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Suits you, settlor

This week, I will continue my deliberations on the proposals for the reform of the taxation of trusts. During Technical Connection&#39s many years in business, we have made trusts something of a speciality. If we were to open a retail store, the name Trusts-R-Us springs to mind, subject to ensuring that we were not exposed to any legal action for “passing off”.

But, seriously, we at Technical Connection believe that we have some authority for concluding that too many people in financial services see trusts as difficult, confusing or unnecessary. Not surprisingly, there is a less than complete understanding of trusts which undoubtedly leads to incomplete advice being given in some circumstances.

This is not to say that trusts should be used in every or even most cases involving financial services products. Having said that, they probably should be used in connection with ordinary protection plans for, say, the benefit of the family and definitely in the case of protection plans to provide funds to meet inheritance tax on the death of, say, the second of a married couple to die.

The benefits delivered by both these types of trust, being founded on a non-incomeor non-capital-gains-producing asset (a life policy) and providing IHT effectiveness, should not be affected adversely by the implementation of any of the proposals for trust reform.

But when it comes to investment plans which are held in trust but are not based on life insurance, the proposals for reform will be relevant, particularly where collective investments are concerned.

Before looking at the changes, it is worth reminding ourselves of the decision-making process that leads us to determine whether a trust is appropriate in any particular set of circumstances and, if so, what sort of trust. We can then get some feel for the proportion of investors who would be affected by the proposals for reform.

After all, those clients for whom a trust is not suitable or those whose trusts do not produce income or capital gains – who represent quite a large proportion of clients – will find the proposals irrelevant.

I think it is really important to ascertain generic suitability of a trust quite early on in the advice process. In the context of an investment, it is important to ask the very simple question: “Do you require to retain unconstrained (complete) access to your investment, including all the income and capital gains that it produces?” If the answer is yes, then a trust that operates during the client&#39s lifetime (inter vivos for the Latin scholars among you) and is to be effective to remove the asset from their estate for IHT purposes will not be appropriate.

If the investor does not need total access as described above, some of the insurance-based schemes available may be suitable. Determining this lends itself to a flow-chart approach and it will be so much the better if this process can be completed online.

Such a process is a classic example of securing scale based on know-how and understanding. After all, the questions that one asks to determine what type of trust is likely to be most suitable will be the same regardless of the investor. There will be a number of tracks down which you can go depending on the answers given to a systematic flow of questions.

For example, if the answers reveal that the investor needs access to the investment, wants to minimise IHT, is happy to receive a flow of regular payments but does not need to be able to dip indiscriminately into the capital, a discounted gift trust may be suitable. For those who are happy to gift but would like to access the capital originally gifted but not the growth, a loan trust may suit. You get the picture.

For any of these trusts, the proposals for reform are unlikely to be relevant as they are founded on insurance policies and their main aim is to minimise IHT. It is where a trust is not IHT-focused and life-policy-based that the proposals for reform are likely to be more relevant, not in respect of the IHT benefits but in respect of the trust income and capital gains.

Perhaps the most obvious arrangement fitting this bill is a trust of a collective investment. There are fewer packages available from providers of collectives than life policy providers. Why? A combination of factors, I suspect. It is not usual, it is seen as outside core functions and most fund management groups seem to focus less on needs-based packages. Life policies are easier to manage inside a trust. That is not to say that no collective provider offers draft trusts to wrap its products – some do – it is just that fewer do than do not.

It is these combinations that could be affected by the reforms. As I said last week, they definitely will be affected by the increase in the tax rate on trust income and gains to 40 per cent. The rate on trust dividends will move up from 25 per cent to 32.5 per cent, as for higher-rate taxpayers, and not 40 per cent.


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