The income and capital gains tax changes relating to trusts proposed in the Pre-Budget report have been included in the Finance Bill 2004 and are effective from April 6.
For interest in possession trusts, the income tax position is unaffected by the proposals.
Discretionary trusts and accumulation and maintenance trusts, however, have the power to accumulate income and thus pay tax at the “rate applicable to trusts” (RAT) which will increase from 25 per cent to 32.5 per cent in the case of dividend income and from 34 per cent to 40 per cent for all other income. This is bad news for those trusts accumulating income as there will be a reduction of over 9 per cent in actual income accumulated.
Where income is paid out to beneficiaries, this change should be tax-neutral for them as they will simply be able to reclaim a bigger amount of tax if appropriate. Higher-rate taxpayers will have no further tax to pay. The increases will, however, improve the Inland Revenue's cashflow as they will get tax at 40 per cent or 32.5 per cent when the income accrues to the trustees and need only refund lower-taxpaying beneficiaries when that income is subsequently paid out and a claim is made.
From a CGT perspective, the rate applicable to all trustees will increase from 34 per cent to 40 per cent from April 6. There is no prospect of a beneficiary reclaiming any CGT paid by the trustees and so this represents a straightforward tax increase of almost 18 per cent. A separate tax regime applies to chargeable gains under single-premium bonds and this is relevant to all three types of trust outlined above.
Trustees are assessed to tax on chargeable gains if the creator (settlor) of the trust:
Is dead and a chargeable gain arises in a tax year subsequent to his death or Is non-UK resident when a chargeable gain arises.
In these circumstances, the trustees are chargeable at the RAT. From April 6, the tax charge will increase to 40 per cent on the “gross” chargeable gain for offshore bonds and to 20 per cent on the “net” chargeable gain for UK bonds.
It should be noted that up until April 6, trustees of UK bonds had a liability to tax at 12 per cent (that is, 34 per cent less 22 per cent tax deemed to be paid within the life funds).
The rate of UK life fund tax on income and capital gains was reduced to 20 per cent from April 1, 2003 by the Finance Act 2003 and from April 6, the tax credit on chargeable gains on UK bonds reduced from 22 per cent to 20 per cent.
It is difficult to make a direct comparison but where dividend income is received by a bond (due to charges, timing, etc.) with a chargeable gain then being triggered by the trustees (taxable at a rate of 20 per cent for a UK bond held by trustees) compared with dividend income being received directly by trustees (which is accumulated and then distributed by the trustees), the position from April 6 of £1,000.00 with a tax credit of £111.11 will be broadly as follows in the table below.
Any type of trust realising capital gains will be adversely affected by the 40 per cent CGT charge.
Trusts which accumulate income will be penalised by having to pay extra tax. If the trust income is paid out to a beneficiary, it may be possible for some or all of the tax deducted to be recovered by the beneficiary but there will be a cashflow advantage for the Inland Revenue.
For bonds where the tax charge will fall on trustees, the increase is not good news either but it may be possible to avoid this problem by assigning the bonds free of trust prior to “triggering” the chargeable events.