A Vulnerable Person’s Trust (VPT) is usually set up by a settlor to provide for the future financial security of a vulnerable person.
If the trust is correctly established for this purpose and the beneficiary meets the relevant criteria, it can benefit from a number of tax advantages that are not generally available to other trusts.
Who qualifies as a vulnerable beneficiary?
In basic terms, the vulnerable beneficiary must be one of the following:
- A child under the age of 18 where one of their parents has died.
- A person who, because of a mental disorder within the meaning of the Mental Health Act 1983, is incapable of administering their property or managing their affairs.
- A person who is receiving, or is entitled to receive, certain qualifying state benefits.
The trust must be set up either solely for the benefit of the vulnerable person or in such a way that certain assets are clearly identified and ringfenced specifically for their benefit.
What are the Inheritance Tax benefits?
From an Inheritance Tax (IHT) perspective, qualifying trusts for vulnerable beneficiaries can benefit from favourable treatment compared with trusts that fall within the normal relevant property regime.
This can mean:
- The trust is not generally subject to the usual 6% IHT charge that can arise on each ten-year anniversary for relevant property trusts.
- The usual IHT exit charges that can apply when assets leave a relevant property trust do not generally apply in the same way.
- Transfers into qualifying trusts can also receive favourable IHT treatment, although the circumstances of the settlor and the transfer need to be considered carefully.
However, on the death of the vulnerable beneficiary, the trust assets may be treated as part of that person’s estate for IHT purposes. When combined with the rest of their estate, this could result in an IHT liability.
What about Income Tax and Capital Gains Tax?
Many discretionary trusts can face Income Tax rates of 39.35% on dividend income and 45% on other income, while trustees generally pay Capital Gains Tax (CGT) at 24%.
A Vulnerable Person’s Trust can receive more favourable treatment.
An election can be made so that the trustees receive a tax reduction based broadly on the amount of tax that would have been payable if the qualifying income and gains had arisen directly to the vulnerable beneficiary.
The actual tax position will depend on the beneficiary’s personal circumstances, including their other income and available allowances.
For example, dividend income falling within the basic rate can be taxed at 10.75%, while qualifying capital gains may be subject to CGT at 18%, depending on the beneficiary’s circumstances and the nature of the disposal.
A higher Capital Gains Tax annual exemption
A qualifying Vulnerable Person’s Trust is also entitled to the full CGT annual exempt amount of £3,000.
This compares with an annual exempt amount of £1,500 for most other trusts.
The special treatment does not, however, apply in the tax year in which the vulnerable beneficiary dies.
Transferring assets into a Vulnerable Person’s Trust
Care needs to be taken when assets are transferred into a VPT.
While transferring cash does not normally create a CGT liability, transferring other assets into a trust can constitute a disposal for CGT purposes and potentially result in tax becoming payable by the settlor.
Reliefs may be available in certain circumstances, including for some business assets, but this will depend on the nature of the assets and the circumstances of the transfer. Professional advice should therefore be taken before assets are placed into the trust.
Purchasing residential property through a VPT
Advice should also be sought where a Vulnerable Person’s Trust is considering purchasing residential property.
The tax treatment can depend on the type of trust – including whether it is discretionary or interest in possession – as well as the individual circumstances of the beneficiary.
Additional property taxes may apply depending on where the property is situated, with different regimes operating in England and Northern Ireland, Wales and Scotland.
It is therefore important to consider the potential property tax implications before a trust proceeds with a residential property purchase.
Getting the right advice
Vulnerable Person’s Trusts can offer significant tax advantages while helping to provide long-term financial security for a vulnerable beneficiary.
However, the rules surrounding eligibility, trust structure, taxation and the transfer of assets can be complex. Getting the structure right from the outset is therefore important to ensure the trust qualifies for the available tax treatment and continues to meet its intended purpose.
If you are considering setting up a Vulnerable Person’s Trust, or already have a trust in place and would like to understand its tax position, our team can help.
Get in touch with us to discuss your circumstances and the options available.