Tony Wickenden: Trustee planning issues advisers need to be aware of

Tony Wickenden

Having considered the legal and tax fundamentals of trustee investment in my previous articles, it is now time to look at planning. As mentioned before, there is an immediate opportunity to initiate trustee investment engagement with professional connections based on the capital gains tax and dividend tax changes. The changes are current and relevant: a good combination.

When making investment recommendations to trustees, the following planning considerations should be borne in mind:

  • Under an interest in possession trust a beneficiary is entitled to income and the trustees of such trusts should not therefore usually invest in non-income- producing investments, such as capital investment bonds, or in accumulation units/shares (that is, where the accumulation of dividends is reflected in the unit/share price). In some cases capital investment bonds (but not accumulation units or shares) may be suitable as part of a portfolio to deliver the capital appreciation the trustees may be seeking to achieve in addition to income
  • Where the trustees invest in collectives, any dividends declared, even if reinvested (for example, in accumulation shares), are fully taxable. However, any reinvested dividends can be added to the base cost of the shares for CGT purposes
  • When investing for growth, the choice will often be between capital investment bonds and collectives. The relative merits of each option are compared briefly further on
  • For interest in possession trusts it is important to ensure any trust income is paid directly to the beneficiary entitled to the income if the trustees want to avoid having to make trust tax returns and pay tax at the basic rates.

Can capital investment bonds ever be appropriate for trustees?

Consider the following in relation to them:

  • They are non-income producing and so offer simple administration and no tax return requirements until a chargeable event gain arises
  • No tax on switches (for example, when reviewing or rebalancing investments) or on beneficiaries becoming absolutely entitled to the trust assets
  • Trustees pay income tax at 25 per cent on onshore bond gains (45 per cent trust rate less 20 per cent tax credit) and at 45 per cent on offshore bond gains
  • Ability to offset the standard rate band against offshore bond gains
  • Ability to take regular tax-deferred withdrawals of capital (up to 5 per cent of the original investment each year for 20 years), which can be distributed to beneficiaries to provide a tax-efficient form of “income”
  • May be particularly appropriate for trusts (especially discretionary trusts) where income and capital gains are to be accumulated and would otherwise bear tax
  • Assignment to a beneficiary is not a chargeable event, giving potential for tax mitigation on distribution
  • No CGT, although this means no scope to use the trustees’ annual CGT exemption or the 20 per cent tax rate on gains. A reserve for tax on capital gains will also be made by a UK life company, which will impact negatively on the unit price
  • There is scope to use the benefi-ciary’s personal savings allowance for capital investment bond gains but there is no scope to use the £5,000 dividend allowance
  • A capital investment bond is a non-income producing asset and so will be inappropriate if natural income is required.

How about UK collectives?

  • There is scope to use the beneficiaries’ personal allowance, as well as the personal savings allowance (for interest distributions) and dividend allowance on an arising basis if the trust is a bare trust or an interest in possession trust (subject to the parental settlement rules). The position here has improved post-5 April with the introduction of the personal savings allowance, the dividend allowance and gross interest and dividend payments.
  • There is scope to use the trustees’ annual CGT exemption and 20 per cent rate (except for gains made on residential property that is not the beneficiary’s principal private residence, where the rate continues at 28 per cent)
  • There is the benefit of the standard rate income tax band (£1,000) for discretionary trusts.

All the above also apply to offshore reporting funds.

How about offshore non-reporting funds? 

Here are the key tax points to take into account when determining their suitability:

  • Gains are calculated in accordance with CGT principles but taxed as income
  • Death of a beneficiary may give rise to a gain in some circumstances (and depending on trust type)
  • No scope to use annual CGT exemption or 20 per cent CGT rate
  • Effective tax deferment until investment realised
  • All gains taxed at 45 per cent on trustees (except for bare trusts).

Trustee investment is without doubt a relatively complex area. However, that makes it one  that is highly unlikely to be dealt with without the benefit of informed advice. The difficulty of the subject matter makes it an area in which differentiation based on “know-how” is a real possibility. No bad thing in a competitive marketplace.

Tony Wickenden is joint managing director of Technical Connection. You can find him Tweeting @tecconn