Category: Articles

IR35 – Are you at risk?

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Are you concerned about the new IR35 rules and how they may affect your business or subject to an HMRC investigation? Ingrid McCleave explains what you need to look out for.

The extended off-payroll workers rules now often referred to as the new IR35 rules came into effect on 6th April 2021. They are intended to reduce the number of off-payroll workers (‘contractors’) who treat themselves as being self-employed by taxing them as employees. 

This is achieved by placing responsibility for determining the employment status of the contractor with the organisation receiving the contractor’s services. If your organisation receives services from individuals who are not on your payroll and who work through an intermediary then the new IR35 rules may apply.

Who do the Rules Apply to?

The new IR35 rules apply to organisations which are in the private sector, medium or large in size and connected to the UK.

A company (or an LLP) is small if it satisfies two or more of the following requirements:

  • It’s annual turnover is not more than £10.2m;
  • It’s balance sheet total is not more than £5.1m;
  • It has no more than 50 employees.

For a group company to be a small company the small business test must be applied to the group as a whole.  There are rules to aggregate the turnover of connected persons, so for complex structures external advice may be needed to confirm the position.

An organisation will have a UK connection if immediately before the beginning of the relevant tax year the entity is either UK tax resident or has a permanent establishment in the UK.

Only contractors who are either resident in the UK or perform their services in the UK can be caught by the new IR35 rules.  The jurisdiction of the contractor’s intermediary company is not a relevant factor.  The IR35 rules are targeted at working arrangements which involve intermediaries acting as the contractor’s personal entity.

Personal Service Companies

Personal service companies are the most common intermediary through which businesses engage with contractors. A contractor would only be caught by the new IR35 legislation if he or she owns the material interest in the personal services company.

Material interest

Material interest is defined as beneficial ownership of or the ability to control more than 5% of the ordinary share capital of the company;

  • An entitlement to receive more than 5% of any distributions that may be made by the company; or
  • An entitlement to receive more than 5% of the assets on winding up.

This can cause problems in that it is often difficult to independently identify corporate ownership structures.

Companies House can confirm whether an individual owns over 50% in the corporate entity.  It will not however identify ownership between 5% and 50% of the intermediary. It will also not identify whether the contractor is entitled to distributions or assets on winding up. It is therefore essential that the engager of the contractor’s services request detailed information and evidence of ownership structure, often coupled with contractual indemnities. The new rules apply if the intermediary is a company in which the contractor (or his associates or together with his associates) have a material interest.  A material interest is a 5% ordinary shareholding in the company.

A second type of intermediary company caught under the rules is a company from which the contractor has received (or has the right to receive) a ‘chain payment’.  A chain payment is the amount paid for the services which the contractor has provided to the client.  The legislation makes it clear that where PAYE is already applied to a contractor’s earnings the new IR35 rules will not apply.

The new IR35 rules do not apply where the agency employs the contractor and operates PAYE on earnings paid to the contractor.  However if the agency contracts with the contractor’s intermediary, ie personal service company, rather than with the contractor directly then the new IR35 rules can still apply.

The new IR35 rules apply where a contractor personally performs (or is under an obligation personally to perform) services for an engager.  Where your organisation contracts with a service provider for a fully outsourced service typically it is not entering into a contract for the supply of a particular contractor.  Your organisation is not therefore the ‘client’ for the purposes of the new IR35 rules.  In an outsourced arrangement the service provider is the client and it is therefore the service provider that must apply the new IR35 rules.  Advice should be taken on whether this is an outsourced service.

If the contractor and personal service company fall within the scope of the rules then you must examine whether the contractor would have been an employee or your organisation had it not been for the existence of the intermediary.  This is known as a ‘status determination’.  If it is decided that the contractor would have been an employee they are referred to as being ‘deemed employed’ by the client.

Who’s responsibility is it to determine employment status of contractor?

It is up to the engager to determine whether the IR35 legislation applies.  HMRC will seek underpaid Income Tax and NIC from the engaging entity.  Engagers must ensure that where they are relying on the representations made by contractors that they have processes in place to validate the information provided, requesting detailed back up documentation from the contractor and checking the data as much as possible against Companies House.

The obligation to determine the contractor’s employment status and the preparation of the status determination statement falls on the engager of the services of a contractor.  If these obligations are not complied with the engager becomes liable for any underpaid Income Tax and NIC as well as interest and penalties.

Determining who the engager is may have its own complexities where there are multiple agencies and outsourced services. Where the outsourced service primarily relates to the provision of specific individuals (possibly naming them) there is a risk that it may not be an outsourced service.

Careful consideration of mixed service contracts and bespoke payment agency arrangements, for example where it is commission based, should be carefully analysed.  The engager when analysing these arrangements needs to consider whether the contractor’s services are similar to those of employees.  If this is the case then this may not be an outsourced service. HMRC have given guidance on this point stating that where the service provided by the worker sits squarely with the nature of the business this indicates this is not an outsourced service. It is essential that businesses and their suppliers agree where the responsibility lies for undertaking employment status assessments.

Engagements with small companies fall outside the scope of the new IR35 rules

All decisions and their rationale should be documented in case of HMRC enquiry. Periodic reviews should be undertaken since arrangements may change over time.   Procedures need to be put in place to ensure this occurs.  Contracts should be revisited to ensure they reflect the true nature of the engagements.

It is clear that a determination by the engager that a contractor is employed under the IR35 legislation will not be welcomed by the contractor because their remuneration would be subject to Income Tax and NIC deductions.

Contractors have historically challenged their employment status determinations, completing HMRC’s check of employment status tool, leading to dispute resolution.  The new legislation states that the engager is required to consider these challenges within 45 days of receipt and to provide a statement either confirming the original decision with supporting reasons or to amend the original decision, unless there was a corresponding day rate increase.  They would leave.

VAT and Contractors’ Invoices

Regardless whether the contractor’s invoice is subject to a further payment of PAYE and NIC, the VAT element is still payable to HMRC. Procedures need to be in place to identify these invoices so that only the amount due to the contractor under the IR35 rules is paid and the VAT element processed through the ultimate engager’s VAT Return.

Employment Rights

These changes do not entitle the contractors to employment rights.  This has been specifically stated by the Government.  However, since the contractor will be treated as an employee there is a risk that they will request holiday pay, sick pay and other employment benefits.

Conclusions

Engagers should review whether their contractors come within IR35 and a procedure set up for deadlines for the acceptance of new engagement terms.  It will be necessary to review all supply chains to ascertain whether those suppliers use contractors. 

Due diligence of supply chains because of the transfer of liability provisions within the new legislation.  Underpaid Income Tax and NIC can transfer to the first agency in the contractual chain but if not collected by them to the end engager itself.  Contracts need to be reviewed to ensure there are adequate indemnities and obviously the liquidity of the agency ascertained.

Umbrella companies have been used as a substitute for personal service companies to eradicate the need of undertaking employment status assessments, however, contractors may not agree to do so and the engager’s costs could escalate.

There are however further risks if the umbrella company is not registered in the UK.  HMRC is focusing on non-compliant umbrella companies and so there is still a risk that the Income Tax and NIC could pass to the ultimate engager.

To determine the status of the contracts the ‘on the ground’ working arrangements between the parties must be analysed.  Where an agency is involved this will entail understanding the terms of the contract between the agency and the contractor’s intermediary. If the contractor is an office holder of the client organisation they will automatically be a ‘deemed employee’.

The new IR35 rules put an obligation on the client to provide a status determination statement to the contractor and to the intermediary (eg the recruitment agency).  If the client fails to do so and the contractor is working through an intermediary the client will automatically be treated as the ‘deemed employer’ and will be obliged to account for PAYE.

There is no prescribed format for the status determination statement.  If the CEST test has been used HMRC will accept the results of the test. The client must take ‘reasonable care’ in the making of the status determination otherwise they will automatically be treated as the ‘deemed employer’. The status determination statement must be issued before the payments on or after 6 April 2021 are made. The statement can be appealed in writing or orally.

Where there is a chain of entities between the client organisation and the contractor’s intermediary, it will usually be the entity that pays the intermediary (rather than the client) that will be the ‘deemed employer’ and responsible for the payment of tax.

PAYE must be deducted from the amount of the payment made by the ‘deemed employer’.  This will usually be a fee invoice by the intermediary, net of VAT.  The ‘deemed employer’ may also, if it chooses, deduct expenses that would be tax free if paid to an employee such as free subsidised meals provided on their premises.

It may be possible to terminate existing contracts with contractors and enter new contracts with a reduced fee to reflect the fact that the client organisation will now assume responsibility for employer’s NIC. Alternatively the contractor may be willing to abandon their intermediary entity and provide the services to the client via an umbrella company or agency. 

A third option would be for the client organisation to offer the contractor a fixed term contract of employment. This publication is a general summary of the law.  It should not replace legal advice tailored to your specific circumstances. If you would like to discuss your tax situation please call us on 020 7481 2422 or you can email wellers.wealth@wellerslawgroup.com.

