The proposals for reforming trust taxation represent an excellent opportunity for advisers to show their key clients and, perhaps more important, their key professional connections such as accountants and solicitors that they are up to date with developments relevant to financial planning in the upper end of the market.
They also offer broker consultants a chance to show competence and professionalism. IFAs who deal in upmarket business will value clear communication on the proposals and what they could mean for their market and, with this communication, broker consultants can practice the role of being the IFA's business development partner.
As a business exercise, the broker consultant will need to invest time to secure the understanding necessary to deliver clear business-focused communication. The payback will be a strengthening of the relationship with the source of business for the product provider represented and, at a more immediately tangible level, an increase in the likelihood that trust-related business will be done via the consultant's company. This assumes the provider has suitable products and trusts to deliver the necessary solutions.
What are the key issues on trust reform for IFAs? Here are five for you to consider.
The rate of income and capital gains tax on trusts will increase to 40 per cent (and to 32.5 per cent for dividends) from April 6, 2004. This means trust income and gains will be taxed more heavily than at present.
This will not be the case where the trust is a settlor-interested trust (where income and gains are assessed on the settlor) or a trust under which income rights are vested in a beneficiary (when income will be assessed on the beneficiary) or a bare trust (under which capital gains and income are assessed on the beneficiary).
A basic-rate band, possibly of £500, is proposed for trust income from discretionary and accumulation and maintenance trusts which are non-settlor-interested. This could mean the rate of tax suffered on income up to the basic-rate threshold will be more lightly taxed than at present.
Subject to investment considerations and the need for actual income, a low-yield growth-oriented investment strategy may be attractive from a tax viewpoint. If a yield of, say, 1 per cent were acceptable, then up to £50,000 of trust assets could be held and income on the investments would not exceed the proposed basic-rate band threshold. The trust capital could be greater and the band still not exceeded if the yield were lower.
If regular sums are to be paid by the trustees, say, to supplement income, then the withdrawal of capital (with gains, say, not exceeding the trustees' annual exemption from CGT) followed by an advancement may be feasible.
In light of a harsher rate of tax for trusts and a possibly wider settlor-interested definition, it may seem that life insurance-wrapped investments may be more tax-attractive. However, it has to be borne in mind that while tax will be deferred and administration simplified, the provisions for the taxation of gains made under life policies, for example, UK and offshore single-premium bonds, are already based on the widest possible settlor-interested definition.
As I have made clear in earlier articles, all policy gains while the settlor is alive and UK resident will be assessed on the settlor, regardless of the trust terms. The only exceptions are an absolute trust for the benefit of other than a minor beneficiary – a fairly rare phenomenon – and the situation where a chargeable event occurs after the death of the settlor but within the tax year in which the settlor died.
As any new provisions such as the 40 per cent tax rate are likely to apply to all trusts regardless of when they were established, there will be a need to review existing trusts to see if there needs to be any adjustment to investment strategy.
One type of trust where this may be relevant will be funded unapproved retirement benefits schemes. The proposals for pension simplification will also prompt an urgent review of Furbs once it becomes clear that these provisions are to be implemented.
Change to the inheritance tax treatment of trusts is not on the agenda. In cases where the income tax and CGT attraction of a trust lessens as a result of the trust tax rate increasing to 40 per cent (32.5 per cent for dividends), all concerned will need to weigh up the value of the IHT saving against this cost.
However, in assessing the options as to what can be done, aside from adjusting the investment strategy to minimise tax, it will be necessary to be fully aware of the trust provisions. For example, if the trust is IHT, income tax and CGT-effective, in that it avoids any assessment on the settlor, it will have been because, even under current rules, at least the settlor is excluded from all benefit. To avoid any income tax and CGT charge, the settlor's spouse will have also been excluded. This will mean that, in many cases, affected trusts will not be able to wind up and distribute funds direct to the settlor.
Having an awareness and understanding of all the key proposals and what their implementation could mean will stand the IFA and broker consultant in good stead to communicate effectively on this subject and, as a result, do more profitable business.