8.1 The progress so far
In his 2004 Budget, the Chancellor announced that the tax rate applicable to trusts (RAT) would be raised to 40% to combat tax avoidance. This rate applies to income and capital gains. UK dividend income is taxed at 32.5%. He also announced that there would be new measures to prevent this change increasing burdens on certain trusts that have vulnerable beneficiaries.
Two measures were announced – a new tax regime for certain trusts with vulnerable beneficiaries, and a standard rate band of £500 for all trusts paying tax at the rate applicable to trusts. These two measures are confirmed in today’s Budget (Rev 10)
A number of other proposals were put forward in the Budget 2004 and in the Inland Revenue Consultation Document issued in August 2004. These included a set of common definitions and tests for trusts, and the streaming of income through trusts. These measures will simplify the taxation of trusts and were widely supported during consultation last year. However, during subsequent consultation, respondents also raised a number of concerns about some of the detailed aspects of the proposals. A summary of the findings of this consultation has been published with the Budget Press Releases.
In light of this, the Inland Revenue will carry out further development work on these measures and a discussion paper has been published today. It is intended that draft legislation will be published for consultation later this year, prior to the measures being included in next year’s Finance Bill.
8.2 Definite measures announced today
Standard rate band
There will be a new “standard” rate band of £500 for all trusts liable at the rate applicable to trusts.
Legislation giving full details of this will be in the Finance Bill. The effective date for this change is 6 April 2005. The term “standard” is used rather than “basic” as there are a number of different rates involved depending on the type of income. Presumably income will need to be grossed-up to determine whether it falls within the standard rate band.
Trusts which receive all their income up to the standard rate band either net of tax or with an associated tax credit will have no further tax to pay. Those which receive their income gross will have to pay tax at the appropriate rate depending on the nature of the income.
The Inland Revenue Press Release makes no reference to anti-fragmentation rules to prevent settlors establishing a number of trusts to each benefit from the standard rate tax band. However the Regulatory Impact Assessment for Modernising the Tax System for Trusts (also issued on Budget Day) makes the following comment under the heading “Unintended Consequences”
“There is a danger of people seeking to exploit the standard rate band by setting up several small trusts instead of one larger entity, but the savings from doing so are likely to be outweighed by additional administrative costs”.
Trusts for the vulnerable
There will be a new tax regime for trusts for the most vulnerable, allowing these trusts to be taxed on the basis of the vulnerable beneficiary’s individual circumstances for both income tax and CGT. This measure is also to be included in the Finance Bill and the regime will be backdated to 6 April 2004.
Trustees will be able to use the individual beneficiary’s personal allowances, starting and basic rate bands, rather than being taxed at the rate applicable to trusts.
8.3 Further specific items subject to reform
The Inland Revenue have published the Summary of Responses to the Consultation Document issued on 13 August 2004 together with it a new Discussion Paper on the Modernisation of the Taxation of Trusts. Following on from the responses to the August 2004 consultation the Government has asked the Inland Revenue to discuss further with interested parties some more detailed aspects of four of the suggested measures. These four topics are dealt with in the Discussion Paper issued today.
The proposal is that income that the trustees pass on to beneficiaries before the 31 December falling after the end of the relevant tax year in which the income was received by the trustees should be exempted from RAT and instead taxed on the beneficiary. There are a number of areas still under discussion, such as dealing with deemed income, management expenses, the proposed phased abolition of tax pool and others.
Definition of a trust
A set of common definitions and tests will be introduced for income tax and CGT. The aim is to improve consistency and make it easier for all trustees, especially lay trustees, to correctly determine their tax status and treatment.
The most important definitions under discussion are those of trust/settlement and settlor-interested trust. Different definitions exist currently for income tax, CGT and IHT. The suggested common definition is the one in section 43 IHT Act 1984.
The areas under discussion relate to the practical implications of the new definitions, especially given the number of other relevant terms, egg. Settled property, disposition, trust, different legal basis of trust law in Scotland etc.
Residence test for trusts
The proposal is to harmonise the income tax and CGT tests for trustee residence on the basis of the current income tax test although some respondents felt that the CGT test should be used instead. This remains the subject of consultation.
The proposal is that where trust assets have been split off into a separate sub-fund administered by a different group of trustees, the trustees should be able to elect for that sub-fund to be treated as if it were a separate trust for all income tax and CGT purposes. There are a large number of detailed considerations still under discussion.
8.4 Other issues still subject to consultation/discussion
One issue under discussion where no consensus was reached concerned whether trusts set up by approved pension funds should be included within the new regime for trusts with vulnerable beneficiaries (see above). It has been decided that the Inland Revenue will consult further with the pensions industry on this issue.