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Settlor of the land

Continuing on the subject of the underlying investments of trust-based IHT planning solutions

Tax Planning
Tony Wickenden

Last week, I started to look at the potential appropriateness of collective investments as well as insurance products as the underlying investments for trust-based inheritance tax planning solutions.

Despite the undoubted merits of investment bonds as trustee investments, the introduction of the single 18 per cent CGT rate both for individuals and trustees has caused increasing numbers (advisers, platforms and fund managers alike) to consider the appropriateness of collectives as investments to underpin some of the (now) standard IHT planning trusts. And with this comes the need to be more informed about income tax and capital gains tax on trustee investments.

As well as the fundamental rules on the taxation of income and gains arising to trustees, it is also necessary to consider the anti-avoidance provisions that can apply where the settlor or others connected with the settlor can benefit under the trust. The basic intent of such legislation is to assess the income or gains under an “affected” trust on the settlor. The introduction of a “universal” CGT rate of 18 per cent has caused the “settlor-interested” anti-avoidance legislation in connection with trust capital gains to be swept away. Anti-avoidance (settlor-assessing) legislation does still exist, although, in respect of trust income. This legislation will apply where either the settlor or settlor’s spouse can benefit under the trust. It is important to consider this when determining the most tax- appropriate investment.

Interestingly, these anti-avoidance provisions may operate to reduce the rate of tax payable on trust income from April 6, 2010. From that date, the rate of tax on trust income (outside of the standard-rate band) increases to 50 per cent for non-dividend income and 42.5 per cent for dividend income.

However, if the anti-avoidance provisions apply, then the income will be assessed on the settlor and that person’s highest tax rate may well be less than that.

According to the Government, only 3 per cent of taxpayers in the UK have income that exceeds £150,000, the level above which the 50 per cent rate is payable by individuals. Interesting.

In light of the increasing willingness to consider non-insurance-based investments as being suitable as trustee investments, I would like to consider the tax rules in relation to trust income under trusts where, first, the settlor’s spouse is excluded from all benefit and then trusts where they are not.

In each case, it will be assumed that the settlor is excluded to achieve IHT effectiveness. It is appreciated that special rules apply under loan trusts where, while the loan is outstanding, the trust will be treated as “settlor-interested” regardless of the inclusion of the spouse in the beneficial class.

Under discretionary trusts under which the settlor’s spouse is excluded from all benefit, as no one is entitled to income under such a trust, the trustees themselves are taxed on any income arising from the funds at their own rates.

First, there is a special “standard rate” which applies to income received by the trustees up to £1,000 (gross) in a tax year. If income is received with a tax credit (20 per cent on interest or 10 per cent on dividends), the trustees will have no further tax liabilities if total grossed-up income falls within this band. This provision was specifically introduced in 2005 to simplify the tax treatment of relatively small trusts.

If the settlor has created more than one trust (but ignoring bare trusts), the standard-rate band will be divided among them equally but will not be less than £200 for each trust.

On income in excess of £1,000, the trustees are taxed at a special rate, which is 40 per cent (going up to 50 per cent from April 6, 2010) for non-dividend income and 32.5 per cent (going up to 42.5 per cent from 6 April 2010) for dividend income.

The trustees are entitled to any tax credit (for example, 20 per cent for interest and 10 per cent for dividends) at this stage. If the trustees decide to distribute income to a beneficiary they must have first paid 40 per cent (50 per cent from April 6, 2010) income tax on that distribution. However, the 10 per cent dividend tax credit will not be available if they decide to distribute the actual income they have received to the beneficiaries, and so additional tax would have to be paid on that distribution (the tax credit on interest can be passed on to a beneficiary receiving any distributed income).

The beneficiary will be taxed on any income received from the trust, grossed up to take account of any tax credit in respect of tax paid by the trustees. Where appropriate, the beneficiary can make a tax reclaim.

If the beneficiaries under the trust include minor children of the settlor who are unmarried and not in a civil partnership, and any income from the shares or units held in trust is actually paid to such a child or for his or her benefit, it will all be assessed to tax on the settlor if this income, and income from all other gifts the settlor has made to or for the benefit of that child, exceeds £100 gross in a tax year. The £100 annual gross limit is per settlor, per child, per tax year.


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