One of the most common, though little discussed, aspects of US-UK cross-border estate planning is the UK tax treatment of the revocable trust used as a will substitute in the US (sometimes called a ‘living trust’). Though completely transparent and tax-neutral in the US, lifetime trusts have, especially since the UK Finance Act 2006 (FA 2006), raised the possibility of undesirable tax consequences in the UK. US citizen clients in the UK undertaking fresh planning are often advised either to avoid revocable trusts (despite some practical advantages) or simply not to fund them with more than a token amount during their lifetimes. That is no comfort for the many US clients in the UK with such trusts already established and funded with substantial income-generating assets, who are frequently faced with the need to take specialised advice.
There is a certain injustice in that a commonplace, uncontroversial and completely tax-neutral form of basic estate planning on one side of the Atlantic should run the risk of being treated as a taxable settlement in the UK, and it is frustrating that there is no definitive answer to the question from HMRC or courts in the UK.
Background
The revocable trust has largely replaced the traditional will across much of the US, chiefly to avoid subjecting settled assets to probate, which can be expensive and time-consuming in the US. A will is needed only to ‘pour over’ any unsettled assets into an already-established trust, with all of the specific dispositive and technical provisions to take effect from the settlor’s death. Clients in the US are usually advised to transfer virtually all of their assets into revocable trusts during their lifetimes, but are assured that they can still retain day-to-day control of the assets by acting as a sole or co-trustee and that, for US tax purposes, the revocable trust will be treated in exactly the same way as a will, only taking effect on death.
It is not uncommon to encounter US citizens resident in the UK with these revocable trusts, either settled before moving to the UK or even afterwards, as US citizens are taxed on their worldwide income, capital gains, gifts and estates. The US settlor-trustee who has become resident or domiciled for inheritance tax (IHT) purposes in the UK often has no inkling of the UK tax implications. They may have assumed that the trust income was taxable on the remittance basis (either now or in the past), not realising that, when the settlor-trustees became UK-resident, the trust itself may have become fully taxable in the UK, or they may have settled revocable trusts after becoming IHT-domiciled, with no idea that, following the FA 2006, this may trigger an immediately chargeable transfer, as well as taxation under the relevant property regime. Even worse, clients in this situation are often told that attempts to rectify the situation by revoking or exporting their trusts may themselves trigger capital gains tax (CGT) in the UK.
Despite the frequent occurrence of similar fact patterns, there is remarkably little concrete authority on their treatment, and few commentators address the fundamental question of whether such trusts are settlements for UK tax purposes in the first place.
What is a settlement for UK tax purposes?
‘Settlement’ is not precisely defined for UK income tax and CGT purposes. Section 620(1) Income Tax (Trading and Other Income) Act 2005 states that it ‘includes any disposition, trust, covenant, agreement, arrangement or transfer of assets’, and this provision is also incorporated for CGT purposes by s97(7) Taxation of Chargeable Gains Act 1992 (TCGA 1992). Not all such arrangements are settlements for tax purposes, however, and clearly the term ‘settlement’ is not co-extensive with the term ‘trust’. Legal arrangements such as long leases are not trusts, but they may be settlements under this definition. Equally, not all trusts are settlements for tax purposes – the bare trust being the obvious example.
The IHT definition of ‘settled assets’ is particularly broad.1 HMRC acknowledges, though, that a bare trust is not a settlement for IHT purposes.2
There is no single statutory definition of the term ‘bare trust’ and its meaning will depend on its context.3 Section 68 TCGA 1992 defines ‘settled property’ as ‘any property held in trust other than property to which section 60 applies’. Section 60 (captioned ‘Nominees and Bare Trustees’) in turn applies to ‘property held by a person as nominee for another person or as trustee for another person absolutely entitled as against the trustee …’,4 namely ‘a case where that other person has the exclusive right, subject only to satisfying any outstanding charge, lien or other right of the trustees to resort to the property for payment of duty, taxes, costs or other outgoings, to direct how that property shall be dealt with.’5 It is in this sense that the term ‘bare trust,’ is used, though, as a matter of English law, the definition is not so simple in all contexts.6 A settlement, though, must have an element of gratuity,7 which is lacking in a bare trust.
As US trust laws generally have not developed the concept of the bare trust by that name, it is necessary to go beyond the simple label ‘trust’ and consider the nature of the legal arrangement involved. I believe that, where the legal rights conferred by foreign law fall short of creating the irreducible core obligations of a trust referred to by Millett LJ in Armitage v Nurse as being fundamental to the concept of a trust (‘If the beneficiaries have no rights enforceable against the trustees there are no trusts’),8 there should be no ‘settlement’ for UK tax purposes.
The nature of an American revocable trust
One of the few UK commentators to address whether a US revocable trust is a settlement for UK tax purposes is James Kessler QC, and I concur with his view that,9 where a trust is governed by the law of a state that has adopted s603 of the American Uniform Trust Code (UTC) – and it is not overridden by anything in the trust’s express terms, and at least for so long as the settlor remains competent to revoke the trust –10 it is not a settlement at all for UK tax purposes and should be treated, as it is for US tax purposes, as the equivalent of a bare trust during the settlor’s lifetime and thereafter as a will. Section 603 UTC provides that:
While a trust is revocable [and the settlor has capacity to revoke the trust] rights of the beneficiaries are subject to the control of, and the duties of the trustee are owed exclusively to, the settlor.
