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Gang of four

Last week, I summarised four main points for financial advi-sers emerging from the consultation on trust taxation reform:

•The proposed anti-avoidance provisions in respect of capital gains made by trustees of bare trusts for minors.

•The proposed common definition of a trust.

•The proposed definition of settlor-interested trusts and •The proposed common trust residence definition.

Bare trusts for minors

The most important point is the Inland Revenue&#39s confirmation that it intends to use income tax legislation to treat both income and capital gains as the settlor&#39s where parents have created trusts for their minor unmarried children. This will affect all bare trusts, including designations of collective investments, created by parents for the minor unmarried children.

At present, while such trusts are subject to the parental settlor provisions in respect of income (the £100 rule), capital gains are treated as the beneficiary&#39s. Once the new rules are introduced, expected to be from April 6, 2005, capital gains will be assessed on the parental settlor until the child reaches 18 or marries under this age.

However, where gains are not realised until the child is 18 (or, if earlier, after they have married), then the child&#39s full annual exemption will be available. Furthermore, where the settlor is other than a parent, the child&#39s full annual exemption will always be available.

Common definition

It is proposed to have a common definition of trusts for income and capital gains tax purposes. The definition contained in section 43 Inheritance Tax Act 1984 will be used. This defines a settlement as: “Any disposition or dispositions of property, whether effected by instrument , by parol or by operation of law, or partly in one way and partly in another, whereby the property is for the time being:

a) Held in trust for persons in succession or for any person subject to a contingency, or b) Held by trustees on trust to accumulate the whole or part of any income of the property or with power to make payments out of that income at the discretion of the trustees or some other person, with or without power to accumulate surplus income, or c) Charged or burdened (otherwise than for full consideration in money or money&#39s worth paid for his own use or benefit to the person making the disposition) with the payment of any annuity or other periodical payment payable for a life or any other limited or terminable period, or would be so held or charged or burdened if the disposition or dispositions were regulated by the law of any part of the UK; or whereby, under the law of any other country, the administration of the property is for the time being governed by provisions equivalent in effect to those which would apply if the property were so held, charged or burdened.”

The wider definition of settlement in the anti-avoidance sections of Part XV of ICTA 1988 will remain. The exclusion of bare trusts from the definition of settlement will remain so the trustees of what the Revenue refers to as “genuine” bare trusts will not be subject to income tax or CGT except in certain circumstances where the trustees opt for self-assessment. This does not contradict the provision relating to parental bare trusts discussed above as this is part of the anti-avoidance provisions dealt with in the settlor-interested test.

Settlor-interested test

Different tests apply for income tax and CGT purposes. There is also an extended test applying to non-resident trusts. The proposal is to have one test applying to UK-resident trusts for income tax and CGT purposes and to retain the extended test for non-resident trusts.

The general test for UK-resident trusts will be the current income tax test, namely, that either the settlor or settlor&#39s spouse can benefit under the trust or that a minor unmarried child of the settlor is entitled to income under the trust or receives income from such a trust. Where a trust is settler-interested, as now, all gains and income will be assessed on the settlor.

The minor children&#39s test will apply to both income tax and CGT. Such a trust will cease to be settlor-interested when the child reaches 18.

Trust residence test

It is proposed to harmonise the tests for income tax and CGT by applying the income tax test because it provides simplicity and clarity. The income tax test is based on residence. If all trustees are UK resident, the trust is treated as UK resident and all its income is liable to UK tax. If all trustees are non-resident, the trust is treated as non-resident so only UK-source income is within the UK tax regime.

Where only some trustees are non-resident, the status of the settlor is taken into account. If the settlor was resident, ordinarily resident or domiciled in the UK at the time he made the settlement or provided funds, the trust will be treated as UK resident, otherwise as non-resident.

All trusts will be expected to apply the residence test and be either UK resident or non-UK resident for income tax and CGT. Given that some trusts may presently be treated as UK resident for income tax and non-resident for CGT, there will be a 12-month transitional period before the harmonised test will apply.

It is essential to note that trust reform is confined to certain aspects of income tax and CGT as they relate to trusts. There is no proposal to change the way IHT operates in connection with trusts. This will be a relief given the onslaught of the pre-owned assets rules.

There is also no impact on the taxation of life policies held in trust. These are already subject to the widest possible settlor-interested tax provisions in that while the settlor is alive and UK resident, all chargeable event gains are assessed on the settlor regardless of the type of trust and identity of the settlor. The only exception is where a policy is held in bare trust for the benefit of a beneficiary over the age of majority, when gains would be assessed on the adult beneficiary.


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