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For financial advisers, trust business represents an excellent way of creating or expanding relationships with other professional advisers. Your entry ticket is understanding the fundamentals of how trusts are taxed and the legal position regarding trustee investments. The Trustee Act 2000 is the starting point for learning the legal aspects of trustee investments in England and Wales. Broadly speaking, all trusts can invest with no constraints, subject to the trustees meeting their fiduciary responsibilities to all beneficiaries and taking due care over investments so that they are properly diversified and managed in line with modern portfolio theory. There is also a need to seek advice on investments unless the trustees believe it is inappropriate to do so. More on this later. In his 2004 Budget, the Chancellor announced that the tax rate on trusts (Rat) would be raised to 40 per cent from April 6, 2004. This applies to income and capital gains. Dividend income is taxed at 32.5 per cent on the grossed-up dividend, with the trustees having a 10 per cent tax credit. He also announced that there would be new measures to prevent this change increasing burdens on certain trusts that have vulnerable beneficiaries. Two measures were confirmed in this year’s Budget – a new tax regime for certain trusts with vulnerable beneficiaries and a standard-rate band of 500 for all trusts paying tax at the Rat. A number of other proposals were put forward in the 2004 Budget and Inland Revenue consultation document issued in August 2004. These included a set of common definitions and tests for trusts and the streaming of income through trusts. These measures would simplify taxation and were widely supported during consultation last year. But respondents subsequently raised a number of concerns about some detailed aspects of the proposals. A sum- mary of findings was published alongside the Budget 2005. The Revenue will carry out development work on these measures and a further discussion paper was published on Budget day. It is intended that draft legislation will be published for consultation later this year, prior to the measures being included in next year’s Finance Bill. It is important for advisers to understand the latest position to establish themselves as serious in this market. How will the standard-rate band of 500 work? It is available for all trusts liable at the Rat. Legislation giving effect to this change is in the Finance Act 2005 and the effective date is April 6, 2005. The term “standard” is used rather than “basic” as there are a number of different rates involved, depending on the type of income under consideration – for example, 20 per cent for savings income (usually received net of this rate anyway), the basic rate for rent (received gross) and with the 10 per cent tax credit on dividends being sufficient to cover the basic/standard-rate liability. Income will need to be grossed up to determine whether it falls within the standard rate band. As for most basic-rate taxpaying individuals, tax will usually be taken care of at source. This means that trusts which receive all their income up to the standard-rate band either net of tax or with an associated tax credit have no further tax to pay. Those which receive income gross will have to pay tax at the appropriate rate, depending on the nature of the income. The 2005 Budget press release made no reference to anti-fragmentation rules to prevent settlors establishing a number of trusts to benefit from the standard-rate tax band. However, the Regulatory Impact Assessment for Modernising the Tax System for Trusts, also issued on Budget day, includes the comment: “There is a danger of people seeking to exploit the standard-rate band by setting up several small trusts instead of one larger entity but the savings from doing so are likely to be outweighed by additional administrative costs.” The new tax regime for trusts for the most vulnerable allows these trusts to be taxed on the basis of the vulnerable beneficiary’s individual circumstances for both income tax and CGT. Trustees can use the individual beneficiary’s personal allowances, starting and basic-rate bands, rather than being taxed at the rate applicable to trusts. This measure is in the Finance Act 2005 and the regime is backdated to April 6, 2004. The introduction of the standard-rate band is meant to take around 30,000 of the smallest trusts out of the full self-assessment system. This is very welcome although the 500 limit is considered by many to be too small. However, it should serve to encourage the creation of smaller trusts, where the reporting requirements and additional tax in the case of discretionary trusts and accumulation and maintenance trusts may have been an obstacle to planning.