view on the tax and registration status of US revocable trusts. As far back as December 2020, it was rumoured HMRC intended to bring a test case.

In the meantime, your clients should consider whether to retain this structure in its current form given the UK nexus. Total or partial revocation may be appropriate, or it may be preferable to ensure the trust does qualify as a settlement, particularly if your clients are likely to become UK domiciled in future.