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The main thrust on trusts

Over the last couple of weeks, I have considered the impact of the potential change to the taxation of capital gains made on investments (other than insurance-based investments) held in bare trusts created by parents for the benefit of their minor unmarried children or designated for them.

This is part of a wider set of possible changes to the income tax and capital gains tax treatment of trusts contained in the consultation process on this subject. There appears to have been very little discussion in the financial services sector of the consultation on trusts, probably because:

•The gaze of the tax planner has been averted by the pre-owned assets provisions and •The tax changes have little impact on trusts made up of life policies.

Just in case you are interested, what follows is a summary of the main proposals in the consultation. These points emerge from part seven of the latest consultation document.


A number of definitions are to be harmonised. In particular, there will be common definitions of trusts and settlor-interested trusts for income tax and CGT purposes. There will also be a common residence test for all trusts based on the current income tax test.

For income tax and CGT purposes, all trusts will be divided into three categories, which are settlor-interested, bare and general trusts.

Settlor-interested trusts

Trust income, including deemed income, will be treated as the income of the settlor if the settlor and/or his spouse can benefit under the trust. Income will retain its character, for example, dividend income received by the trustees will be treated as dividend income arising to the settlor and so on.

Some aspects of the proposals remain to be clarified and no doubt there will be some objections presented to the Inland Revenue in respect of some proposals. For example, the document refers to the proposal that trustees would pay tax at 40 per cent (32.5 per cent for dividends) on all trust income. If the tax paid by the trustees exceeds the settlor&#39s liability, he or she would reclaim any tax not due through self-assessment. This compares unfavourably with the current position where trustees have a liability for no more than basic-rate tax and higher-rate tax-paying settlors pay additional tax.

Given that the stated objective of the Revenue is to simplify the system, it seems unusual that it would introduce a rule based on duplication of assessment rather than simplification. Doubtless there will be representations made during the consultation process.

Payments of income out of the trust to beneficiaries other than the settlor would be treated as payments by the settlor to those beneficiaries. This is the practice currently followed by the Revenue although not presently covered in legislation.

For CGT, although gains will be assessable on the settlor, trust losses will not be capable of being set against personal gains. Further, putting assets into a settlor-interested trust will be treated as a disposal/acquisition, as it is now.

Bare trusts

No changes are proposed for the bare trust regime, save for the proposal that bare trusts for minor unmarried children of the settlor will be treated in the same way for CGT as for income tax purposes.

General trusts

Trusts which are not settlor-interested or bare will be general trusts and would include discretionary trusts, accumulation and maintenance trusts and interest in possession trusts. The tax treatment of interest in possession trusts would continue as it is now.

For A&M and discretionary trusts, a £500 basic-rate tax band will apply from April 6, 2005. It is proposed that this band will apply after deduction of streamed income, that is, income paid out to a beneficiary before December 31 following the end of the tax year in which the income arose to the trustees.

There is no change proposed for the CGT treatment of these trusts.

Trusts for the vulnerable

These are trusts set up for the disabled and for minor children on the death of a parent. Subject to the satisfaction of certain conditions, income and capital gains can be taxed on the basis of the vulnerable beneficiary&#39s circumstances, that is, as a bare trust.


Employee share option trusts will continue to benefit from preferential treatment and the Revenue confirms it will seek to ensure that, for tax purposes, trusts are treated the same in all parts of the UK, as at present.

Deceased estates

Changes are proposed to apply the lower rate of tax (20 per cent) on any capital gains realised by personal representatives up to a capped limit.

Anti-avoidance provisions

It is intended that the current anti-avoidance provisions will be retained. The Revenue states that it recognises that the new system will need new provisions to stop new tax avoidance techniques.

From this summary, four important points stand out:

•The proposed anti-avoidance provisions in respect of capital gains made by trustees of bare trusts for minors.

•The proposed new common definition of a trust.

•The proposed new definition of settlor-interested trusts.

•The proposed new common trust residence definition.

I will look at these in more detail next week.


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