Life Interest Will Trusts

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Life Interest Will Trusts – what are they and how do they work? Ingrid McCleave explains in her third article in her tax and trusts series how Life Interest Will Trusts are impacted by different events and the implications for the main types of tax.

  A.   Life Interest Will Trusts

Under a Life Interest Trust (sometimes called an Interest in Possession Trust), the Trustees have no power to accumulate the income within the trust. Under the terms of a Life Interest trust, the Trustees must pay out the income of the trust, to a nominated beneficiary, or beneficiaries. The Trustees cannot hold back any of the income and keep it within the Trust. 

The beneficiary is called the life tenant and is legally entitled to the net income of the trust, after taxes and expenses each year. A life tenancy does not necessarily mean a right to the income for the rest of one’s life. For example, a life tenant could be given a right to income until a specified age or a certain point in time e.g. on the event of remarriage or bankruptcy. When that interest ends, the capital of the trust will pass to another beneficiary called a remainderman or sometimes also called reversionary beneficiary. If the Trustees have power to remove future income, this does not negate the existence of a current life interest. An exclusive right to enjoy an asset within a trust is also an Interest in Possession, even if that asset does not produce any income, therefore if the Trustees permit a beneficiary to occupy a dwelling house at less than full commercial rent, or no rent, this will create an interest in possession. 

Trustees will have flexible powers to distribute capital at their discretion. It is therefore possible for the life tenant to receive a capital distribution or for the remainderman to receive trust capital before the tenant has died.

B.    Inheritance Tax position of a Life Interest Will Trust/ Interest in Possession Will Trust 

Where a life interest is created on death, the inheritance tax treatment depends on the identity of the life tenant.

Where the deceased spouse/civil partner has a life interest or right to occupy in the trust, the transfer on death is exempt from inheritance tax. This mirrors the rule that transfers to spouses/civil partners are exempt. Where the deceased is UK domiciled and the spouse/civil partner is non-UK domiciled, the spouse exemption on the life interest/right to occupy is limited to £325,000. Where any other individual has a life interest/right to occupy, the transfer on death of the life interest/right to occupy is chargeable and subject to inheritance tax.  

On the death of the life tenant, the trust assets will be treated as part of the life tenant beneficiary’s estate and the executors must declare the value of the underlying assets on the life tenant’s death estate return. If the life tenant only has a right to income or to occupy part of the trust fund, the same proportion of assets in the life interest trust is deemed to form part of his estate. Assets held by the deceased life tenant in his own right i.e. personal assets, make up his free estate. The value of his free estate less any liabilities of the estate, plus the value of the underlying assets in his share of the life interest trust, make up the total amount chargeable to inheritance tax.

Even though the life tenant was only entitled to the income of the trust during his lifetime, on his death we pretend that the capital assets underlying his life interest are part of his estate for inheritance tax purposes.

It is not subject to the exit charges and principal charges (10-year anniversary charges) that Discretionary Trusts are subject to.

C.   Lifetime cessation of a Life Interest/Interest in Possession Will Trust

In certain circumstances, a life tenancy can end whilst a life tenant is alive. It could be terminated under the trust deed for example, where the life tenancy terminates at a certain age. Alternatively, the life tenant can bring his right to income or to occupy (life interest) to an end at any time. One example of this may be a life tenant transferring his right to income or to occupy to another person. Alternatively, they may decide to waive their right to income or to occupy to accelerate the remainderman’s interest coming into being. The remainderman may be an individual who inherits the underlying capital assets of the life interest trust absolutely or it may be a discretionary trust. 

The inheritance tax treatment of the lifetime cessation of the life interest depends on whether capital assets leave the trust or another beneficiary take a successive interest in possession, or the capital assets go to the remainderman. 

If the life tenancy terminates during the lifetime of the life tenant and the assets leave the trust i.e. the underlying capital assets pass to another beneficiary i.e. remainderman, this is usually a potentially exempt transfer by the life tenant. This means that the life tenant has to survive 7 years after the event for it to fall completely outside of his estate for inheritance tax purposes. 

The exceptions to this general rule are where the life tenancy ceases and the assets pass to the life tenant’s spouse, in which case the transfer is exempt, or the life tenancy ceases and the assets pass to the life tenant, in which case there is no transfer of value and no inheritance tax is due.

Any inheritance tax payable, as a result the life tenant not surviving seven years, is usually paid by the Trustees, although the life tenant’s estate could be made liable for any tax, which remains unpaid by the due date.

Where another beneficiary takes a successive life interest during the lifetime of the current life tenant without assets leaving the trust, there is a transfer of value for inheritance tax purposes because assets will be leaving the estate of the current life tenant. The new life tenancy now comes under what is called the relevant property regime and the transfer will be immediately chargeable to inheritance tax. Any inheritance tax due will be paid by the Trustees. The annual exemptions of £3000 for current and preceding year will be available as deductions, assuming the previous life tenant has not already used them.

An Example: A deceased testator leaves their entire net estate on a Life Interest Trust for their spouse/civil partner for life, with reversion to their children on their spouse’s death and a clause providing for the spouse’s interest to terminate on the event of their remarriage. If the spouse dies during the life tenancy, the underlying value of the capital assets of the trusts will be added to their personal net estate for inheritance tax purposes and the inheritance tax due will be apportioned between the spouses executors and the life interest Trustees. The children will receive the trust assets, net of the trusts share of the inheritance tax due. 

If in the above example, the spouse remarries, the life interest trust will terminate, the underlying trust assets will pass to the children. This is a potentially exempt transfer by the spouse and the children will pay inheritance tax if the spouse dies within 7 years. There is no exist charge on the assets passing to the children as the assets are not coming from a discretionary trust, as explained above. 

The same applies if you substitute the children’s reversionary interest, to that of discretionary trust i.e. a discretionary trust receives the assets on termination of the life interest, whilst the life tenant is alive, or the life tenancy subsist and the life tenant gives it away. 

 D.    Disposal of a Life Interest in a Life Interest Will Trust/ Interest in Possession Will Trust

An interest in possession is a right to income. This right is an asset in itself and could have significant value. The life tenant may therefore want to sell his interest. The purchaser would then become entitled to the trust income. Any gains are not chargeable to tax, provided the life tenant received his interest via the original will and did not purchase his interest from the original life tenant. If you do not want to risk a life tenant selling their interest, then you need to consider a Protective Trust arrangement, whereby, if the life tenant attempts to sell his interest, the life interest ceases and the trust become fully discretionary, but is not subject to exit or principal charges. 

E.   Income Tax position for Trustees of a Life Interest Will Trust/ Interest in Possession Will Trust

If it receives rental income, the property business profits are fully charged at the basic rate of 20%. The same rate applies regardless of the level of income. Property income deductions are the same as they are for individuals.

If interest is received, it is wholly charged at the rate of 20% regardless of the level of income. Interest is received gross. Trustees are not entitled to the personal savings allowance. 

Dividends are received gross and are charged at the dividend ordinary rate of 7.5%. The dividend allowance is not available to Trustees. 

Life Interest Will Trusts are not allowed to take a deduction for any expenses incurred in managing the trust. 

 F.   Capital Gains Tax position of a Life Interest Will Trust/ Interest in Possession Will

If a Trustee appoints an asset to a beneficiary (they are deemed to have disposed of the asset at market value) or sells a trust asset at market value, this is a disposal by the Trustees for capital gains tax purposes and capital gains could arise. Trustees receive an annual capital gains tax annual exempt amount, which is equal to half of an individual’s annual exempt amount (currently £12,300, so £6,150 for a trust). The Trustees annual exempt amount is divided by the number of UK trusts settled by the same settlor/testator (the person who set up the trusts) after the 6th June 1978. Overseas trusts and trusts no longer in existence are ignored.

Capital Gains Tax implications of the death of the Life Tenant – when a life tenant dies, the trust’s assets will either pass to the remainderman and the trust will come to an end, or, the trust will continue, either with another life tenant taking a successive life interest, or with the trust fund becoming discretionary, with no rights to income.

The capital gains tax position on the death of the original life tenant gives rise to a deemed disposal by the Trustees of all of the assets in the trust at that time. This is regardless of whether the trust continues or ends. 

The deemed disposal takes place at market value. Capital gains, or losses, will arise to the Trustees at this point.

Under general capital gains tax principles, death is not an event, which triggers a charge for capital gains tax purposes. Therefore, any gains arising on the deemed disposal will not give rise to a capital gains tax charge. 

Business Asset Disposal Relief – This is a capital gains tax relief available to tax payers who sell or give away their businesses. It reduces the rate of capital gains tax paid by taxpayers on qualifying disposals to 10%. Gains are eligible for Business Asset Disposal Relief up to a maximum life time limit, which is currently 1 million pounds. The relief is also available where a Life Interest Will Trust makes a disposal. In order for a Business Asset Disposal Relief claim to be made in respect of trust gains, the beneficiary that fulfils the criteria must have a life interest in the trust. 

