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In bondage to the taxman

Taxation and trusts follow each other round the seminar circuit and the technical pages of the industry press. Every year, we have a different angle to consider or formula to follow to work out how much tax is payable by whom.

Consequently, much has been written about the Trustee Act 2000, which became effective on February 1, 2001. The major benefit of this legislation is the wider scope of investment choice for trustees of most trusts, whenever they were created.

The great news for advisers is that life insurance and capital redemption bonds are now acceptable assets for trusts governed by statutory investment powers.

Combining bonds and trusts is another theme you will have read a lot about. After the dead settlor regime changed in 1998, it seemed clear who was liable for the tax on chargeable events and when.

But it is important that we consider certain trusts that previously may not have been likely to be able to invest in bonds but now find that avenue of opportunity available to them.

There is a growing trend in the UK to follow the examples set across the Atlantic and, where possible, to sue individuals or corporate bodies for negligence that results in physical or mental injury. In fact, the NHS alone has an estimated £3.9bn in current outstanding negligence claims.

The key area for consideration here is that unsuccessful defendants will often pay compensation to a personal injury trust. Let me explain the significance.

Imagine the personal injury trust created for an individual after an accident in hospital. Payments to such trusts can run into millions of pounds and are becoming increasingly common. The trustees, with their new investment powers and duty of care from the Trustee Act 2000, can consider using capital payments as well as income to maintain the beneficiaries.

If the trustees invest in a single-premium bond, then who would be liable for any tax when a chargeable event gain subsequently occurs?

SS547 and 547A ICTA 1988 broadly state that the taxpayer for chargeable event gains realised by trustees is the creator of the trust and the person from whom the trust funds originate, often loosely referred to as the settlor.

Consider a £1m compensation payment invested in an offshore bond. It would provide tax-deferred income of 5 per cent or £50,000 a year for 20 years. After 20 years, the value could still be £1.36m, assuming growth of 7 per cent each year. If a higher-rate taxpaying individual held the bond direct, the tax charge on later encashment would be £544,000.

However, if the sum is held in a personal injury trust, who is the settlor who would be liable for any tax? Is it the NHS hospital trust? If so, would the hospital pay the tax?

Who cares, provided the trust wording excludes the power contained in S551 ICTA 1988 to reclaim any tax from the trust.

From your injured client&#39s perspective, this looks like the perfect result – virtually tax-free growth inside the bond and realised gains taxable on a third party, if at all.

Consider the alternative of unit trusts. What annual capital gains tax allowance would be available for the trustees to use? Normally, £3,750 would be available. However, under the trust grouping rules, this reduces, as for every other existing trust with a common settlor, to a minimum allowance of £750.

How many trusts might a hospital NHS trust have set up? How will the trustees know what allowance to use? Is this more or less efficient than bonds?

What should you do the next time you see one of the ambulance-chasing advertisements promoting the merits of suing for medical negligence? You might want to consider that, if it is your client on the receiving end of a cheque, then there might be some further planning for you to consider.

For those IFAs involved in advising existing trustees on their current and new duties under the Trustee Act 2000, the opportunities the act has presented to them continue to grow. In an increasingly competitive and changing market, professional connections and trustees will value the added benefit an IFA can bring to the taxation and trust arena.

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