Much has been written over the last two or three years about the advantages that certain trustees of discretionary trusts or accumulation and maintenance trusts can enjoy by investing some of their capital in single-premium bonds.
The changes to the taxation of dividends in the hands of these trustees from the 1999/00 tax year has been the catalyst for this and has resulted in much activity in the investment world.
All the points previously discussed remain valid and there are still substantial amounts of single-premium bond business to be written in this market as far as financial advisers are concerned. What, however, is the position as far as trustees of interest in possession trusts are concerned?
The adverse change in the treatment of dividends did not affect them as, in the main, the trust is treated as a conduit and the tax treatment of dividend income relies on the tax position of the individual beneficiaries. There was, however, an adverse tax change for trustees of interest in possession trusts from 1998/99.
From April 6, 1998, such trustees became chargeable to capital gains tax at a rate of 34 per cent instead of the equivalent of the basic rate of income tax, which at that time was 23 per cent. This was an increase of approximately 48 per cent on the previous rate.
There is a further point to bear in mind as far as trustees of interest in possession trusts and CGT is concerned, which is that the maximum annual exemption is only £3,600 for 2000/01 – half the individual's annual exemption of £7,200.
This amount can be reduced if there has been more than one trust created by the same settlor since June 6, 1978. It is divided down by the number of trusts as follows:
One trust – £3,600.
Two trusts – £1,800 for each trust.
Three trusts – £1,200 for each trust.
Four trusts- £900 for each trust.
Five or more trusts- £720 for each trust.
Don't forget that a life policy effected in trust for inheritance tax purposes counts as one trust for these purposes.
So, trustees of interest in possession trusts who wish to have their equity portfolio managed are in somewhat of a quandary. With a high CGT rate and a low annual exemption, they are caught between a rock and a hard place.
What is the answer? This is where the undoubted benefits of authorised unit trusts or shares in open-ended investment companies score heavily. The reason is that the managers of these investments can deal in equities with no liability for CGT on either the unit trust or the company. There will also be no CGT liability on the trustees of interest in possession trusts when such dealing is undertaken.
This is possibly the ideal way to have an equity portfolio managed for such trustees while deferring the liability for any CGT which would otherwise arise. The obvious benefit of this is that the deferred CGT will be working for the benefit of the beneficiaries of the trust rather than being in the hands of the Inland Revenue.
Could there be an even more beneficial answer, bearing all this in mind? Consider a fund-of-funds unit trust. This is an investment vehicle that can deal in other unit trusts and Oeics without any CGT being paid at that time in the same way as outlined above. Using such a vehicle can give a very wide spread of investments across many sectors but result in large-scale CGT deferral if required.
Of course, whatever annual exemption is enjoyed by the trustees of an interest in possession trust can still be used each year if required, by actually realising units in a unit trust or shares in Oeics. Bear in mind that old-style bed-and-breakfasting is no longer with us and the impact of the last-in, first-out rule. The effects of CGT taper relief on these investments also has to be borne in mind.