Modernising the tax system for trusts
Comments from ACCA
February 2004
Overview of proposals
Trusts and tax avoidance
We disagree with the presumption that tax avoidance and trusts are linked. Such an inaccurate starting point is counter productive and leads to the notion of change for changes sake
In general terms, while paragraph 4 states that the Government is not attracted to the idea of changing the legislation for the sake of change, the consultative document as a whole proposes radical change which would ultimately achieve little. Nor are the proposals likely to be held up as fair or simple in their effect. There is also no recognition that tax law and trust law do not at present coincide. We consider that they should so do and that this should have been the objective of any reform proposals.
Paragraph 5 says that the proposals will reduce compliance, but the reality is that much of the complication is caused by the introduction of the non-repayable Rate Applicable to Trusts (RAT) in relation to discretionary and accumulation trusts. This will now increase the problem with the increased rate of RAT to 40%. The other complication is the multiplicity of income rates now applicable to different sources of income generally.
Income tax
The intention, stated in Paragraph 11, to raise the RAT to 40% is excessive. It should be left at its current level, especially as the tax cannot always be recovered.
A basic rate band for trusts
We have already said that the multiplicity of tax rates in use in the tax system as a whole is a considerable complexity. A basic rate band which applied to the first slice of income liable to the RAT could reduce the number of Self-Assessment tax returns required and we would suggest that this might be set at half the individual basic rate limit. There should also be an exemption from the impact of the RAT where income flowed through to beneficiaries quickly; this would be welcome.
Different types of trusts
The proposal to re-categorise trusts seems not to lead to a situation which will be greatly different from the current position. We wonder to what extent such an exercise is really worthwhile as the distinctions already exist. We have made below some general comments.
Capital Gains Tax
The only issue with these paragraphs is the proposal that principle private residence relief ("PPR") would be due only if the settlor occupied a property owned by the trust as their only or main residence. This ignores the position of the dependant should the settlor cease to occupy the residence. Sections 225 and 226 relating to beneficiaries and to dependent relatives occupying before April 1988 should be retained.
Bare trusts
Income tax.
No change necessary.
Capital Gains Tax
Paragraph 22 states "PPR would be available only if the absolute beneficiary occupied a property owned by the trust and all other conditions were met." What would be the position where, as is frequently the case, the trust is a vehicle for holding the property for more than four beneficiaries?
General Trusts
Income Tax
Paragraph 25 raises the helpful suggestion that discretionary income payments made a short time after the year-end, say the end of April, could �flow through� to the beneficiary. This would be useful, but a longer period (say end of June) should be permitted to allow proper accounts to be made up, thus avoiding an over-distribution. This is the fundamental point we need to stress � but the Revenue point is that the beneficiaries may wish to file their Tax Returns quickly.
Paragraph 26 raises the problem of identifying the source of income where there is a mixed trust or a discretionary trust. It is suggested that where there is a fund in which an interest in possession exists, this fund be treated as the paragraph proposes; the contents of the fund are readily identifiable. Any discretionary income would then be taxed at the basic rate and, if accumulated at the additional rate, as previously.
Paragraph 32 deals with the proposal to codify trust management expenses. At present there is inconsistency between the different types of trust and further details of what is proposed would be welcome.
Capital Gains Tax
Paragraph 35 suggests that it would be a better approach to treat such gains as taxable in the year in which they arose. This would be more consistent with the treatment should the trustees be taxed on the gain, but may cause hardship if the beneficiary received assets other than cash.
Specialist Trusts
Trusts for minor orphaned children
Paragraphs 40 to 42 suggest that these trusts be treated as settlor-interested trusts, subject to an election being made by the trustees. Is this intended to apply only to orphans, or perhaps to children who have a surviving parent? The suggestion appears to be a good one as at present, Section 31 Trustee Act creates an Accumulation and Maintenance Trust under which accumulations (made for sound financial reasons) are taxed harshly.
Trusts for disabled people
Paragraph 45 suggests that the existing CGT or IHT definitions of disabled trusts seem a good place to start; it is considered that they are seriously defective.
Section 89 Inheritance Tax Act 1984 provides favourable Inheritance Tax treatment to trusts:
"(a) under which, during the life of a disabled person, no interest in possession in the settled property subsists, and which secure that not less than half of the settled property which is applied during his life is applied for his benefit."
A disabled person is defined for this person by subsection (4) as a person who, "when the property was transferred into settlement" was "(a) incapable, by reason of mental disorder within the meaning of the Mental Health Act of administering his property or managing his affairs, or in receipt of an attendance allowance under section 64 of the Social Security Contributions and Benefits Act 1992 or the Social Security Contributions and Benefits (Northern Ireland) Act 1992, or in receipt of a disability living allowance under section 71 of the Social Security Contributions and Benefits Act 1992 or the Social Security Contributions and Benefits (Northern Ireland) Act 1992 by virtue of entitlement to the care component at the highest or middle rate."
This ignores the situation of persons who are physically incapacitated by an accident, entitled to the care component of disability living allowance, but not in receipt of it, due to enforced residence in a National Health hospital. Any receipt of compensation cannot be settled on a disabled person�s trust under this legislation and will therefore affect their right to means tested benefits.
Marriage settlements
These are not included in the Discussion Paper but merit consideration. They have been less popular since the introduction of what is now Section 77 TCGA 1992, which charges them as settlor interested trusts. Many of them were set up many years ago, under Estate Duty legislation and the beneficiaries are elderly. The income is often small and the trustees supplement the income by making capital disposals. It should be possible to reinstate the trustees� annual exemption in cases where, for example, they are Estate Duty exempt trusts (having been charged on the death of the first spouse and exempt from IHT on the death of the second) and gains are necessary for the maintenance of the life tenant.
Estates in Administration
The proposal to align the taxation of estates in administration is to be viewed positively. It should be possible to review the treatment of the expenses, albeit they are subject to different considerations. There would be obvious difficulties where residuary beneficiaries had different tax profiles e.g. charities and taxable persons.
We look forward to participating in the next stage of the consultation process.