There are many reasons why a trust might need to be wound up, from a beneficiary becoming entitled to its full capital, a beneficiary passing away, its assets being fully distributed or simply the trust having served its purpose.
Whatever the reason, closing or winding up a trust can be complicated, may incur costs and can have serious tax implications.
To understand the implications of winding up a trust, it helps to first understand the different types of trust.
What is a trust?
A trust, at its simplest, is a legal entity that holds assets on behalf of its beneficiaries. It is created by a settlor who transfers assets into a trust, which is then managed by a trustee (or trustees). A trustee has a legal and fiduciary duty to act in the best interests of the trust’s beneficiaries and adhere to the terms of the trust itself.
Trusts are used for a wide range of purposes, ranging from estate and tax planning to protecting assets for children or vulnerable adults. The settlor when creating the trust will often write a non-binding letter of wishes, to act purely as guidance to the trustees, as to how assets or the income they generate is managed or eventually distributed.
The three most commonly used trusts are:
- Bare trusts, where assets are held for beneficiaries who have an absolute right to the assets and income. This is seen more as a “nomineeship” type structure, and is tax transparent (i.e. the beneficiary is the party assessed for tax purposes, despite the bare trustee ‘holding’ the assets).
- Discretionary trust, where the beneficiaries receive income and/or capital distributions from the trust at the trustees’ discretion. This structure is tax opaque and the trustees are taxed at the higher rate.
- Interest in Possession (IIP) trust, where a life beneficiary (otherwise known as a “life tenant”) has the legal right to receive all the income (or rent-free enjoyment) from the trust’s assets for the duration of their life, or upon a certain event occurring specified by the trust deed. This structure is tax translucent, and precise tax treatment depends on how and when the trust was created. There is generally a mixture, with some taxes being assessed on the life tenant and others on the trustees.
Termination
How a trust is terminated will depend on what type of trust it is. Some trusts, such as a bare trust, will be terminated by an event such as a beneficiary reaching a certain age and demanding the assets to be transferred to them absolutely, or if they were to pass away. Other trusts can be terminated by the actions of its trustees.
Whatever the trigger for termination, trustees must ensure they have a record of its winding up, either as a trustee resolution or more preferably a formal deed.
Whilst the process is straightforward with a bare trust, it can quickly become complicated with discretionary or IIP trusts. The valuation, sale and distribution of assets can be time-consuming, incurring professional fees.
Trustees need to ensure that all trust assets are distributed to the correct beneficiaries before a trust can be terminated. Before they do so, they must first make reasonable checks to see whether there have been any changes to beneficiaries and their entitlements. It is important that trustees regularly review beneficiaries’ circumstances and are familiar with the terms of the trust deed, to ensure legal and practical efficiency at the time of winding up.
Tax considerations
If a trust has been filing UK Self-Assessment tax returns, the trustees will submit a final return and ensure the trust is closed with the Trust Registration Service. Failure to notify HMRC can result in penalties for late or non-filing of tax returns.
Assets distributed to beneficiaries will naturally fall into their estate for inheritance tax (IHT) purposes, but assets distributed from a discretionary trust (and some IIP trusts) may also trigger an immediate IHT charge (and reporting) due by the trustees under the Relevant Property Regime. These calculations are complex, with historic information, the length of time the trust has held those assets and the availability of the trustees’ nil-rate band all being relevant to ascertain the level of liability.
Trustees also need to consider capital gains tax (CGT) exposure when closing a trust, with CGT payable on gains on assets that are sold or distributed in-specie. Trustees will need to calculate chargeable gains and reliefs or exemptions available to them, and any liability should be reported in the trust’s final Self-Assessment tax return.
Given the above, we would strongly recommend legal advice is sought before tackling the task of collapsing a trust. Our specialist Private Client department are always glad to assist and offer bespoke advice on your circumstances.
Contact our Private Client Solicitors
If you are in need of advice or assistance on any of the legal issues mentioned in this article, please contact any member of our experienced Private Client team on 020 7631 4141 or email privateclient@bishopandsewell.co.uk
The above is accurate as at 19 August June 2025. The information above may be subject to change.
The content of this note should not be considered legal advice, and each matter should be considered on a case-by-case basis.