The UTC has to date been enacted in 28 US jurisdictions.11 An adopting state is not obliged to accept s603, and, if it does, it has the option to include the bracketed language regarding the settlor’s competence. A few other states have equally explicit statutes to the same effect as s603 UTC,12 which I believe should support the same conclusion that revocable trusts under those laws should also be treated as bare trusts.
In the absence of such a statute, however, law is less clear. Nevertheless, there is growing recognition of a result similar to that made explicit by s603 UTC and s15800 California Probate Code, as seen in s74(1)(b) of the Restatement (Third) of Trusts (‘The rights of the beneficiaries [of a revocable trust] are exercisable by and subject to the control of the settlor’) and leading US commentators.13
Until recently, US cases and commentators have been sparing in discussing the rights of beneficiaries of revocable trusts. The leading US treatise in the field, Scott on Trusts, did not even discuss the issue until the fifth edition, now entitled Scott and Ascher on Trusts, s16.5 of which cites s603 UTC, and similar statutes in its discussion of the emerging trend in the trust laws of the various American states to recognise that beneficiaries of revocable trusts are not owed fiduciary duties while the settlor is living and not incapacitated. In particular, it states that:
‘The fact that the settlor of a revocable trust has the right, at any moment and for any reason, to terminate the trust strongly suggests that the trustee ought to be able to look to the settlor, and to the settlor alone, for advice, direction, and control… Surely the trustee’s duties run primarily, and perhaps even exclusively, to the settlor, while the settlor remains competent. …
A power of revocation is the functional equivalent of ownership and is ordinarily held in an individual, rather than a fiduciary, capacity, even if the power holder is also the trustee. While a trust remains revocable and the settlor remains competent, the trustee may properly act in reliance on the settlor’s direction and authorization, even if the direction or authorization is contrary to the terms of the trust or the trustee’s other fiduciary duties. The rights of the beneficiaries of a revocable trust are, therefore, subject to the settlor’s control for so long as the settlor retains the power to revoke and remains competent. Likewise during that period the duties of the trustee are owed primarily to the settlor.’14
This passage acknowledges, however, that recognition of this view, and of the validity of revocable trusts as will substitutes, has been long in coming and is far from uniform. Also, while Scott and Ascher and the Restatement, which often states what its academic compilers feel the law ought to be rather than what is established by cases in the various US jurisdictions, are influential, they are not binding. There is still need for caution and careful review of the law and particular facts, but, where it can be established, by reviewing the facts, trust terms and applicable statutes and cases, that the settlor is absolutely entitled to the trust fund, it should follow that the trust is a bare trust and not a settlement for UK tax purposes.14
This stands to reason. If you were to try to draft something under the law of England and Wales that (1) vested title in a trustee but (2) left the settlor absolutely entitled during his lifetime (at least while competent), and (3) disposed of the trust fund after the settlor’s death, you would have to draft two documents: a bare trust and a will. The fact that the law and practice in most US states now allows all of those effects to be combined into one document does not alter the underlying legal effect.
Subject to the express terms of the trust, where a clear statute such as s603 UTC applies, an American revocable trust should not be treated as a settlement for UK tax purposes, at least while the settlor has capacity to revoke. Without such a statute, the same result may still apply under decided cases in the relevant jurisdiction. Further clarity both in US case law as to the settlor’s rights under a revocable trust, as well as in UK tax and legal authorities confirming the treatment of revocable trusts where the settlor remains absolutely entitled, would be welcome.
- 1Section 43(2) Inheritance Tax Act 1984
- 2For example, Correspondence between HMRC and CTP/CIOT from September to December 2006, HMRC answer to question 33
- 3Underhill and Hayton, Law of Trusts and Trustees, 18th ed (2010), paras 4.1(1) and 4.3
- 4Section 60(1) TCGA 1992
- 5Section 60(2) TCGA 1992
- 6Lewin on Trusts, 18th ed, (2008), paras 1–21 et seq
- 7CIR v Plummer, 54 TC 1
- 8[1998] Ch 241 at 253
- 9Kessler, Taxation of Non-Residents and Foreign Domiciliaries, 12th ed (2013–2014), para 84.5, citing Armitage v Nurse
- 10To avoid complications in the event the settlor becomes incapacitated, a suitable durable power of attorney may allow their attorney to revoke on the settlor’s behalf, or this may be within the powers of a guardian appointed in the appropriate jurisdiction
- 11Alabama, Arizona, Arkansas, District of Columbia, Florida, Kansas, Maine, Massachusetts, Michigan, Mississippi, Missouri, Montana, Nebraska, New Hampshire, New Mexico, North Carolina, North Dakota, Ohio, Oregon, Pennsylvania, South Carolina, Tennessee, Utah, Vermont, Virginia, West Virginia, Wisconsin and Wyoming. It has been introduced in 2014 in the legislatures of Kentucky and Maryland
- 12California Probate Code, s15800; Florida Stat. Ann. s736.0603(1); Iowa Code, s633A.3103; Minnesota Stat. s501B.20; Montana Code Ann. s72–33–701 to 704; Utah Code Ann. s75–7–606
- 13For example, Scott and Ascher on Trusts, 5th ed (2007), s16.5, and Bogert Trusts and Trustees, 3rd ed (2010), s964
- 14 a b Scott and Ascher on Trusts, s16.5 (footnotes omitted)