Fully discretionary trusts cannot claim Business Asset Disposal Relief. 

For a Life Interest Will trust disposal to qualify, the disposal must be of either (i) a business owned by the Trustees, but run by the life tenant, either alone or in partnership or (ii) shares in a qualifying company. The qualifying company must be the life tenant’s personal trading company and the life tenant must have had a minimum of 5% shareholding and must be an employee or officer of the company throughout a period of 2 years, ending within the 3 years up to the date of the disposal. It is not therefore essential that the beneficiary had a 5% shareholding and worked for the company at the date of disposal by the Trustees, but he must have satisfied these conditions in 2 of the 5 years up to the date of disposal. The Trustees have no minimum shareholding; it is the life tenant who must own at least 5% of the shares. It is not necessary for the life tenant to have had a life interest for 2 years.

The life interest must be permanent; it cannot be for a fixed term, although it can be revocable. This allows Trustees to create a life interest (if it was a purely discretionary trust), just before the share sale to obtain the relief, then revoke that life interest later.

The Trustees and life tenants must make the claim for relief jointly, since it is the life tenant’s relief, which is being utilised. The life tenants lifetime gains ceiling of £1 million is reduced by any gains for which Business Asset Disposal Relief is given to the Trustees.  

Where a life interest trust has more than one life tenant, the gains eligible for Business Asset Disposal Relief are apportioned by reference to the qualifying life tenant’s proportional entitlement to the trust income.

Investors Relief – this relief enables individuals to claim relief on a disposal of shares in an unlisted trading company in which they do not work. This is available to the Trustees of a Life Interest Trust, provided a beneficiary has a life interest in the relevant shares for at least 3 years prior to the share disposal. The other conditions are that prior to disposal of the shares, the Trustees have subscribed for and owned shares in the unlisted trading company for at least 3 years. A further condition is that the eligible beneficiary has not been an employee of the company for at least 3 years prior to the share disposal and his interest in possession is not for a fixed term. The qualifying gains will be taxed at 10%. The beneficiary has a lifetime gains ceiling of £10 million in which investors relief can be claimed. This is in addition to their Business Asset Disposal Relief. The Trust does not have its own lifetime allowance, but instead uses the beneficiary’s lifetime allowance. The Trustees and the beneficiary make the claim jointly. 

Principal Private Residence Relief – if the Trustees own a Trust property and one or more beneficiary’s occupy that property as their only or main residence, Principal Private Residence Relief is available on the disposal of the property. The following periods are exempt for Principal Private Residence Relief: (i) the period during which the property was occupied by the beneficiary; (ii) the last 9 months of ownership; (iii) deemed occupation period which include periods of absence up to 3 years, periods of absence during which the beneficiary was abroad by reason of his or her employment, periods of absence up to 4 years where the beneficiary was required to work elsewhere. The deemed occupation periods can only apply to trust gains where the same beneficiary occupied the trust property, both before and after the period of absence.  

G.     Tax Position of a Beneficiary of a Life Interest Will Trust/ Interest in Possession Will Trust

The net income of the trust after taxes and expenses will flow through to the beneficiary. This income is taxed on the beneficiary in the year in which is arises. As this income will have already been taxed in the hands of the Trustees, the life tenant will receive tax income and this income will need to be reflected on her self-assessment return. Trust management expenses are deemed to have been paid from dividend income in priority to interest and rents, thereby reducing the amount of income received or deemed to be received by the life tenant. If trust management expenses exceed trust income received by the life tenant for the year, the trust management expenses will be carried forward and deducted from income arising in future years. 

If the life tenant is a basic rate taxpayer or has losses, the tax credits attaching to the income can be recovered. The trust income retains its character and is taxed as rental income, savings income and dividend income respectively, in the hands of the life tenant. The life tenant will be entitled to a personal savings allowance in respect of his trust interest and to the dividend allowance in respect of his trust dividends. 

Certain capital receipts are treated as income e.g. life assurance gains and offshore income gains, among a few. These are taxed at 45%.

Sometimes the Trustees mandate trust income to the life tenant e.g. bank interest and dividends. In these circumstances, the Trustees do not report or pay tax on the income, the life tenant is directly chargeable on her self-assessment return. 

The property business profits are calculated as for a discretionary trust and interest costs are subject to the same restriction, however, the Trustees are not entitled to the 20% tax reducer. Instead, the tax reducer is given to the life tenant via their own income tax computation, so the Trustees must notify the life tenant of the amount of interest, which has been disallowed.

If you have any questions about any of the above, please contact us on 020 7481 2422 or by email at wellers.wealth@wellerslawgroup.com

Incorporation Relief

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You currently run your business as a sole trader or partnership and want to know the advantages and disadvantages of incorporating that business.

One of the advantages is that a company has limited liability whereas as a sole trader or partnership you have unlimited liability.

As an individual, your trading profits may be taxed at 45%, whilst a company pays tax at 19% for 2019/20 and 2020/21.

A disadvantage is that you will no longer be able to set your trading losses in the future against other income, once you have incorporated.

You also need to consider what your stamp duty land tax bill will be on transfer of land and buildings to the company.  If it is too great, you may instead wish to consider Gift Relief as an alternative.

This article explores the Capital Gains Tax implications when a sole trader transfers his business to a limited company by transferring the business assets to the company, through which he continues to trade. 

The sole trader and the company are connected persons and therefore there is a deemed disposal by the individual to the company at market value.

Usually the only Chargeable Assets are land, buildings and goodwill.  Plant and machinery, other than exceptionally, suffer losses, which are dealt with under the Capital Allowances regime.

If any buildings transferred have benefited from structures and buildings allowance (where they have been used for business purposes such as offices, retail premises, factories and warehouses), having met the conditions of the allowance, the consideration for the disposal is increased by the total amount of allowance already claimed when calculating the gain for Capital Gains Tax purposes.

The object of Incorporation Relief is the deferral, wholly or partly, of gains on chargeable assets. 

The deferred gain is rolled over and set against the base cost of the sole trader’s shares in the company. The gain will be charged when the shareholder sells his shares in the company.

The calculation is as follows:

£
Deemed gain on transfer of land and buildingsx
Deemed gain on transfer of goodwill x
Total gains x
Less: 
Incorporation Relief   x
Gains x (value of shares received) divided by total consideration    (x)
  
 £
The base cost of the shares in the new company: 
Market value of shares at incorporation x
Less:  
Incorporation Relief  (x)
Base cost of shares x===

Usually the value of the shares received is the same as the total consideration received by the individual from the new company and the Incorporation Relief fraction will be one.  In these circumstances, the whole of the gain is deferred and no gain is chargeable.

If the company pays for the business with loan stock i.e. something other than shares, a Chargeable Gain will arise.

The mechanics of this is usually achieved by the company opening a Directors’ Loan Account. The sole trader who then becomes a director can then withdraw money from the loan accounts once the company is profitable.

To qualify for Incorporation Relief the following conditions must be met:

  • The business must be a going concern.
  • All assets of the sole trader’s business must be transferred, with the exception of cash, to the company.  If the sole trader wishes to retain land and buildings outside of the company e.g. to save Stamp Duty Land Tax, he will not be eligible for the relief.
  • The consideration received by the sole trader must be wholly or partly in shares.

The relief applies automatically when the above conditions are met.

In order not to waste the sole trader’s Capital Gains Tax annual exempt amount, it is possible to calculate the amount of Directors’ Loan required to generate a gain equal to it.

If the sole trader decides to utilise Entrepreneurs’ Relief, he can organise his consideration so that a Chargeable Gain above the annual exempt amount is triggered and he can take advantage of the relief at this stage. He may wish to do this if the shares in the company on sale would not qualify for Entrepreneurs’ Relief.

Entrepreneurs’ Relief is available on any Chargeable Gains on the transfer of land and buildings but not goodwill where the sole trader receives 5% or more of the shares in the company.  The rationale behind this is that if the sole trader is retaining less than 5% of the shares then he is truly selling the business and reducing his involvement in it and therefore in those circumstances Entrepreneurs’ Relief would be available on the gains attributable to the transfer of goodwill.

Provided, the company is the shareholder’s personal trading company and the shareholder works for the company and meets the other criteria for Entrepreneur’s Relief, you can look through the incorporation and include the period during which the business was owned by the sole trader, when considering the two-year qualification period for Entrepreneurs’ Relief, prior to the sale of the shares. Entrepreneurs’ Relief will be available provided shares were issued wholly or partly in exchange for the transfer of the business as a going concern.  Provided the business and the shares in the personal company have been owned for a combined period of 2 years and the individual shareholder works for the company. A subsequent sale of the shares would qualify for Entrepreneurs’ Relief.

