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Modernisation or stealth taxation?

The Pre-Budget report has created an opportunity for you to contact your trustee clients to update them on the potentially significant changes to trust taxation of income and capital gains.

In paragraph 5.93 of the Pre-Budget report, the Chancellor recognises that “trusts have a positive role to play in assisting people to manage their tax affairs and in particular in holding assets on behalf of vulnerable people. However, the tax regime for trusts has not kept pace with the times and is not always fair. The Government is determined to tackle the exploitation of trusts and to make the system fairer for the less well-off.”

The Inland Revenue issued a later press release (Press Notice 6) entitled, Tackling Tax Avoidance and subtitled, A series of measures to protect tax revenues from fraud, evasion and avoidance. In this, paymaster general Dawn Primarolo said: “The measures announced today demonstrate the Government&#39s determin-ation to tackle tax avoidance and create a fair environment for all.”

The press release confirmed that the rate applicable to trusts (that is, broadly the rate at which discretionary trusts pay tax on income and all trusts pay tax on capital gains) will change. From April 6, 2004, it will rise from 34 per cent to 40 per cent. However, the Revenue is consulting on the future taxation of trusts (including those holding insurance bonds). The proposed timetable of consultation will end with legislation contained in the 2005 Finance Bill.

The following day, in a brief paper entitled, Modernising the Tax System for Trusts, the Revenue stated that they “would like to hear any ideas for modernising the tax system for trusts”. This paper sets out the areas they think need to be discussed and some possible answers.

On December 17, the Inland Revenue published four more discussion papers which contain more detail on their thinking. What areas do they seem to believe need modernisation?

The most significant ideas floated are that:

•All income and gains of trusts created for the benefit of the settlor or his immediate family might be treated as his income and gains.

•All income and gains of bare trusts might be treated as those of the beneficiary.

•All income and gains of other trusts might be treated as those of the trustees and where accumulated taxed at the rate applicable to trusts.

•Trusts might have a very small income tax basic rate band of £500 and only income above that level would be subject to higher rate tax.

•As an alternative to these ideas and very radically, the tax regime for all trusts should mirror that applied to life policies, that is, that all income and gains should be treated as those of the settlor.

A few technical areas are also mentioned as needing discussion, including the definitions of trusts and settlements and the residence rules for trustees.

For those of you with long memories, this looks very reminiscent of the 1991 Revenue consultation document on taxation of trusts which has since been gathering dust.

The overall feeling is that, if completed, these proposals appear (at this very early stage) to create a more level playing field between insurance bonds and mutual funds.

This is because currently trustees investing in mutual funds pay tax at 34 per cent but those investing in a bond pay tax at the marginal rate of the settlor, who may be a higherrate taxpayer.

However, this remains uncertain. There is a direct reference to life policies held by trustees. The papers state that: “There are special rules for taxing life insurance policies held on trusts. They will also be considered as part of the discussions on a modern tax system for trusts.”

There is no signal of the Government&#39s thoughts in this area and this is the main reason for the uncertainty. The ABI is asking for an early meeting with the Revenue to understand more clearly their thoughts on life insurance arrangements.

In summary, the financial services industry should give a cautious welcome to the Chancellor Gordon Brown&#39s acknowledgement that trusts have an important role to play in society.

However, it is important that the exercise does not become one which is more about raising by stealth the tax revenue received from trusts.

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