What Is ‘Asset Protection’? In a sense, the answer to this question is obvious. If you’re fortunate enough to own valuable assets, you’re naturally going to want to protect them from the various threats that face them.
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When it comes to protecting your assets, the first thing to come to most people’s mind are trusts. Trusts are in many ways uniquely suited to asset protection. But before considering how you can put these arrangements in place to safeguard your wealth, we need to give a bit of background as to what trusts are, and how they work.
The concept of a legal trust is a peculiarly English one – although trusts have spread to a number of other legal jurisdictions which have been influenced by the English. If we were going to attempt a thumbnail definition of trusts, it would be that they are arrangements where assets of any kind are held by one person under rules which require them to be used for the benefit of other people.
Those holding the assets are referred to as ‘trustees’, and those for whose benefit the assets are held are referred to as ‘beneficiaries’. The third person in the triangle which you always have with a trust situation is the ‘settlor’, who is the person who transferred the assets to the trustees, for the benefit of the beneficiaries, in the first place. The settlor is the person who ‘settles’, that is gives, the assets to the trust.
Fundamentally there are only three types, and they are:
- Bare Trusts
- Life Interest Trusts
- Discretionary Trusts
Taking bare trusts first, these are only trusts in a manner of speaking. Lawyers might say there is a technical difference between a bare trust and a nomineeship, but for practical, and tax purposes there doesn’t seem to be any difference. A bare trust, or nomineeship, is an arrangement where an asset ‘really’ belongs to A, but it is somehow registered in the legal name of B. A common example of this is where you lodge your quoted share portfolio at your bank. Usually, the name on the register of the plc’s concerned will be that of the bank’s nominee company. However, the shares are ‘really’ yours, in the sense that you have the absolute legal right to direct how they will be dealt with, and you are entitled to receive the dividends paid on those shares, without there being any discretion on the part of the bank to retain them.
Bare trusts are often used in practice where minors are involved. There are various legal disabilities attaching to those under eighteen, with regards to owning land, entering into contracts, etc. So, assets which belong to minors are often held by others, perhaps their parents, on their behalf. Nevertheless, these are still bare trusts where the children are treated as the owners for most practical, and all tax, purposes.
In theory, we shouldn’t need to say anything else about bare trusts in the context of a report on asset protection. To all intents and purposes, an asset held in a bare trust is yours and is, therefore, vulnerable to any third-party attacks on your financial position. In practice though, bare trusts may have a role to play in asset protection, in that sometimes the purpose of the trust is to conceal the fact from third parties that you actually own the asset concerned.
This ability to keep commercial confidentiality as to ownership has recently received significant blow from the government: as far as the shares in UK companies are concerned, there now needs to be disclosure of all those who possess enough shares in a company, whether in their own name or through nominees/bare trustees, to exercise a ‘significant influence’ over the company.
Having disposed of bare trusts, we can come on to those which, arguably, are more deserving of the title ‘trust’. The technical difference between the two sub-divisions of these real trusts, which we’ve listed above as life interest trusts and discretionary trusts, is that in a life interest trust the income, or the use of the asset, is something to which one or more of the beneficiaries have a right.
In a simple life interest trust situation, you might have, say, an investment property in the trust. The life interest gives the beneficiary the entitlement to receive the rent as it arises. That is, the trustees can’t exercise any kind of discretion to say ‘no, we’re hanging onto this money until we see fit to pay it to you.’ Instead, the life tenant (as the beneficiary with a life interest is called) can require the payment of the rent immediately. In practice, the income in life interest trusts is often mandated directly to the beneficiary and doesn’t pass through the trustees’ hands at all.
Discretionary trusts are those where the trustees have discretion whether or not, or when, to pay income over to the beneficiaries. Broadly, both sorts of fully clothed trusts can be seen as giving the same level of asset protection, and these days the distinction between the two is really only important from the practical income tax point of view. As this is a report on how asset protection interacts with tax, though, we’ll set out the difference here, and having done this will just refer to ‘trusts’ as if there were only effectively one type.
Where you have income arising to a life interest trust, which is payable to the beneficiaries immediately without any exercise of the trustees’ discretion, the income is treated as that of the beneficiaries. Leaving aside the question of trustees’ expenses (which present complications created by an unholy alliance of lawyers and accountants, but which are probably ‘too much information’ for the purposes of this report) the life tenants will be treated as receiving the same amount of income as arises on the trust assets. So, the income goes into the beneficiary’s personal tax return as trust income, and therefore contributes to the overall total income of the beneficiary, and therefore his tax liability for the year.
With a discretionary trust, the income tax treatment is more complex and cumbersome. Initially, the income of the trust bears the top rate of income tax, which is currently 45%. As and when payments of income are made to beneficiaries, the trustees pay out amounts which are treated as if they had had 45% tax deducted, and therefore the beneficiaries can reclaim tax if their own personal rate, on this income, is less than 45%. Case Study 9 illustrates how this works. A word of caution is necessary, here, and this is that the straightforward rules set out in the case study don’t apply, necessarily, to dividends received; the taxation of which is now in a terrible mess thanks to a combination of Gordon Brown’s elimination of the tax credit in 1997, and the more recent changes to the taxation of dividends with effect from 6 April 2016. In the case of dividends, the case study has to be seen as showing the principles in broad general outline, and subject to complications in the computation, together with some restriction in the amount of tax that can be claimed back.
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