Dis-applying Incorporation Relief

The sole trader can elect to dis-apply Incorporation Relief if they want to use full Entrepreneurs’ Relief or have Capital Losses to use.  This may be the preferred route where the shareholder no longer works for the company at the date of the subsequent sale of the shares and so Entrepreneur’s relief would not be available at that stage.

Gift relief

To avoid paying Stamp Duty Land Tax on the transfer of the building to the company at market value, the sole trader can alternatively gift the assets to the company.  The deferred gain is rolled over and reduces the base cost of the assets in the hands of the company. The deferred gain does not reduce the base cost of the shares.

If you do not transfer all of the business assets except cash to the company, Incorporation Relief is not available.

This is a complex area and the advice of your accountant or tax advisor should be obtained in advance of any transaction.  We are very happy to advise you either separately or in conjunction with your accountant or legal advisor.

Wellers Wealth are very happy to work in conjunction with your independent financial advisor, accountant or legal advisor on such matters.

Please call us on 020 7481 2422 or email us at wellers.wealth@wellerslawgroup.com if you would like to know more.

This article was written by Ingrid McCleave and the law is correct as at 24th November 2020. Please note that tax legislation changes frequently, so this article should not be relied upon without seeking further legal advice.

Entrepreneur’s Relief

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How to use Entrepreneur’s Relief? 

The budget 2020 announcements reduced the lifetime limit for gains qualifying for Entrepreneurs’ Relief from £10 million to £1 million for qualifying disposals made on or after 1 March 2020. So how should you make use of this important tax benefit?

The Government’s rationale for this reduction is the relief has done very little to generate additional entrepreneurial activity, primarily benefitting a small number of very affluent tax payers.

John Cullinane, the Tax Policy Director of the Chartered Institute of Taxation is calling for MPs to look closely at the Government’s plans for Entrepreneurs’ Relief and in particular why the review was not carried out in public.  He goes on to say “there are people affected by the March 2020 budget change who have reinvested money in the expectation of the relief that they will no longer receive”.

Under the budget 2020 proposals, Entrepreneurs’ Relief is to be re-badged “Business Asset Disposal Relief”.

Entrepreneurs’ Relief is a Capital Gains Tax Relief available to taxpayers who sell or give away their businesses. 

The relief operates by reducing the Capital Gains Tax payable on the gain (or deemed gain in the case of a gift) to 10%.  This is regardless of whether the taxpayer is a basic, higher or additional rate taxpayer. 

Up until the budget 2020 there was a lifetime limit of the gains qualifying for Entrepreneurs’ Relief of £10 million, but this has now been reduced £1 million. 

The relief is available to sole traders or partners selling or gifting the whole or part of their business, company directors and employees who dispose of shares or securities in a personal trading company that they work for and directors and employees who acquired shares under the EMI Option Scheme.

To qualify there must have been material disposals of business assets. 

A business asset is defined as:

  • The whole or part of a sole trader or partnership business.
  • A disposal of an asset used in a business at the time the business ceases to be carried on.
  • A disposal of shares (securities, loan stock etc.) in a company.
  • A material disposal means that the business must have been owned by the taxpayer for at least two years prior to the disposal.
  • A disposal of furnished holiday lettings qualifies for Entrepreneurs’ Relief, provided the other conditions are satisfied.  A residential property business would not qualify.

In respect of assets used in the business at the time the business ceases, the asset must be sold within 3 years of the cessation of trade. 

Shares in a personal company

The conditions are that the individual owns at least 5% of the ordinary share capital and at least 5% of the voting rights which is exercisable by the individual by virtue of that holding. 

The second condition is that the taxpayer must work for the company or for another company in the same group.  This would include full-time or part-time employees or directors.  There is no minimum number of hours of work required.

In addition, the shareholder must either be entitled to at least 5% of the distributable profits and 5% of the assets available on the winding up and/or be entitled to at least 5% of the proceeds of disposal of the whole of the ordinary share capital of the company.

Associated disposals are also eligible for Entrepreneurs’ Relief:

The associated disposal rules do not apply to sole traders.

To qualify as an associated disposal a number of elements must be satisfied. You must have made a material disposal of the business or shares and securities in a company. As part of the withdrawal from the business you make a disposal of an asset which has been used in that business for at least 2 years and was acquired on or after 13 June 2016. The asset must have been owned by you for 3 years prior to disposal. 

An example: a company director owns at least 5% of the shares of a company and also owns the premises from which the company trades. Provided he sells the building at the same time as he sells the shares, this could be an associated disposal provided the other criteria apply.

Entrepreneurs’ Relief can be claimed on part-disposals of businesses or business assets provided the disposal represents at least 5% of the shareholding (see above) or 5% of partnership assets. Provided the taxpayer has owned 5% or more for three of the eight years prior to the disposal, a material disposal may be of less than a 5% interest provided it is of the whole of the individual’s partnership assets/shareholding. 

The associated disposal must take place within one year of the business cessation or within three years, so long as the assets have not been leased or used for any other purpose.  If the individual taxpayer has charged the business rent for use of the assets, at its full market rent, no Entrepreneurs’ Relief is available.  If less than the market rate rent has been charged for the business, some Entrepreneurs’ Relief will be available.  If no rent is charged, then full relief is available.

Interaction with Rollover Relief

If you make a material disposal of business assets and you re-invest in a new business, you may look at first to see if there is any Rollover Relief available for the investment in the new business and apply Entrepreneurs’ Relief to any gains remaining after the Rollover Relief has been claimed. 

Interaction within Incorporation Relief

If you transfer your business to a limited company you may wish to consider whether Entrepreneurs’ Relief would be available to you on any gains arising on the incorporation.

The main point to note is, that Entrepreneurs’ Relief will not be available in respect of any gain arising on the transfer of goodwill to the company. Under Section 169LA TCGA 1992 where goodwill is disposed of to a close company and the transfer is of 5% or more of the share capital of the company (or the shareholder exercises at least 5% of the voting rights or the shareholder is a beneficiary entitled to at least 5% of the profits available for distribution and at least 5% of the assets on a winding up or would be beneficially entitled to at least 5% of the proceeds on the disposal of the whole company) then goodwill is no longer a relevant business asset for the purposes of Entrepreneurs’ Relief.

In those circumstances, Entrepreneurs’ Relief would not be available for the value of the goodwill but Entrepreneurs’ Relief would be available where the transferor holds less than 5% of the shares of the company and does not meet any of the other tests listed above.  The rationale behind this is that the individual is genuinely selling their business and reducing their involvement in it.

In summary, Entrepreneurs’ Relief is one of the most attractive benefits available to entrepreneurs.  You can claim as many times as you like provided your claims are within the £1 million lifetime limit.  It is available to individuals, not companies.

If you are selling a business, you have to be the sole trader or a business partner for the two year qualifying period. 

If you are selling shares you have to have been an employee or officer in the company as well as owning the shares for the qualifying period.  The company itself must be a trading company or the holding company of a trading group and must have traded within the qualifying period.

There is one case in which you are not required to be working in the business under an extension called Investors’ Relief.

The pitfalls of not dotting your ‘i’s’ and crossing your ‘t’s’

A £1 million tax relief can be lost on a technicality.  It is therefore essential that you seek advice within at least two years prior to your retirement and earlier if possible. This is to ensure that you are eligible for the relief and if you are not eligible, to give us time to see what can be done to ensure you become eligible.  Do not wait until after you have sold your business interests or your shares before checking. 

The sorts of things that you will need to consider are whether you have any evidence that you have worked as an employee or officer for the company because if you can’t prove it you won’t be eligible.  It would be sensible to have a written Employment Contract for example.

There is no set definition of trading given by HMRC.  A company’s trading status is evaluated based on several factors.  Trading can in certain circumstances extend to a one-off transaction resulting in unexpected profits.

Lots of businesses have a mixture of trading and non-trading activities.  Companies with mixed business trading can still be eligible for Entrepreneurs’ Relief provided the non-trading activities are not substantial.  HMRC considers substantial to be anything over 20%.  So for example provided rental income received by the company equates to less than 20% of the company’s total trade and the staff are not spending more than 20% of their time in relation to non-trading activities, then you still may be able to qualify. 

If your company is cash rich you could risk failing the trading status test unless such cash has been earmarked for a trading purpose.

Assets used in the business up to Cessation of Trade and subsequently sold

The business must be owned for at least two years prior to cessation and the asset must be sold within three years of the cessation. In these circumstances, the asset would qualify for Entrepreneurs’ Relief. 

EMI shares

There are additional requirements to comply with if the shares are from an EMI.  To be eligible for Entrepreneurs’ Relief you must have:

  • Purchased the shares after 5 April 2013.
  • Be offered the option to buy them at least two years before selling them.

The requirement to hold 5% or more of the voting share does not apply when it comes to disposing of EMI shares.

One way round the lower limit (the £1 million lifetime limit) would be to consider gifting shares to your spouse, since these are transferred at no gain no loss. Provided your spouse met the criteria, they would also have a full Entrepreneurs’ Relief lifetime limit.  This doubles your tax relief. 

