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As well as the changes to trustee taxation discussed last week, in particular, the 40 per cent rate applicable to trusts (Rat) and the 500 standard rate band, the Inland Revenue has published a summary of responses to the consultation document issued on August 13, 2004, together with a discussion paper on the modernisation of the taxation of trusts. The new discussion paper results from the responses to the August 2004 consultation, following which the Government has asked the Revenue to discuss further some more detailed aspects of four of the suggested measures. Looking first at income streaming, the proposal is that income that the trustees pass on to beneficiaries before December 31 after the end of the relevant tax year in which the income was received by the trustees should be exempted from the Rat and instead taxed on the beneficiary. There are a number of areas still under discussion, such as dealing with deemed income, management expenses and the proposed phased abolition of the tax pool. A set of common definitions and tests will be introduced for income tax and capital gains tax. The aim is to improve consistency and make it easier for 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 inheritance tax. 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, for example, settled property, disposition, trust and the different legal basis of trust law in Scotland. There is also a proposal 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. This remains the subject of consultation. Finally, there is a proposal 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 income tax and CGT purposes. There are a large number of detailed considerations still under discussion. Since many issues have still not been decided, it is a case of “watch this space” for those who are interested in this subject. The most important immediate issues are the standard rate band for certain trusts and the new provisions regarding trusts for the most vulnerable. It is unlikely that all trusts subject to the Rat have considered their position since the rate went up to 40 per cent last year, with the Schedule F trust rate for dividends having been increased to 32 per cent. Reviewing the trust’s investment portfolio would seem a sensible thing to do and financial advisers have a real role to play here. Another area of interest is the CGT treatment of bare trusts created for minor unmarried children of the settlor. The original consultation document suggested bringing the CGT treatment of such trusts in line with the income tax treatment, including the parental settlor anti-avoidance provisions where the beneficiary is a minor unmar- ried child of the settlor. If that were to happen, the attraction of bare trusts for own minor children on grounds of CGT efficiency would be reduced unless the realisation of gains was deferred until after the child’s 18th birthday or earlier marriage. However, no change was proposed in the Budget, which means the current rules continue for another year. If the purpose of investing is to meet the costs of higher education, the funds will be needed when the beneficiary is over 18, so the capital gains will be assessed on him anyway. For those with children who do not qualify for the child trust fund or where the potential contributor to the CTF is uncertain about contributing to a fund under which benefits can only be paid direct to the child at 18, a designated collective or one held on bare trust may represent an acceptable alternative. This could be viewed as a quasi-CTF with the potential to be as tax-effective. How? If income does not exceed 100 gross in a tax year per parental contributor per unmarried child beneficiary, or where the contributor is other than a parent, income will not be assessed on the contributor. Capital gains tax up to the child’s annual exemption will be exempt and taper relief is a valuable means of diminishing the taxable value of long-term gains. For those concerned about direct payment from a CTF to the child at 18, this will provide an acceptable alternative. Payment will be made to the nominee (parent/grandparent), who will then be obliged to use the funds for the child’s benefit.