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Tinkering with trusts

Still on the subject of the pre-Budget report, I turn this week to the proposals for reforming the taxation of trusts.

Like it or not, trusts are an important part of the financial planning toolkit. Like financial products, they are an important means to an end – the end being the improvement of the client&#39s financial well-being. The determinant of whether trusts should be employed in planning must be the degree of utility they deliver.

In most cases where a trust is used in connection with a financial product, there are two common factors. First, the product used is an insurance product. Second, the reason for using the trust is a desire to avoid, minimise or provide for inheritance tax.

In addition, especially in connection with ordinary life insurance plans, the existence of a trust to surround the product will mean that there will be no need to wait for a grant of representation before the policy proceeds are paid. Proof of death and policy ownership, delivered by the trustees, is all that is necessary.

The proposals for trust reform give a timely reminder of one of the reasons why life companies have largely cornered the retail market in this area – simplicity.

Life policies do not produce taxable income or capital gains, with all tax being deferred until a chargeable event occurs. Without taxable income and gains arising on a year-by-year basis, there is no tax work to do and the asset subject to trust (the life policy) is easy to manage.

The advantage of using protection plans to provide for, say, inheritance tax is that no other product can deliver the financial leverage (the sum assured in relation to the premium) that enables the right amount to be paid at the right time. The addition of the trust to the product – provided you use the right trust – also ensures that the sum assured is paid into the right hands, usually tax-free.

So let us return to the proposals for trust reform. Not many of you will have read these proposals in detail andsome of you may not even be aware that they exist. With everything else going on in your marketplace – pension simplification, depolarisation and with-profits, to name but a few – it is hardly surprising.

While these proposals for change to trust taxation are important, it is also essential that you appreciate that they are only in respect of income tax and capital gains, not inheritance tax. For those of you whose use of trusts extends no further than life pol-icies, you probably (stress, probably) have very little to worry about. There may even be some opportunities for life insurance – wrapped investments for existing trusts – but we will look at that later.

The only income tax implications for life policies held in trust is in connection with chargeable events. Relatively recent changes to the chargeable event rules, where policies are held in trust, have been implemented. Compared with the rules on the taxation of ordinary income and capital gains made on trust investments, they look pretty harsh.

Broadly speaking, ordinary trust income and capital gains under UK trusts will be assessed on the settlor if the settlor or the settlor&#39s spouse can benefit under the trust. Harsher rules apply in respect of capital gains made under offshore trusts under which the settlor, the settlor&#39s spouse or the settlor&#39s children or grandchildren can benefit. In these circumstances, all gains will be assessed on the settlor.

As I have said, in most cases, those connected with life policy trusts do not have to consider these provisions as the policy produces no true income and only qualifying pol-icies caught by section 210 TCGA 1992 (largely, traded endowments) can be subject to capital gains tax. For non-qualifying policies caught by section 210 TCGA 1992, the income tax charge takes precedence over the capital gains tax charge.

However, the chargeable event provisions in section 547 ICTA 1988 provide that all chargeable event gains made under life policies held in trust will be assessed on the settlor provided he or she is alive and UK resident. This is regardless of whether the settlor, the settlor&#39s spouse, children or grandchildren can benefit under the trust.

There is one exception to this rule, which is that any chargeable event gain under a bare trust will be assessed to tax on the beneficiary if he or she has attained age 18.

The new proposals for the taxation of trusts introduce the possibility of a wider definition of a settlor-interested trust (I will look at this next week) but it cannot be wider than that in respect of life policies in trust, where every trust with a live UK-resident settlor is settlor-interested, regardless of who the beneficiaries are.


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