If you are dissolving your company, Entrepreneurs’ Relief can still be claimed provided:

  • The distribution of company assets is taxed as a capital distribution, not as income.
  • Distribution takes place within three years of the date of cessation of trade.
  • In the two years prior to the company ceasing to trade, the usual qualifying conditions were met.  

You will need to discuss this with your accountant but you may find paying the 10% Capital Gains Tax suits you better than seeking out your profits over several years with a traditional small salary of £12,000 or so per year plus dividends on which only 7.5% tax is payable.

There is anti-avoidance legislation that was introduced in April 2016 which prevents individuals from closing companies simply as a way of taking advantage of the tax efficiency of the capital distribution route rather than an income distribution.

Distributions from the voluntary liquidations of a company may be treated as income distributions in the following circumstances:

  • If the company is a closed company (a company with five shareholders or less).
  • If the shareholder receiving the distribution is involved with a similar trade or activity within two years.
  • If the intention of winding up the business appears to be to obtain a tax advantage.

In these instances, the distributions could be subject to income tax and ineligible for Entrepreneurs’ Relief.

The legislation surrounding Entrepreneurs’ Relief is complex and professional advice should be sought well in advance of retirement, incorporation or gifting of business assets.

Wellers Wealth are very happy to work in conjunction with your independent financial advisor, accountant or legal advisor on such matters. 

Please call us on 020 7481 2422 or email us at wellers.wealth@wellerslawgroup.com if you would like to know more.

This article was written by Ingrid McCleave and the law is correct as at 24th November 2020. Please note that tax legislation changes frequently, so this article should not be relied upon without seeking further legal advice.

Discretionary Will Trusts

Posted on by Wellers

Many financial advisers I have worked with really want to know the tax benefits of the different types of trusts.  I have therefore started with an explanation in relation to Discretionary Will Trusts which must be differentiated from Lifetime Discretionary Trusts set up during a person’s lifetime, outside of their Will.

Wherever there is a separation of legal title and beneficial ownership, a trust arrangement will exist. In this relationship, the Trustees actually own the assets. However, the Trustees must not benefit from those assets themselves. Instead, the Trustees have a duty to use the income and capital of the trust for the benefit of the beneficiaries, as instructed by the Trust Deed.

Family trusts set up by Will are not contentious or controversial and are not black listed by HMRC and do not fall foul of recent anti-avoidance legislation.

In a trust set up by a Will, the trust is created on the date of death of the testator. Trustees are a separate legal person. Trustees as a legal body will themselves have income tax, capital gains tax and inheritance tax liabilities and will have to file self-assessment tax returns. The same self-assessment rules apply to Trustees as they do for individuals. No personal allowances are available to reduce trust income. When calculating the income tax liability of the trust, the same rates of tax usually apply regardless of the levels of trust income. The various rate bands, which apply for individuals, do not apply for trusts. A trust cannot be an employee; therefore, trusts will never receive employment income. The sources of income in a trust tax computation are normally restricted to rent, interest and dividends.

The beneficiaries of the trust are the only persons who are entitled to use or enjoy the income or assets of the trust.

If a Trustee appoints an asset to a beneficiary (they are deemed to have disposed of the asset at market value) or sells a trust asset at market value, this is a disposal by the Trustees for capital gains tax purposes and capital gains could arise. Trustees receive an annual capital gains tax annual exempt amount, which is equal to half of an individual’s annual exempt amount (currently £12,300, so £6,150 for a trust). The Trustees annual exempt amount is divided by the number of UK trusts settled by the same settlor/testator (the person who set up the trusts) after the 6th June 1978. Overseas trusts and trusts no longer in existence are ignored for this purpose..

If either Trustees distribute income to a beneficiary, at their discretion or in accordance with the beneficiaries entitlement e.g. Life Tenant (who has the right to income – see below), that income is charged to income tax in the hands of the beneficiary.

Any trust, which is liable to UK income tax or capital gains tax, must register with HMRC using their online trust registration service.

There are various different types of trusts and the three that we will be primarily looking at from the perspective of your Will are Discretionary Trusts, Life-interest Trusts (sometimes called Interest in Possession Trust) and Protective Trusts.

Discretionary Will Trust

A discretionary trust is the most flexible form of trust as it enables the Trustees to use and distribute the income and capital of the trust entirely at their discretion. They have the power to either retain or distribute income as they see fit.

A. Inheritance Tax position for Discretionary Will Trusts

If an individual leaves his entire estate to a discretionary trust, this is a chargeable transfer for inheritance tax purposes on death. This will be the case even if the spouse is a beneficiary of the discretionary trust. As the whole of the estate has been left to a chargeable beneficiary, inheritance tax is payable in full.

A distribution by a discretionary trust, will normally give rise to an exit charge. However, any distributions from a discretionary will trust within two years of death are deemed to have been made by the deceased in the will. This means that no exit charge arises and if the Trustees make a distribution to an exempt beneficiary such as a spouse or charity, this is treated as having been made by the deceased in his will and is therefore an exempt transfer. As inheritance tax would already have been paid by the executors on the basis that the whole of the estate is chargeable because it went to a discretionary trust, a distribution to an exempt beneficiary, for example to a spouse, will lead to an inheritance tax repayment.

Once two years have elapsed, the normal rules for discretionary trusts apply i.e. exit charges and principal charges (see below).

If a beneficiary of a discretionary trust dies, no part of the discretionary trust will fall within the beneficiary’s estate.

Because, under normal circumstances, HMRC cannot levy an inheritance charge on a discretionary trust beneficiary, any inheritance tax charges will arise on the trustees instead.

There are two types of inheritance tax charge on the Trustees of a Discretionary Will Trust. The first is the principal charge that arises on each 10th anniversary from the creation of the trust (which is the date of death). This is at most a 6% charge on the revaluation of the trust fund less the available nil rate band (currently £325,000).The second is the exit charge when the discretionary trust distributes cash or capital assets to a beneficiary.

No exit charge will be levied where income is distributed.

To calculate the actual rate of tax, you have to look at the inheritance tax history of the creator of the trust because it is affected by their cumulative chargeable transfers (i.e. the number of other trusts they’ve set up) in the 7 years before the creation of the current trust and by any other trusts set up by them on the same day (i.e. where they have set up two different trusts in their will). The calculations are quite complex and I do not intend to explain them here.

B. Income Tax on Discretionary Will Trusts

Discretionary trusts are particularly useful when the trust is established for minor beneficiaries because the terms of the trust will enable trust income to be accumulated during periods when the beneficiaries are too young to receive the money. It is therefore the preferred vehicle to a life interest trust where the beneficiary has an entitlement to the net trust income, irrespective of their age.

From an income tax perspective, trust income that is distributed to the beneficiary belongs to the beneficiary. This effectively means that the income tax, which was paid by the Trustees via the self-assessment process, will come back to the beneficiary if their marginal tax rate is lower than that of the trusts.

The Trustees pay tax as follows:

Non-savings income is charged to income tax at a flat rate of 45%. Interest is also charged at 45%. Dividends are charged at 38.1%. To arrive at income, which is chargeable, some relief is available for trust management expenses; the 45% only applies to income, which is available for distribution. If the Trustees have received some income and that income has been used to meet expenses of the trust, such income is not available for distribution and is not chargeable at 45% or 38.1%. Only expenses, which are properly deductible against the income of the trust, may be relieved. This means that any expenses, which should be charged against the capital of the trust, for example, legal fees associated with capital items, cannot be deducted for income tax purposes. Trust management expenses are set against dividend income in priority to other income. Next they are set against interest and finally against non-savings income. The expenses are grossed up before deduction to reflect the type of income it’s being deducted from, for example, if a trust expense of £925 has been incurred, the Trustees must have earned a dividend of £1000 to meet that expense.

The first £1000 of income is taxed at 20% or 7.5%. This rate applies to non-savings income in priority to interest and in priority to dividends.

C. Capital Gains Tax on Discretionary Will Trusts

There is no similar, two-year rule, for capital gains. Instead, for capital gains tax purposes where assets are distributed from the discretionary will trust before the end of the executor’s administration period, these are treated as having been made on death at probate value. No capital gains tax liability will therefore arise in the discretionary trust on asset appointments out of the trust to discretionary beneficiaries until the administration period has been completed.

Once the administration period has been completed, any disposal or deemed disposal, by the Trustees, of an asset will be subject to capital gains tax. For example, on the appointment out of the asset to a discretionary beneficiary. The disposal takes place at market value.

Business Asset Disposal Relief – This would be relevant if the trust owned a business and is a capital gains tax relief available to tax payers who sell or give away their businesses. It reduces the rate of capital gains tax on disposals that qualify for Business Asset Disposal Relief to 10%. It is not available for purely discretionary trusts. It is necessary for the discretionary trust first to create an interest in possession (a right to income), which can be revocable or irrevocable. Please see section on Life Interest Will Trusts for further details.

