I have considered some income tax, capital gains tax and inheritance tax implications and there is clearly quite a bit of tax law to get your head round, despite the welcome CGT simplification with the abolition of anti-avoidance provisions in the wake of the introduction of the flat 18 per cent rate. But is getting your head around these provisions
Well, it depends. The CGT and income tax rules will only be relevant if the trust assets actually produce income and capital gains. For most financial advisers, the most common product held in these trusts will be a life insurance policy – protection or investment – so the answer to both questions would seem to be no, both in respect of old and new trusts. However, this conclusion might be a little hasty for three reasons.
First, even if an old (pre- March 22, 2006) flexible trust is attached to an insurance product now, it might not be for ever. A review of wrapper appropriateness may – I stress may – mean that a move from a bond to a collective can be justified.
In carrying out such a review, it is critical that all commercial, investment and tax factors are weighed up and documented, along with the basis for any decision made. The assumptions used in making the decision also need to be noted and the whole process underpinned by the principles of treating one’s customer fairly.
Second, even if there is no switch of wrapper, if any proceeds from the insurance policy are not paid out immediately by the trustees, say, where the beneficiaries are minors, there will be the need to invest these or just hold them on deposit.
At that point, income tax and possibly capital gains tax become relevant, depending on the investment. The taxation of chargeable event gains is the same regardless of whether the trust is a flexible interest in possession trust or a fully discretionary trust. The gain is assessed on the settlor if alive in the tax year of encashment and UK resident. If the settlor is deceased or non-UK resident, chargeable event gains will be assessed on UK resident trustees at 40 per cent.
Of course, they will be entitled to a 20 per cent tax credit where the underlying investment is a UK bond or bond with an EEA insurer with at least a 20 per cent internal tax rate. The credit will not be available for an offshore bond.
If the trustees are non-UK resident and the settlor is non-resident or deceased, then gains should be noted and any capital payment from the trust to a UK resident beneficiary will be assessed to income tax on that beneficiary up to the amount of previously untaxed chargeable event gains that have arisen to the trustees but have not been assessed.
It is worth remembering that in relation to the settlor charge, the fact that a UK resident settlor may be non-UK domiciled does not mean that chargeable event gains are assessable on the remittance basis, even if the £30,000 charge is paid or the settlor qualifies for one of the exemptions, for example, by having unremitted overseas income and capital gains of less than £2,000 in the tax year. Basically, chargeable event gains, even on offshore bonds and regardless of the domicile of the settlor, are assessed on the arising basis.
Third, in light of the CGT changes and most obviously the introduction of the flat 18 per cent rate, there may – I stress may – be a greater proportion of investments being wrapped in collectives.
I have written much over the last year on the relative merits of bonds and collectives as tax wrappers and if one thing has emerged from these musings, it is that wrapper choice depends very much on the facts and is far from being the no-brainer (that is, all investments should be in collectives) that some had concluded.
Growth-oriented funds can often look tax attractive in a collective wrapper but they always did. In many cases, the wrapper choice that should have been made on tax grounds before the introduction of the 18 per cent rate will be the wrapper choice on tax grounds in the current environment.
That said, there will undoubtedly be greater focus on the role of collectives as non-Isa wrappers for capital investment and this is just as relevant for trustee investments.
There are many pre- March 22, 2006 interest in possession trusts and these trusts will continue to be set up, especially where the trust is established by will. The immediate post-death interest rules give continued tax-favoured treatment where, for example, the surviving spouse is given a life interest with remain- der to, say, children. In this case, IHT is deferred until the death of the surviving spouse but the trust does not get hit by the relevant property regime.
The immediate post-death interest rules can also work where the person given the life interest is other than a spouse. This could be useful for flexible trust- based nil-band planning without having to consider the relevant property regime.
For lifetime trusts where flexibility is required but there is no overriding need or desire for trust income to be paid to or applied for the benefit of a particular beneficiary as of right, then, especially given CGT neutrality due to the 18 per cent rate, it is more likely that a discretionary trust will be chosen, especially if a collective investment is to be the investment product underlying the trust.
So, I would conclude that for advisers who are going to be more deeply involved in trusts and trust-based investment advice, it will be hard to ignore completely the tax treatment of interest in possession trusts.
Next week, I really will look at why a review of pre-March 22, 2006 interest in possession trusts ahead of October 6 will be worthwhile.