Typically, trusts are used for tax mitigation and/or to enable effective provision to be made for family members (both present and future). Whilst the tax regime over the years has slowly eroded, Malcolm Finney points out that trusts can still be highly effective mechanisms enabling long term provision for family members.

Onshore Versus Offshore
Trusts may be set up within the UK (i.e. are resident in the UK) or “offshore” typically in low/nil tax areas (e.g. Bermuda; British Virgin Islands). Generally speaking, offshore trusts are likely to be inappropriate for a UK domiciled and resident individual (broadly, someone born and raised in the UK), although of immense benefit for a non-UK domiciled individual.

Discretionary Versus Fixed Interest 
Trusts fall into two broad categories, namely, discretionary and fixed interest. The former are extremely flexible, leaving the trustees to take decisions about allocating trust income/capital amongst the trust beneficiaries in the light of circumstances prevailing at the relevant time. The latter are less flexible providing that (normally) one individual is entitled to all of the trust income as of right (i.e. the trustees have no say over how it is to be utilised), with the trust assets passing to someone else on the individual’s death.

Example 1: Discretionary Trust
John Smith would like to make provision for his three children aged 10, 15 and 16.  As each of his children are very different and their needs may vary significantly in the future, outright gifts by will may, therefore, be inappropriate. Therefore, John sets up in his lifetime a discretionary trust for their benefit.

Example 2: Fixed Interest Trust
John Smith is married to Sarah and they have one child, Samson, aged 13. John agrees with Sarah that on his death he will leave her a fixed interest, and on her death the trust assets should go to Samson.

Bare Trust
The simplest of trusts is the “bare” trust under which an adult simply holds assets for the beneficiary, who receives the assets on reaching age 18; the adult is a trustee, although with very limited powers. Such trusts do not permit long term family planning and cannot prevent the beneficiary taking the assets at age 18 (which may be unacceptable to many parents).

Protective Trust
Parents may wish to provide for a child but are concerned that he/she may either squander or sell their inheritance; outright gifts by will are thus inappropriate. One solution is the so-called “protective” trust (basically a fixed interest trust). The child is entitled to the trust income as of right but should he/she attempt to alienate his/her interest (e.g. sell it) the entitlement to the trust income ceases immediately (thus making it impossible to profit from such alienation).

Disabled Trust
Parents with a disabled child may be concerned as to what happens on their death. The setting up of a trust may offer a solution enabling long term provision to be made for the child; suitably structured, no loss of means tested or other benefits should occur.

Taxation
Unfortunately, the tax treatment of trusts is complex whether the tax concerned is income, capital gains or inheritance tax.

Trusts are exposed to an 18% capital gains tax rate (the same as individuals); discretionary trusts are exposed to a 40% income tax charge on non-dividend income and 32.5% on dividends (to be increased for the tax year 2010/11 to 50% and 42.5% respectively); property comprised in a discretionary trust (or a fixed interest trust set up on or after 6th April 2008) is subject to inheritance tax every ten years (maximum rate 6%) or if property leaves the trust (rate less than 6%); fixed interest trusts set up pre 6th April 2008 are subject to inheritance tax in a slightly different manner.

Anti-avoidance provisions may also apply to a trust; in which case, for example, the individual creating the trust may be liable to income tax on the trust income (not the trustees).