Investors Relief – This again is not available to a purely discretionary trust. The Trustees will need to seek advice and consider the implications of meeting the criteria of creating a life interest in order to obtain the relief. The relief enables individuals to claim relief on a disposal of shares in an unlisted trading company in which they do not work. Please see section on Life Interest Will Trusts for further details.

Principal Private Residence Relief – if the Trustees own a Trust property and they permit one or more beneficiaries to occupy that property as their only or main residence, Principal Private Residence Relief is available on the subsequent disposal of the property. The following periods are exempt for Principal Private Residence Relief: (i) the period during which the property was occupied by the beneficiary; (ii) the last 9 months of ownership; (iii) deemed occupation period which include periods of absence up to 3 years, periods of absence during which the beneficiary was abroad by reason of his or her employment and periods of absence up to 4 years where the beneficiary was required to work elsewhere. The seemed occupation periods can only apply to trust gains where the same beneficiary occupied the trust property, both before and after the period of absence.

Principal Private Residence Relief is restricted where at the time the property was transferred to the trust, gift relief was claimed to roll the settlors gain against the Trustees base cost. Clearly, this would only be necessary on a lifetime gift into trust and not when the trust is set up on death, since the value of the property would be subject to inheritance tax and not capital gains tax on death. However, it is relevant where the Trustees of the Discretionary Will Trust appoint a property to a beneficiary and gift relief is claimed on that deemed disposal to the beneficiary. If the beneficiary then occupies the property as his only or main residence, Principal Private Residence Relief will not be given to that individual when they sell the property. It may therefore be preferable to NOT make a Gift Relief claim on appointment of the property out of the trust to the beneficiary absolutely and instead, for the Trustees to pay the capital gains tax liability on appointment of the property out of the trust. This will enable the beneficiary to claim full Principal Private Residence Relief on a later disposal by them.

Discretionary trusts pay exit charges when assets are appointed out to a discretionary beneficiary absolutely. If it is an asset subject to capital gains tax, then there may also be a chargeable gain upon which capital gains tax is due. In such cases, the inheritance tax paid on the transfer to the discretionary beneficiary is an allowable deduction for the beneficiary for capital gains tax purposes. It can be treated as an additional cost incurred by the beneficiary in acquiring the shares, in the event of a future disposal.

D. Tax position of the beneficiaries of Discretionary Will Trust

Any income distributed to a beneficiary of a discretionary trust is deemed to have been paid net of a 45% tax credit. This 45% rate applies irrespective of the type of income actually received by the Trustees. For example, if the Trustee’s only source of income is UK dividends, on which tax is paid at 38.1%, if that income is subsequently distributed to a beneficiary, it will still carry a 45% tax credit. The beneficiary may then be able to claim a repayment of tax if they are a basic rate or higher rate taxpayer.

As the beneficiaries in receipt of income distributions can always claim a tax credit of 45%, HMRC must have a method of making sure that any tax reclaimed by beneficiaries does not exceed the tax originally paid by the Trustees. They do this by asking the Trustees to maintain a tax pool. The tax pool is a running total of tax paid by the Trustees, less any tax credits, which have been taken out of the pool by the beneficiaries. Tax on income used to pay trust management expenses does not enter the pool. Receipts of a capital nature that are charged to income tax e.g. gains on life assurance policies are entered into the pool, but the tax stated is restricted to 25% of the chargeable income. Whenever beneficiaries claim tax credits on distributions, the balance in the pool will go down. Where a tax pool becomes negative, the Trustees must make up the difference and pay it under self-assessment. This usually happens when some of the trust income received is from dividends. Therefore, Trustees with an asset base consisting mainly of shares need to be careful when deciding how much income to pay out. The tax pool will close when the trust is wound up i.e. when Trustees make a decision to distribute all remaining funds to the beneficiaries. Any tax credits within the tax pool at that point will not be repaid by HMRC. They will then be lost, so it is common planning for Trustees to make sufficient income distributions just before the trust is finally wound up to enable the beneficiaries to take advantage of the 45% tax credit, which often leads to tax repayments to the beneficiaries.

There are interest restrictions for property income. No interest costs are deductible from rental income. Instead, discretionary trusts receive tax relief for the disallowed interest as a tax reducer. The tax reducer is the lower of (i) the interest costs disallowed; and (ii) the taxable profits of the rental business x 20%. The tax credit is therefore 45% of the property business profits after the disallowance of interest.

If you have any questions about any of the above, please contact us on 020 7481 2422 or by email at wellers.wealth@wellerslawgroup.com

Choosing the Right Trust

Posted on by Wellers

How different types of trusts work?

There are a number of different types of trusts.  Given the regularity with which I am asked what type of trust is best for a given situation I have provided a brief definition of some of the key types, setting out their advantages and disadvantages and briefly referring to their tax treatment. 

Bare Trust

This is the simplest form of trust.  It consists of one or more trustees and one or more beneficiaries. Some have described it as a half-way house between a full trust and outright ownership. 

The beneficiary has an immediate and absolute right to both the capital and income of the trust at 18 years of age provided they have sufficient mental capacity. 

The assets of the trust are held in the name of the trustee or trustees but the trustee has no discretion over the assets held in trust.  The trustee of the bare trust is a mere nominee in whose name the property is held.  Except in the case of bare trusts for minors, the trustee has no active duties to perform.  The trustee must simply follow the instructions of the beneficiary provided they are lawful, in relation to the assets held in trust.   A bare trust can be express or implied by conduct. 

There can be more than one beneficiary provided each beneficiary is absolutely entitled to their share of the trust’s assets.  The trustee has no discretion to change the shares or to use the income from one beneficiary’s share to benefit another beneficiary.

It is straightforward to administer which keeps running costs down and  there is no limit on the number or amount of assets held by the trust and it can hold any kind of asset.

Advantages

Bare trusts are useful vehicles to pay for school fees since the amount can be estimated in advance and only that amount put into the trust.  Often this is a vehicle used by grandparents to pay for grandchildren’s school fees, since once gifted into the trust the sum falls outside of the grandparent’s estate after seven years and they are not taxed on the income of the trust, which parents would be if they had settled the money into a bare trust. 

Disadvantages

The lack of control for the trustees.  They do not have a discretion.  The beneficiary is entitled to take control of the trust fund as soon as they reach 18 years of age and to demand that the assets are put in their names, provided they have mental capacity. The age that the beneficiary becomes entitled to the trust assets is always 18 years of age and this cannot be altered.  The assets in the trust are not ring fenced against creditors of the beneficiary and on the death of the beneficiary will form part of their estate for Inheritance Tax purposes.  

The bare trust is a rigid structure.  Once established the beneficiaries and their share of the trust assets cannot be changed.  No future beneficiaries can be added as the trust has been set up absolutely for the named beneficiaries and this cannot be reversed. A gift to the bare trust is irrevocable and therefore cannot be undone once executed.

It is not a recommended vehicle for large sums of money since the beneficiary will have full access at 18 years of age.

Taxation of bare trust

Income Tax

Except where a parent has settled money into bare trust for a minor, the income received by a bare trust is taxed at the beneficiaries’ marginal rate of tax.  It is treated as if the beneficiary had received it directly themselves. 

If parents have set the trust up, then any trust income over £100 is taxed at the parents’ marginal tax rate as if they had received the income.  This would not be the case for grandparents, as explained above.

Capital Gains Tax

A gift into a bare trust would be a deemed disposal for Capital Gains Tax purposes and to the extent that the then market value exceeded the original acquisition cost and any enhancement expenditure, Capital Gains Tax would be charged on the notional gain on the beneficiary. 

Just as above, gains realised by the trustees are treated as if they were realised by the beneficiary and it is the beneficiary’s annual exempt amount that would be available to offset any gains.  

Inheritance Tax

The assets of the bare trust are in the beneficiaries’ estate and will be subject to Inheritance Tax on their death.  Just as with any other gift, if you make a gift into a bare trust you need to survive 7 years for the value of that gift to fall outside of your estate for Inheritance Tax purposes. This is the case where the beneficiary is not also the settlor of the trust funds into trust (i.e. the person gifting the money into the trust). The rules are different for settlor interested trusts    

Discretionary trust

The definition of a discretionary trust is one where none of the beneficiaries has a present right to present enjoyment of the income generated by the trust property.  The trustees have a discretion as to how to apply the trust capital and the income of the trust as it becomes available.  The trust will contain a definition of the class of beneficiaries on whose behalf the trustees hold the trust property but it is up to the trustees to decide how much is paid, how often payments are made and to whom.

As no individual beneficiary can claim the income or capital as of right, such a beneficiary has a mere hope (to be distinguished from a right) that the trustees will at some time exercise their discretion in his or her favour. 

The right of the beneficiary under a discretionary trust, subject to the terms of the trust, is to be considered by the trustees in the exercise of their discretion whether to appoint income or capital and, indeed how much.

