Succession Planning

Introduction

In a discretionary trust property is transferred to the trustees by a settlor. The trustees have a discretionary power to apply the trust fund for the benefit of one or more of a number of beneficiaries specified in the trust deed. This discretion is absolute i.e. the trustees decide the amount of the benefit the beneficiaries should receive and when they should receive it. The beneficiaries have no interest in the trust fund for legal or taxation purposes. They merely have the right to be considered favourably by the trustees for an appointment of property or income from the trust fund.

Taxation

Prior to establishing a discretionary trust, it is important to consider the tax implications of the trust under the various tax heads to include Income tax, Capital Gains Tax (“CGT”), Stamp Duty, Capital Acquisitions Tax (“CAT”) and Discretionary Trust Tax (“DTT”). For the purpose of this article, I am going to focus on the CAT and the DTT implications in the context of trusts created for young children and individuals with disabilities. 

CAT

No charge to CAT arises on the creation of a discretionary trust, as the potential beneficiaries of the trust do not have a beneficial entitlement to any of the assets in the trust. A charge to CAT may arise when the beneficiaries receive an appointment from the trust.

Discretionary Trust Tax

Discretionary Trust Tax imposes an initial levy of 6% on the market value of the trust fund. However, the legislation provides for a refund of 50% of the initial levy if the trust is wound up and all of the trust assets are appointed absolutely to beneficiaries within five years.

The initial levy arises on property which is subject to a discretionary trust in accordance with section 15 of Capital Acquisitions Tax Consolidation Act (“CATCA”) on the later of:

• the date on which the property becomes subject to the discretionary trust;
• the date of death of the disponer; or
• the date on which there ceases to be a principal object under 21 years of age (where property settled on/after 31 January 1993).

A principal object is defined to include a spouse or civil partner of the settlor, the children of the settlor or of his or her civil partner/spouse or any children of a predeceased child of the settlor or of his or her civil partner or spouse.

In addition to the initial levy, an annual levy is charged on the value of assets comprised in a chargeable discretionary trust on 31 December in each year. The 1% annual levy will not arise in the same twelve month period as the initial levy.

Young Children

A discretionary trust established by a Will can be very useful in providing for young children. It is generally accompanied by a letter of wishes which sets out what the parents would like to happen with the trust fund. This is a very individual letter from the parent to the trustees. It may include, for example that the trust fund should be divided equally between their children unless there was good reason for doing otherwise. It may specify the age at which they would like the children to benefit.

Clients with young children will often not wish their children to inherit substantial assets at a young age. Many would prefer their children to have developed a degree of maturity, established careers and have an understanding of financial matters, before they inherit anything of substance. In addition, when children are very young it is difficult to anticipate their future needs, some children may require more assistance than others. Discretionary trusts facilitate a wait and see approach, enabling parents to choose individuals whom they would trust to assume their role and apply the trust fund for the benefit of their children and appoint the funds to them absolutely when they consider it appropriate.

A charge to CAT may arise for the children on receipt of an appointment from the trustees. If the appointment is made for the support, maintenance or education of a minor child, where both parents have died, the appointment may be exempt from CAT under the provisions of section 82(4) of the CATCA. In order for the exemption to apply, the benefit must be considered normal expenditure taking into account the financial circumstances of the parent prior to his or her death. This is a very limited benefit and only available to a minor child where both parents have died.

Discretionary trust tax may arise when the youngest child turns 21 years of age assuming there is no interest in possession. It is possible to mitigate this liability by appointing funds to the older children in advance of the youngest child turning 21.

Beneficiaries with Disabilities

A discretionary trust is often the optimum method for providing for vulnerable beneficiaries. Parents of children with disabilities face a number of difficult issues in seeking to make provision for their children. In most cases, the parents will have been the primary care-givers and will be anxious to ensure the child will be looked after, not only financially but also to ensure that their day-to-day living and emotional needs will be met.

Parents want to ensure that the persons caring for the child after their death will have sufficient resources and flexibility to meet the changing needs of the child as they arise. It will often be very difficult to assess future needs and people may be reluctant to act as primary care-givers in this situation. There will also be uncertainty as to the role of the State going forward and the impact any provision may have on the benefits the child may currently receive.

In dealing with the variables presented, the discretionary trust structure offers huge flexibility to adapt to a child’s changing needs. It may also be possible, depending on the capacity of the child, for the child to be one of the trustees and thus have an input into the decision making process.

CAT liability may arise on the appointment of funds to the child or vulnerable beneficiary. However, under section 84 of the CATCA, a benefit taken exclusively for the purpose of discharging qualifying expenses of an individual with a disability is exempt from CAT. Qualifying medical expenses are defined as expenses relating to medical care, including the cost of maintenance in connection with medical care.

Section 17(1)(d) of CATCA provides for an exemption from discretionary trust tax where a discretionary trust is established:

(i)   for the benefit of one or more individuals, and

(ii)  for the reason that such individuals, or all such individuals, is or are, because of age or improvidence, or of a physical, mental or legal incapacity, incapable of managing that individual or those individuals’ affairs.

This is not an automatic exemption, it is necessary to make an application to Revenue when the trust is established providing them with a medical certificate from a doctor confirming the child is incapable of managing their affairs for the relief to apply.

Protective Trusts

A discretionary trust is a means of providing for adult beneficiaries who suffer from drug, alcohol, gambling or other addictions, without the risk of the funds being depleted due to reckless management. In these particular situations, a tax liability, in particular discretionary trust tax, is secondary to the desire to protect a vulnerable family member. Depending on the circumstances, it may be possible to claim the exemption from discretionary trust tax in accordance with section 17 of the CATCA as outlined above, on the basis that the individual is incapable of managing their affairs. Each case is decided on its own particular merits. For example, I understand the relief has been granted previously in the case of an individual suffering from alcoholism.

Conclusion

Discretionary trusts can assist greatly in implementing a client’s wishes with regard to their succession plan. As outlined above, they are particularly useful in providing for vulnerable family members. They offer a significant level of flexibility in dealing with their changing needs as they enable the trustees to decide the amount and timing of any benefit they receive from the trust. Depending on the beneficiaries’ circumstances and the manner in which the trust is established this can be achieved in a tax efficient manner.