What are the differences between a trust and a limited company

A limited company

A limited company stands as a distinct legal entity capable of holding assets on behalf of its owner, even though technically relinquished by the owner. However, shares remain part of the owner’s estate for Inheritance Tax (IHT) considerations. Unless the asset is cash or utilized in a trade, Capital Gains Tax (CGT) becomes payable upon its transfer to the company, potentially accompanied by Stamp Duty Land Tax (SDLT) in England or Northern Ireland if involving land or buildings.

Once within the company, the applicable corporation tax rate on any income or capital gain will not exceed 25%, potentially dropping to 19% if annual earnings fall below £50,000. Personal taxation only occurs upon withdrawal of income by the owner, a process they can carefully manage through dividend declarations or salary and officer’s fees. Consequently, income can accumulate within the company without incurring personal taxes if left unwithdrawn.

An additional benefit of the company’s separate legal status is the limitation of risk inherent in investments, as implied by its name. The owner’s liability is confined to their initial investment; no further personal liability exists. Furthermore, companies have enduring lifespans, enabling the transfer and gifting of shares to successive family members indefinitely.

How are Trusts different?

When placing an asset into a trust, the settlor relinquishes legal ownership to a trustee, who holds it for the benefit of another individual or group. While the settlor may declare themselves as trustees, they no longer retain ownership of the asset for their own benefit.

Depending on the trust type, income tax rates vary, ranging from a standard basic rate for interest in possession trusts—where beneficiaries have rights to asset income with trustees paying tax as a credit—to an additional rate for discretionary trusts starting April 2024. In the latter, trustees exercise complete discretion over both capital and income, and beneficiaries can reclaim a 45% tax credit on income distributions. Trustees are subject to higher Capital Gains Tax rates for 2023/24—18% on disposals, rising to 28% for residential properties, with only half the annual exemption of individuals. Income tax and CGT liabilities may make trusts financially burdensome under certain circumstances.

Yet, trusts offer a significant advantage over companies: assets exit the settlor’s personal estate for Inheritance Tax (IHT) purposes after seven years, while the settlor retains some control over capital through trustees. Trusts possess their own nil-rate band for IHT purposes (currently £325,000), exempt from IHT consequences for values below that threshold. Assets entering trusts incur no CGT, and no SDLT applies to land or buildings settled within them.

The similarities

By placing an asset into either a limited company or a trust, the act essentially involves giving away the asset. In the case of a limited company, it becomes a distinct legal entity separate from the individual investor. Although the investor may own all shares and thereby indirectly the asset, the company itself owns the income and returns initially.

Similarly, placing an asset into a trust results in relinquishing ownership—the beneficial ownership, which holds practical significance, transfers from the original owner. Those establishing trusts (referred to as “settlors”) can derive benefits from their own trusts, but for tax purposes, they typically remain deemed owners of the asset. Trusts are established to provide future generations, often descendants, with asset use, while legal ownership resides with trustees (which can include the settlor during their lifetime).