Advantages

Discretionary trusts are useful if the settlor is unsure about which of the beneficiaries will need help in the future and in what proportions.  They are also useful as asset protection vehicles because none of the beneficiaries have an enforceable right to the assets of the trust, nor do their creditors. 

Discretionary trusts are useful in estate planning to benefit members of the family in the event of an unexpected death. Property within the trust is exempt from creditors.  A creditor cannot take trust property in bankruptcy or liquidation (unless the debt was originally a trust debt). An exception to this will be where a settlor gifts assets into trust to prevent known creditors accessing funds. In these circumstances if it is established that the act of settlement was done to defraud creditors, the trust can be set aside via litigation.

This type of trust, if properly managed, can be a very tax efficient structure.  There is freedom to implement tax planning after the trust has been set up in response to the changing circumstances of the beneficiaries.

Discretionary trusts allow the settlor of the trust funds to outline how they wish the trust fund to be used, during their lives and thereafter.  The settlor’s wishes are not legally binding, but are useful guidance to the trustees.  If professional trustees are used, the settlor may have the peace of mind that their wishes will be complied with, since there would be no conflict of interest, as there may be between a trustee who is also a beneficiary. 

In terms of flexibility, the trustees can respond to changing family circumstances easily due to the control they have over the use and distribution of assets held by the trust because of the discretion they are given under the terms of the trust. 

Disadvantages

This trust is more costly to administer.  The services of accountants and lawyers may be required to submit trust tax returns and for trust documentation to be drafted.  For example, for every distribution to beneficiaries there must be Deeds of Appointment drafted.

Only profits, not losses are distributed to beneficiaries. 

Taxation

The funds fall fully outside of the settlor’s estate after seven years.  The funds within the trust fund fall within the relevant property regime.  In broad terms, ‘relevant property’ is property that is not comprised in the estate of the settlor or a beneficiary.  In order to ensure that such assets are not therefore outside the scope of Inheritance Tax, relevant property is subject to exit and principal charges.  These principal charges fall due on the tenth anniversary of the creation of the trust.  The assets within the trust are revalued and a tax charge of 6% of the excess in value above the then nil rate band is charged to Inheritance Tax and paid at that point.  In simple terms, this is repeated every ten year anniversary and/or on exit of the asset from the trust fund. 

Trustees are responsible for paying tax on income received by discretionary trusts.  The first £1,000 is taxed at the standard rate. 

If the settlor has more than one trust, this £1,000 is divided by the number of trusts they have.  However, if the settlor has set up five or more trusts, the standard rate band for each trust is £200. 

The tax rates are below:

Trust income up to £1,000

Type of incomeTax rate
Dividend type income7.5%
All other income20%

Trust income over £1,000

Type of incomeTax rate
Dividend type income38.1%
All other income45%

Trustees do not qualify for the dividend allowance.  This means trustees pay tax on all dividends depending on the tax band they fall within.

Interest in possession trusts/life interest trusts

The interest in possession trust is often referred to as a life interest trust or a fixed interest trust.  In its simplest form, the beneficiary (or life tenant) is entitled to the net income from the fund in which he has an interest (after the trustees have deducted expenses properly incurred by them in the exercise of their management powers) for the rest of his life or for a fixed period.

On the death of the life tenant, the right to trust income will pass to another if the trust document provides for this or will end with the distribution to the capital beneficiaries or become part of a discretionary trust. 

Interest in possession trusts created during the lifetime of the settlor before March 2006 were potentially exempt transfers.  Inheritance Tax was only chargeable if the settlor died within seven years of setting up the trust. 

The Finance Act 2006 made significant changes to the Inheritance Tax treatment of interest in possession trusts.  These changes took effect from 22 March 2006.  Since 22 March 2006, if an individual creates an interest in possession trust during his or her lifetime the transfer comes within the relevant property regime, and:

  1. The transfer is immediately chargeable to Inheritance Tax; the assets within the trust are ‘relevant property’ and are therefore subject to exit and principal charges.  This was not the case for interest in possession trusts set up before March 2006. 
  2. To understand the Inheritance Tax treatment of interest in possession trusts, we need to be able to differentiate between ‘relevant property’ and ‘qualifying interests in possession’. 
  3. Where trust assets are held on ‘qualifying interest in possession’, such assets are comprised in the estate of a beneficiary.  Therefore, where a beneficiary is a life tenant of a ‘qualifying’ interest in possession trust, the trust assets form part of his death estate.  As ‘qualifying interest in possession trusts’ are already within the scope of Inheritance Tax, property within a qualifying interest in possession trust is not subject to exit and principal charges.

Finance Act 2006 changed the rules such that not all life tenants of interest in possession trusts are now treated as having a ‘qualifying interest in possession’. 

The term ‘qualifying interest in possession’ is used to describe:

IHTA 1984, Section 59 (1);

  1. Assets in a trust for a disabled person;
  2. Assets in an interest in possession trust created on death; and
  3. Assets in a lifetime interest in possession trust created before 22 March 2006. 

IHTA 1984, Section 3A (1):

Assets settled on ‘qualifying interest in possession’ trusts are treated as being part of the estate of the beneficiary with the interest in possession (the life tenant). 

IHTA 1984, Section 49 :

Because such assets are taxed in the beneficiaries’ death estate, ‘qualifying interest in possession trusts’ are not subject to exit and principal charges.

If an individual dies with a qualifying interest in possession in a trust, the trust assets will form part of his death estate.  The executors must declare the value of a qualifying interest in possession on the death estate return   (form IHT400).  If the beneficiary only has an interest in part of the trust fund, the same proportion of the assets in the trust is deemed to form part of his estate. 

Assets held in the deceased’s own right – personal assets etc – make up his ‘free-estate’.  We value the free-estate, deduct any liabilities and then add the value of a qualifying interest in possession to the assets in the free-estate.  This total amount will be charged to Inheritance Tax. 

Taxation

The trustees are responsible for paying income tax at the rates below.

Type of incomeTax rate
Dividend type income7.5%
All other income20%

The trustees are responsible for paying income tax at the rates above.

Sometimes the trustees mandate income to the beneficiary.  This means it goes to them directly instead of being passed through the trustees. If this happens, the beneficiary needs to include this on their self-assessment tax return and pay tax on it. 

Settlor interested trusts

This is where the settlor is also a beneficiary of the trust that they have set up.  In these circumstances the settlor is responsible for income tax on these trusts, even if some of the income is not paid out to them.  However, the income tax is paid by the trustees as they receive the income.

  1. The trustees pay income tax on the trust income by filling out a trust and estate tax return.
  2. They give the settlor a statement of all the income and the rates of tax charged on it.
  3. The settlor tells HMRC about the tax the trustees have paid on their behalf on a self-assessment tax return.  The rate of income tax depends on what type of trust the settlor interested trust is. 

On the death of the settlor the full value of the trust fund forms part of the settlor’s estate.

If you have any questions please call us on 020 7481 2422 or email us at wellers.wealth@wellerslawgroup.com if you would like to know more.

This article was written by Ingrid McCleave and the law is correct as at 24th November 2020. Please note that tax legislation changes frequently, so this article should not be relied upon without seeking further legal advice.

Charity Structures for International Religious Organisations

Posted on by Peter Spencer

If you’re an international religious organisation looking to establish a formalised legal charity in the UK, there are several structures you can adopt to carry out your philanthropic activities. You may wish to bring overseas workers to support your endeavours, but it is crucial to establish your charity and obtain your charity number before considering visa applications.

The three primary structures to consider are trusts, charitable companies, and charitable incorporated organisations (CIOs).

Trusts

Trusts are a well-known but often considered an archaic structure. Trusts are unincorporated, meaning that the trustees of the charity have personal liability and can be sued personally. To register with the Charity Commission, a trust needs a minimum income of £5,000, which is standard for most charity structures.

It is good to be aware of trusts, but they are generally not recommended due to the personal liability involved.

 

Charitable Companies

A charitable company is established as both a company and a charity. It is considered established from the point of registration with Companies House, which can take around 72 hours. This means you don’t have to wait for registration with the Charity Commission to begin charitable activities in the UK, which can take up to six months. This is particularly beneficial if you wish to purchase property in the UK quickly. Like trusts, a charitable company requires a minimum income of £5,000 to register with the Charity Commission.

Unlike trusts, charitable companies are incorporated structures, limiting trustee liability, meaning trustees cannot be personally sued. Another significant advantage is that charitable companies are generally recognised internationally, which can facilitate dealings with foreign banks and reduce the need for extensive explanations. This structure can also be advantageous if you need to borrow money, for example, to purchase property, as banks often prefer charitable companies over CIOs, although this preference is changing.

The primary disadvantages of charitable companies are that they are subject to both the Companies Act and the Charities Act, and the trustees are also directors. This dual responsibility requires some education to ensure compliance with both sets of regulations, including dual reporting.

