Charitable vs. Non-Charitable Trusts

The charitable trust is one of many different types of trust available under British law. They are established for a very specific purpose - to provide a tax efficient method by which individuals can make charitable donations - while other types can be used in a variety of different circumstances. As such, there are a number of important distinctions to be made regarding the legal status and tax treatment of charitable and non-charitable trusts.

Tax Treatment

In the first instance, and of key importance to many settlors of charitable trusts, it is important to remember that charitable and non-charitable trusts are subject to different tax schedules. Many individuals use non-charitable trusts to avoid payment of inheritance tax on death. In order to combat this loss of revenue, transfers into these trusts totalling more than the Nil Rate Band (currently set at £325,000) are subject to a 20% flat tax. This is not the case for charitable trusts; any assets transferred into a charitable trust, whether they are transferred by the original settlor or by other individuals, are exempt from tax, regardless of the value of the transfer.

There are also differences regarding income tax. Generally, income derived from assets held in a non-charitable trust will be subject to income tax at the normal rate. This does not, however, apply to charitable trusts. Any income derived from assets in charitable trusts can be drawn tax-free, with the proviso that they are used solely for the declared charitable purposes of the trust. This extends to investment income; assets can be invested with no ensuing tax liability.

Perpetuity

There are a number of legal distinctions that do not concern tax. Importantly, non-charitable trusts are subject to a ban on perpetuity. This means that all non-charitable trusts must cease to operate within a certain period of time; this period will depend upon the nature of the individual trusts. No such provision exists for charitable trusts, meaning that they can continue operating in the same way forever.

Beneficiaries

Rules regarding beneficiaries also differ for charitable and non-charitable trusts. In a non-charitable trust, it is generally required that the intended beneficiary is specifically identified in the trust instrument. At the very least, a 'class' of beneficiary must be detailed, and the trustees will have some discretion regarding the interpretation of those instructions. In the case of a charitable trust, however, the 'cy-pres' doctrine applies. This means that the courts are able to alter the terms of the trust deed where it is unclear who the intended beneficiaries are, or where it is impractical to act for their benefit.

The cy-pres doctrine requires the terms to be altered in a way that ensures the actual beneficiaries are as close to that which was intended as is reasonably practicable. This rule extends to failed charitable trusts, or those that cease to exist; in these cases, it is equally acceptable to transfer any remaining assets to a beneficiary that is deemed to be close in nature to that which was originally intended.

Clearly, there are a number of specific factors that must be considered when investigating establishing a charitable trust. It is always a good idea, therefore, to seek specialist legal advice in these situations.