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Taken on trust

According to HM Revenue & Customs, around 198,000 trusts filed self-assessment returns in 2006/07. The assets held in trusts are substantial, with 5,500 reporting income in excess of 100,000.

Trustees can access a wide range of investments, from some (but not all) National Savings & Investments products at one end of the risk spectrum to hedge funds at the other. Which product or combination of products is used depends on the specific requirements of each trust but trustees do have specific legal requirements they must meet.

First, trustees must invest the fund. According to Stone v Stone (1869) 5 Ch App 74, assets must be acquired (or retained) to produce a return.

Next, trustees need to consider diversifying the trust investments but have no absolute duty to do so.

According to Learoyd v Whiteley (1886) 33 ChD 347: “The duty of the trustee is not to take such care only as a prudent man would take if he had only himself to consider, the duty is rather to take such care as an ordinary prudent man would take if he were minded to make an investment for the benefit of other people for whom he felt morally bound to provide.”

This was expanded a year later to: “Businessmen of ordinary prudence may, and frequently do, select investments which are more or less of a speculative character but it is the duty of a trustee to confine himself to the class of invest-ments which are permitted by the trust and likewise to avoid all investments of that class which are attended by hazard.”

So trustees must clearly avoid risk. But what should their investment objectives be?

The duty of the trustees is to act in the interests of current and future beneficiaries.

Cowan v Scargill (1984 3WLR 501) says: “In the case of a power of investment, as in the present case, the power must be exercised so as to yield the best return for the benef-iciaries, judged in relation to the risks of the investments in question; and the prospects of yield of income and capital appreciation both have to be considered in judging the return from the investment.”

In a later case, the court held that investment involved “seek ing to obtain maximum return by way of income or capital growth which is consistent with commercial prudence.”

Should trustees consider the use of a life insurance bond as an investment? The key features of bonds (in the context of suitability as a trustee investment) are:

  • They do not produce income.

  • The assets underpinning their value may be changed without triggering a disposal for CGT purposes.

  • They are automatically diversified and the degree of diversification can be increased by use of funds links.

  • They can be assigned without triggering a capital gains tax disposal, andl In the case of an offshore bond, the linked fund does not suffer any UK or domestic tax (except for small amounts of irrecoverable withholding tax). This increases the potential investment return – the “gross roll-up” effect.

    Where trustees are obliged under the terms to produce income, a bond would not be a suitable as it does not generate income. But for other trusts they can be advantageous.

    As bonds do not produce income, their use as a trustee investment obviates the need for a self-assessment return. Trust accounting and invest-ment record-keeping is also simplified. This reduces the administrative costs of running the trust. The trustees are under a duty (see Cowan v Scargill) to maximise the return on the investment. The return is the return after tax and expenses and not simply the after-tax return.

    That bonds can be assigned without a tax charge means trustees can fulfil distribut-ative functions in a tax-effic-iently. In effect, tax responsibility is passed to the recipient beneficiary, thus minimising admin costs and ensuring an even-handedness of treatment.

    The trust rate of income tax will rise to 45 per cent and the trust dividend rate to 37.5 per cent from April 6, 2011, enhan- cing the benefits to trustees from investments where the tax charge is deferred or even eliminated. The life insurance bond could be the investment of choice for most trustees.

    Gerry Brown is tax & trusts manager at Prudential

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