Tech talk
Trust Modernisation - TT13/06
Tech Talks TT04/05 and TT05/05 contained details of the Government's
consultation towards a modernised tax system for trusts. This
process resulted in two significant measures being introduced
in April 2005:
- A new tax regime for trusts for the most vulnerable
(backdated to 6 April 2004)
- A £500 basic rate band applying to the income
of discretionary or accumulation & maintenance trusts
(not interest in possession). Those trusts are chargeable
at the rate applicable to trusts (RAT) which is 32.5% on UK
dividends and 40% on other income and capital gains
Both measures were explored in detail in Tech Talk TT05/05.
In conjunction with these changes a further discussion paper
was issued on a number of other 'simplifying' proposals. In
light of this, draft legislation has now been published for
inclusion in the forthcoming Finance Bill 2006.
The following considers the more important changes.
Settlor Interested Trusts
Current Position
Anti-avoidance legislation treats settlement income as that
of the settlor if he has an 'interest' under it. An interest
arises where the settlor or his spouse are
potential beneficiaries. In addition, settlements are caught
where income is used to benefit an unmarried minor child of
the settlor. There is a de minimis
relief where the income does not exceed £100 per annum
per child which is available to each parent's settlement.
If the threshold is exceeded, the whole of the income is taxable
on the parent. With effect from 9 March 1999 bare trusts for
children are also within this regime.
Regarding capital gains tax, there are also anti-avoidance
rules to assess capital gains on the settlor and not on the
trustees. This applies where the settlor or his spouse are
potential beneficiaries.
Draft Legislation
It is proposed to extend the CGT definition of when the settlor
has an interest in a settlement with effect from 6th April
2006. It is proposed that the settlor will have an interest
where the trust fund "....is, or will or may become payable
to, or applicable for the benefit of a child of the settlor
at a time when the child is a dependent child of his."
In addition it is proposed that the legislation will apply
where "... a dependent child of the settlor enjoys a
benefit deriving directly or indirectly from any of the settled
property, or any 'derived' property."
A dependent child is a minor child who is neither married
nor in a civil partnership.
Implications
- Since 2003, capital gains arising on assets transferred
to settlor interested trusts cannot be held over. Therefore,
extending the definition will mean that hold over will be
denied where the settlement includes potential beneficiaries
which include dependent children, (e.g. on transfer of business
assets to Accumulation and Maintenance Trusts or transfers
to discretionary trusts where the settlor's dependent children
could benefit)
- Existing settlements which are not settlor interested
for CGT purposes may automatically become so from 6 April
2006. Remember however that trustees pay CGT at 40% and therefore
where a gain is assessed on the settlor then a lower rate
of tax may apply depending on his personal circumstances.
The settlor's available personal CGT exemption would apply,
rather than the trustees annual exemption
- Holdover relief will continue to be available on
gifts of business assets (e.g. shares in unquoted trading
companies) to a bare trust for a child
- Holdover relief will continue to be available on
gifts to trusts for adult children or minor grandchildren,
or to trusts where minor children can only benefit when they
are 18.
Common meaning of settlor
From the beginning of this process, the Government has been
keen to harmonise across the tax system the main definitions
which arise. For example, "settlor" is defined differently
for different tax purposes.
HMRC has therefore decided to base the definition of settlor
on CGT definitions (although confusingly the current income
tax definitions will still apply in some situations!)
The draft legislation states that there will be common rules
for identifying the settlor in relation to post death deeds
of variation occurring on or after 6th April 2006. This will
treat the deceased as the settlor in relation to a deed of
variation where the effect of the variation is to direct assets
which would otherwise have been in one settlement to a new
settlement.
For information, when a trust is created under a deed of
variation then for IHT purposes the deceased is treated as
the settlor, yet for income tax and CGT the person making
the deed of variation is the settlor. For avoidance of doubt,
this will continue to be the case under the current proposals.
The new rule mentioned above will only apply in the less common
situation where the funds affected by the variation are already
within a trust, for example where there is an existing life
interest trust under the will which is varied by the beneficiaries
of it.
Basic Rate Band of £500
The implication of the £500 basic rate band applying
to income of discretionary or accumulation trusts was covered
in detail in TT05/05.
Anti avoidance provisions are being introduced to stop a
settlor setting up two or more trusts to get the benefit of
multiple £500 basic rate bands. Therefore if one settlor
sets up more than five trusts then each will get just a basic
rate band of £100.
Other proposals
Currently, it is possible for a trust to be non resident
for CGT purposes but resident for income tax purposes. It
is therefore proposed that the residence test is harmonised
along the lines of the existing income tax rule. The commencement
date is 6 April 2007 regardless of whenever the trust was
created.
Conclusion
Further consideration is to be given on the issues surrounding
income streaming and the abolition of the tax pool. In addition,
work is also continuing on the taxation of personal representatives
of deceased estates.
Regarding this draft legislation however, it has been criticised
by the Chartered Institute of Taxation as being complex and
doing nothing to simplify the taxation of trusts. In addition
they advocate delaying the legislation until 6 April 2007.
Although the draft legislation is billed as modernising and
simplifying, in reality the measures are more concerned with
reducing tax planning opportunities than offering any significant
advantages for trustees.
Graeme Robb - March
2006