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Comments from ACCA
June 2005

ACCA is pleased to comment on the above paper. Our comments follow the same order as the discussion paper itself and the questions asked within each section.

INCOME STREAMING

Income streaming is to be welcomed in that it simplifies the identification of income attributed to the beneficiary. With the increasing internationalisation of both families and businesses, it also gives countries which may be unfamiliar with the concept of trusts the facility to make arrangements in their treaties to grant double tax relief to a beneficiary’s entitlement to the income in question.

If income is to be identified and attributed, it makes sense to include deemed income in the attributable income stream.

The pro rata method such as that used for ESC B18 would be as fair a method as any.

The rules for determining the order in which Trust Management Expenses are offset are complex, but if streaming is optional, the rules should be left alone to ensure consistency with trusts whose income is not streamed. We consider that alternative solutions to management expense attribution could be potentially complex and problematic.

The proposal to exempt income passed on to beneficiaries before 31 December following the end of the relevant fiscal year is sensible, in that it would simplify the system of collecting and attributing tax and obviate the necessity for repayment claims in respect of such income. The choice of 31 December is to be recommended as, not only is Christmas a popular time for distributions, it simplifies matters for beneficiaries in jurisdictions with a 31 December fiscal year.

Abolition of the tax pool

There are many non-tax reasons why a discretionary trust should be set up, such as uncertainty about needs, capabilities or future existence of beneficiaries or potential beneficiaries. For the same reasons, it may be necessary or desirable to accumulate the income for a number of years. It would be grossly unfair if the eventual distribution of the accumulated income were not to have the benefit of the tax pool. The trustees should therefore be able to elect to retain the tax pool instead of adopting the streaming proposals.

If the tax pool were to be abolished, five years would be a reasonable transitional period, but if ESC B18 provisions were to be adopted, six years would be better as it would be consistent with the six year cut-off in ESC B18.

DEFINITION OF A TRUST

The definition in Section 43 IHTA 1984 is tortuous, whereas the concise definition of settled property in section 68 TCGA 1992 is clear and obviates the necessity to distinguish between settlements and trusts. In practice, tax law makes little distinction.

RESIDENCE TEST FOR TRUSTS

The proposal for adopting the current income tax test for the residence of trusts will work if all the trustees of the trust are either UK resident or non-UK resident. However, once one imports the concept of Settlor’s residence, there are problems.

The income tax definition of settlor is as follows:

‘Settlor, in relation to a settlement, means any person by whom the settlement was made.

A person shall be deemed for the purposes of this Chapter to have made a settlement directly or indirectly, and, in particular, but without prejudice to the generality of the preceding words, if he has provided or undertaken to provide funds directly or indirectly for the purposes of the settlement, or has made with any person a reciprocal arrangement for that other person to make or enter into the settlement’. (S 660(G) ICTA 1988).

For Inheritance Tax purposes, this definition is reproduced in Section 44 IHTA 1984.

However, as far as Capital Gains Tax is concerned, the definitions of settlor contained in Schedule 5 paras 7 and 8 TCGA 1992 (for the purposes of Section 86) and that contained in Section 79 are similar:

‘a person is a settlor in relation to a settlement if the settled property consists of or includes property originating from him….

references to settled property (and to property comprised in a settlement), in relation to any settlor, are references only to property originating from that settlor,…’

Applying either definition, it is quite possible for there to be numerous settlors, some of whom do not even know that they are a settlor.

The problems caused by this uncertainty are obvious.

The fact that this proposal could fix the residence of a trust for all time is anomalous when the population including trustees and beneficiaries, are increasingly mobile. There appears to be no good reason for it.

The CGT definition of residence of a settlement, contained in Section 69 TCGA 1992, is simpler.

‘Carrying on a business which consists of or includes the management of trusts, and

Acting as trustee of a trust in the course of that business

Shall be treated in relation to that trust as not resident in the United Kingdom if the whole of the property consists of… property provided by a person not at that time… domiciled, resident or ordinarily resident in the United Kingdom,

And if in such a case the majority of them are… not resident in the UK, the general administration of the trust shall be treated as ordinarily carried on outside the UK’

This allows for the situation where the trust administration is carried on in the UK without penalising the non-domiciled settlor. It is a definition which has the advantage of simplicity, without the disadvantages of involving, possibly inadvertent, settlors.

The question posed is whether there is any evidence that the income tax test has deterred business from coming to the UK. It is difficult to evidence something that does not appear and therefore cannot be quantified, the relevant question would be whether abolition of the CGT test would do so.

SUB FUNDS

Definition
The proposal that separate trust funds administered by different groups of trustees be treated as separate trusts is to be welcomed. The sub fund could be defined as for trusts set up prior to 1965. That is where the sub fund had different investments and different beneficiaries to the other part of the trust.

Election
It would probably be simpler for an election to be irrevocable, but fairer if, dealing with different beneficiaries, it did not cover all trust funds.

Unused losses
Unused allowable losses could, where identifiable to the trust fund, attach to that fund. Otherwise, pro-rated to the market value of trust assets at the date of any election, or indeed, be the subject of the election.

Residence
If the trust were UK resident, but the sub-fund were not, it should be possible to allocate the unused losses as above. In the opposite case, there would probably be no identifiable losses.

If the definition above (different assets and different beneficiaries) were applied, it would be easy to identify such reliefs as taper and EIS deferral to the funds holding those investments. Suitable changes to the relevant provisions could be made to include trust splitting in the chargeable/non-chargeable events as appropriate.

As the trust fund and sub fund would be treated as separate entities, if one were to become non-resident, Sections 88 (Gains of dual resident settlements) and 89 (Migrant settlements) TCGA 1992 would apply to the deemed change of residence.

If there were to be merely UK resident funds, it would be equitable for there to be a hold-over relief on the allocation of the assets between the two funds.

Losses
The absence of any provision to postpone tax may well discourage trustees from making a sub-fund election. Much would depend upon the potential charge to tax and the non-tax (“commercial”) reasons for splitting the trust.

Other points

Finance Act 2005, Section 37 provides a new definition of ‘vulnerable beneficiary’ by including persons who have kidney dialysis, but has not extended it to paraplegics who are not eligible for the higher care component of disability allowance due to their enforced stay in a National Health Service hospital.

It also provides for a joint election by persons who may well not have the capacity to contract.

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