 

Charitable Incorporated Organisation (CIO)

The Charities Commission introduced the CIO structure because many people found the concept of a charitable company too complex. CIOs are incorporated structures that limit trustee liability, meaning that any legal claims are limited to the assets within the CIO.

There is no income threshold for registration with the Charity Commission, so you do not need a pledge letter from your parent charity. However, you must wait for the Charity Commission to grant charitable status and provide a charity number before commencing philanthropic work and bringing overseas workers to the UK.

A key advantage of a CIO is that you only need to file annual reports with the Charity Commission, unlike a charitable company which requires dual reporting. CIOs are more suitable for smaller organisations not looking to purchase property immediately and are comfortable with the wait for Charity Commission registration.

 

It is essential to remember that before bringing overseas religious workers to support your charitable activities, you must have chosen your charity structure and received your charity number from the Charity Commission.

If you want to set up a charity in the UK to facilitate your philanthropic work, get in touch with Peter Spencer today by email at peter.spencer@wellerslawgroup.com.

 

Corporate Insolvency: Care and Caution that should be taken by creditors and debtors

Posted on by Priyanka Kumar

The current financial climate has made getting paid outstanding debts increasingly difficult. Consequently, to put pressure on a debtor, creditors sometimes resort to serving statutory demands, or proceeding with winding-up petitions as a method of debt recovery. A winding up petition is a creditor’s petition to have a company placed into compulsory liquidation by the Court, resulting in the company being wound up.

However, using a statutory demand for a commercial debt should only be embarked upon with care and caution.

In this article we explore the key considerations that should be borne in mind for creditors who are considering serving a statutory demand and debtors who receive one.

 

What exactly is a statutory demand?

A statutory demand is a formal written demand in prescribed form from a creditor to a debtor requesting payment of the debt within 21 days. The prescribed form is governed by section 7.3 of The Insolvency (England and Wales) Rules 2016. Where the debtor is a company, the debt must be for at least £750. (Where the debtor is an individual, it must be for at least £5,000). It is a ‘pre-cursor’ to a winding-up petition (or bankruptcy petition in the case of an individual).

 

Procedure for service

The statutory demand must be served personally upon the debtor’s registered office. It is best to have this personally served (by a process server or otherwise) so there can be no doubt that the demand has been brought to the debtor’s attention.

If the debt remains unpaid and unchallenged for more than 21 day, this demonstrates that a Company is unable to pay its debts, that the debt is undisputed and therefore a winding up petition may be presented. Statutory demands are, therefore, aggressive in nature and should not simply be used as a simple debt recovery tool.

 

What should a creditor consider before serving a statutory demand?

Does the debtor dispute the debt ?

Where there is a ‘genuine dispute on substantial grounds’ about all the sums claimed in the statutory demand or winding-up petition, the court will not hesitate to restrain the creditor from taking any further steps, by setting aside the statutory demand. Unsurprisingly, it is considered an “abuse of process” for a creditor to serve a statutory demand where the debtor genuinely disputes the debt.

The dispute must be genuine. The court will not conduct a ‘mini-trial’ to determine whether the debt is due but if it is satisfied that there is a genuine dispute, it will set aside the statutory demand on the basis the correct forum for the determination of the claim is via a County or High Court claim.

So if the debtor is not paying the debt because it genuinely disputes it, a creditor should consider alternative approaches.

The advantage of using a statutory demand is that it is usually a faster way to recover payment from a debtor than using sending a Letter Before Action in accordance with the pre-action protocol for debt claims and then issuing debt recovery proceedings. However, If the debt is disputed then the Letter Before Action route is the appropriate one.

The debtor has a serious and genuine counter- claim exceeding the debt

 

This article was written by Priyanka Kumar from our litigation team. Get in touch with Priyanka today to find out how she can help you by email priyanka.kumar@wellerslawgroup.com.

How to register for a new ‘e-visa’

Posted on by Oliver O'Sullivan

 From 1 January 2025, all UK visas will be digital “e-visas”. All new visas will be issued as e-visas and every visa issued before 31 December 2024 will need to be converted to an e-visa.

Having a digital e-visa means that there is no longer a physical document, such as a stamp or vignette in a passport or a Biometric Residence Permit card. Instead, a visa is connected to a person’s passport which is registered on a Home Office database.

The Home Office has now invited all current BRP card holders to go through the process of digitising their visas. Here is a guide to getting your e-visa.

  1. You need to create an online account with UK Visas and Immigration. Follow this link to begin the registration process: https://www.gov.uk/get-access-evisa
  2. You will need your BRP card number, your email address, your telephone number and access to a smartphone.
  3. Answer the questions regarding your current BRP card and then ‘create an account’.
  4. Add your personal details and your BRP details and then add your email address and telephone number. You will then receive six digit verification codes to register them so that you can now log in to your account using your BRP number, date of birth and a verification number sent to either your email or as an SMS.

Once you have created a UKVI account, you should then change your logging in document from your BRP to your passport.

Once you have registered online, you now have a digital e-visa. Since there is no longer a physical document, you no longer need a BRP card to travel into the UK. You can now present your passport at the border and your status will be confirmed when your passport is scanned. It is advisable to also carry the confirmation of your status that you can find the paragraph below regarding demonstrating your right to work.

You can also show employers and landlords your immigration status by sharing a link to a secure online page that shows them your visa status. You do this by following one of the links below and logging in exactly how you logged into your UKVI account. You can then send a ‘share code’ by email to your desired recipient.

If you need help registering for an e-visa, get in touch with Oliver O’Sullivan via email at Oliver.OSullivan@wellerslawgroup.com .

Employment Law Changes with the new Labour Government

Posted on by Nina Francis

After 14 years of a Conservative government, Labour have now taken up residence in Downing Street. Alongside the change in residence, the Labour party’s manifesto outlines several changes that employers need to be aware of, it they are enacted, subject to consultation. These key reforms are set to be introduced within 100 days and span from discrimination law and “Day One Rights” to trade unions and industrial action.

 

Day One Employment Rights – Key Changes:

  1. Unfair dismissal, sick pay and parental leave

Currently, an employee must accrue two years of continuous service to a company before they can claim unfair dismissal in an employment tribunal.

Labour’s reform will grant protection of unfair dismissal as well as sick pay and parental leave which will be deemed “Day One Rights”

 

  1. Fair Pay

National minimum wage (NMW) rates are presently based on average earnings.

With Labour’s manifesto, existing age bands (allowing payment of a reduced rate) will be scrapped in favour of a flat rate for all age groups.

“Fair Pay Agreements” will be introduced, under which pay rates are determined by sectoral collective bargaining. It is likely that this will be trialled out in the social care sector before this is rolled out to other sectors due to a lack of support in the business community.

 

  1. Discrimination Law

Currently, equal pay legislation applies to gender pay disparities to cover disabled and BAME employees. Gender Pay Gap Reporting has been mandatory since 2017.

Key changes in this area will include:

  • Implementation of Ethnicity Pay Gap Reporting (for employers with 250+ employees).
  • Implementation of Disability Pay Gap Reporting (for employers with 250+ employees).
  • Gender Pay Gap Reporting action plans are to be published and are to include outsourced workers. This means that pay gap reporting will be a far larger exercise than it has been historically.
  • Sexual harassment will be treated and have similar protections to whistleblowing
  • There will be enhanced protection of sexual harassment for interns
  • A ban on dismissing returning maternity leavers will be introduced, covering six months after the return to work except in specific circumstances.

 

  1. Enforcement

Labour is set to introduce extensions of time limits for tribunal claims from three months to six months. This is due to delays in the current tribunal system.

Labour are proposing to establish a new state body “Fair Work Agency” with the power to inspect workplaces and take legal action where necessary. This will mean documentation and record keeping will become more significant going forward.

 

  1. Ending “one-sided” flexibility

Labour are planning to implement a ban on “fire and rehire”. Further movement is expected in this area as Labour openly criticised the recently released Tory statutory Code of Practice as being “inadequate”.

Additionally, zero hour contracts will be banned and there will be a shift in narrative on empowering employees to request contracts that reflect the hours of work undertaken.

 

  1. Trade Unions and Industrial Action

Labour will be working to simplify trade union recognition and improve trade union worker access to workplaces. Further, self-employed workers are to enjoy the same improvements to trade union rights as workers.

 

  1. Worker Status & Self-Employment

Labour aim to (eventually) abolish:

  • The U.K.’s three tier system for employment status
  • The distinction between employees and workers – this will need further consultation on the logistics of sick pay, family leave and other policies in these models.

Rights for self-employed people will be written in a contract and will enable self-employed workers to take action on late payments, extend health and safety blacklisting protections to the self-employed. Further clarity and consultation is needed in this area.

 

If you have any enquiries relating to these potential changes, please get in touch with Nina Francis by email nina.francis@wellerslawgroup.com or by phone on 020 3831 2664.