Using Declarations of Trust

Declarations of Trust are, as the name suggests, a form of trust.  Unfortunately, trusts have a bit of an image problem, in that people tend to think that they’re either used for tax avoidance or that they’re complicated and expensive to operate.  In reality, they’re very flexible, practical, tools that can be useful in a variety of situations by all sorts of people.  So what exactly is a trust?  Well, a trust is created when the legal ownership of an asset is separated from the beneficial ownership.  A Declaration of Trust is a document that evidences a gift without a change in the legal ownership of the asset transferred, so that the person making the gift becomes a trustee of the asset for the recipient.  You may ask why the donor does not simply transfer the legal ownership as well as beneficial ownership, and perhaps an example will make things clearer.

John and Mary want to get married.  They each own a flat and intend to move into John’s flat and to rent out Mary’s.  As Mary earns more money than John, she is a higher rate taxpayer, while John’s income falls comfortably within the basic rate band.  If they don’t change the ownership of Mary’s flat, the rental income will all belong to her and will suffer more tax than if were assessable on John.  However, changing the legal ownership of a residential property involves registering  the new interest at the Land Registry and this will usually require a solicitor and a hefty fee.  To avoid these costs, once they are married, Mary gifts the property to John by way of a Declaration of Trust, declaring that she will hold it for him and will deal with it as he directs.  Mary retains legal ownership (it is still registered in her name), but John now has the beneficial ownership as the flat has been gifted to him.  This saves both legal fees and tax and everybody is happy.

They are even happier when Mary falls pregnant with their first child and decides to give up work to raise their family.  The rental income from Mary’s old flat will make up some of the loss of her earnings and John and Mary agree that they can afford the change.  However, Mary will subsequently be the one with no income, so they decide to transfer ownership of the rental property back to her, to make best use of her personal allowances going forward.  John now executes a Declaration of Trust in favour of Mary, who starts to report the income as her own on her personal income tax returns.  This again saves on legal fees which would otherwise have been spent on transferring the flat from Mary to John and back again, as well as saving tax in the longer term.

There is, of course, nothing to stop someone gifting an asset to somebody else, but what proof of the gift is there if ownership is later disputed?  In John and Mary’s case, it is not inconceivable that a diligent (nosy?) tax inspector would pick up the fact that the rental income appears on their tax returns at different times and that is the sort of thing that might prompt an enquiry.  This is where Declarations of Trust are particularly handy.  They set out the subject matter of the gift, that beneficial ownership only is being transferred and, as they are generally executed as a Deed, are witnessed to put matters beyond doubt.  Most Declarations of Trust can be fitted onto a single sheet of A4, so they are straightforward and inexpensive to prepare and, all in all, are a convenient way of transferring assets between connected parties, although they will never be a substitute for formal transfers on an outright sale.

Always bear in mind that gifts are disposals for tax purposes and there may be unexpected tax consequences if matters are not planned properly in advance.  There are generally few problems in the case of spouses or couples in a civil partnership, but always get advice first and execute second, not the other way round!

Carl Barwick – Tax Manager
