The Use of Trusts in Private Businesses

Trusts have been used in England and Wales (and elsewhere) for hundreds of years. They are a popular and highly effective vehicle for controlling the destination of assets, protecting younger members of the family from themselves or fortune hunters, mitigating tax liabilities and maintaining voting control.

In a family business the owner (and his or her spouse) will frequently own all the shares or, at the very least, a controlling shareholding. They may be worried that the Government might change the currently favourable Inheritance Tax rules so as to penalise private trading companies. They may, therefore, wish to pass their wealth to the next generation whilst retaining voting control. They may also wish to let those members of the family who work in the business own some shares in their own right. They may be reluctant however to let shares pass outright to other family members who are in need of an income but who do not have any direct interest in the business itself.

In such cases the owners may decide to transfer some shares to children who are working in the business. However, an outright gift of shares will carry with it not only the rights to any future dividends but also voting powers. If there are children who are not working in the business, the owners may prefer that any shares benefiting them should be held in trust, the children receiving the income (i.e. the dividends on those shares) but not having any say in the running of the business. A transfer to a trust would ensure that voting rights remain with the trustees. The owners may also wish, for example, to transfer shares to trusts for the benefit of grandchildren.

By transferring the shares into a trust the owners can:

• Transfer value out of their estate for Inheritance Tax purposes
• Make use of available Capital Gains Tax / Income Tax allowances
• Retain control by being trustees and protect the assets from being squandered by beneficiaries
• Cater not just for present children/grandchildren but for those who may be born later

For taxation purposes trusts are treated as separate entities. For some years now trusts owning shares in trading companies have been very favourably treated in the UK for both Capital Gains Tax and Inheritance Tax. For example, it is possible for owners to transfer, say, 15% of the shares in their wholly owned trading company to a trust for their grandchildren, present and future born, and for any liability to Capital Gains Tax to be held over. Additionally, there will be no liability to Inheritance Tax even if the owners die within seven years of the transfer (provided that the shares were previously owned for at least two years and the trustees have not sold the shares since the transfer into trust). There can be flexibility to vary the entitlements of the beneficiaries if that becomes necessary/desirable. Any increase in the value of the shares will be outside the owners' estates.

July 2006

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