In August 2004, the UK Inland Revenue published its most recent consultation document relating to the proposals to modernise the tax system ...
In August 2004, the UK Inland Revenue published its most recent
consultation document relating to the proposals to modernise the
tax system for trusts. While this document elaborates on the main
UK Government proposals, many details remain to be discussed.
Background In 2003, the Government first announced its
intention to introduce a new tax regime for trusts. The overall
aim of the Government is to achieve a system of taxation of
trusts that it is fair, clear and easy to operate and supports
the competitiveness of the UK economy. At the same time, however,
the proposed reforms are aimed at discouraging people from using
trusts to avoid tax. In summary, the Government wants to
introduce a tax regime “…that does not provide artificial
incentives to set up a trust but, equally, avoids artificial
obstacles to using trusts where they would bring significant
non-tax benefits.” At the 2004 Budget, the Government
announced that, amongst other proposals, the following two
changes will take effect on 6 April 2005:
- A £500 basic rate band applying to the income of all trusts
otherwise chargeable at the rate applicable to trusts will be
introduced; and
- A harmonised trust definition and tests for income tax and
capital gains tax purposes will be introduced.
Basic Rate Band The new basic rate band will apply to
the first £500 of income of all trusts liable at the rate of tax
applicable to trusts. Bearing in mind that the rate of tax
applicable to trusts was raised from 34 per cent to 40 per cent on
6 April 2004, this is a real concession for smaller trusts. The
Government estimates that around one third of all trusts have a
total annual income falling below the basic rate band. These trusts
will no longer be liable to pay tax. The reasoning behind the
introduction of this measure is that tax deductions at source (in
the case of bank and building society interest) or the notional tax
credit (in the case of dividend income) would satisfy the tax
liability of the trustees up to the £500 threshold in any case. Any
trust income in excess of the £500 threshold would, prima facie, be
assessable against the trustees at the rate of 40 per cent.
However, it is also proposed that the basic rate band should be
applied to trust income only after all streamed income and
allowable trust management expenses have been deducted.
Accordingly, it is possible that a trust with an annual income in
excess of the basic rate band still falls entirely within the basic
rate band after the appropriate deductions have been made. For the
sake of completeness, trust income will qualify as streamed income
if it is paid out to the beneficiaries by 31 December following the
end of the tax year in which that income arose to the trustees.
Also, while streamed income would be exempted from the rate of tax
applicable to trusts, the trustees would still have pay tax in
respect of this income at the basic, lower or dividend rates of
tax. In addition to the basic rate band, it has also been proposed
that trusts consistently achieving an annual income of less than
£500 should benefit from a reduced compliance burden. At present,
the proposals would require the trustees of such a settlement to
issue self-assessment tax returns once every five years. However,
trustees will remain under an obligation to notify the Revenue of
any tax liability they incur.
Harmonised Definition of
"Trust" There is broad agreement that the common definition of
a "trust" for income and capital gains tax purposes should be based
upon the definition of "settlement" used for inheritance tax
purposes. The scope of this definition will, however, remain
subject to the existing anti-avoidance definitions contained in
current income tax and capital gains tax legislation, such as
section 660G of ICTA 1988, for example. Further, the new definition
of "trust" for income and capital gains tax purposes will adopt the
concept of a single and continuing body of trustees, as opposed to
the inheritance tax concept of a trustee from time to time.
Finally, the Revenue’s consultation paper allays fears the new
definition of "trusts" will include bare trusts. It categorically
states that the new harmonised definition of "trusts" will ensure
that:
“… the trustees of genuine bare trusts will not be subject
to income tax or CGT, except in those rare circumstances […] where
it is more convenient for both the trustees and the beneficiaries
for the former to opt into the Self Assessment regime.” More
detail on the circumstances in which bare trustees might be liable
to tax can be found in the Inland Revenue’s Tax Bulletin 32.
Harmonising the TestsM Settlor-interested trusts
There is, as yet, no consensus on a definition of
"settlor-interested trust", although the proposal that all trusts
with a living settler should fall within the definition, has been
rejected. The Revenue continues to consult on how best the tests
for "settlor-interested trusts" contained in current income and
capital gains tax legislation could be harmonised. An important
qualification to the new definition of "settlor interested trusts"
is that this would only apply to UK resident trusts. Offshore
trusts would remain subject to the extended tests currently being
used. The "minor children test" under current income tax
legislation will be extended to the capital gains tax legislation.
A trust would cease to be settlor-interested when the child reaches
the age of eighteen.
Residence test The Revenue has
announced the alignment of the definitions of "UK residence" of a
trust under the income and capital gains tax regimes. The current
proposal is for the income tax test to be used as the common test,
as it is felt that this would introduce simplicity and clarity.
Hereby, where all trustees are non-UK resident, the trust would be
an offshore settlement, whereas where all trustees are UK resident,
the trust is UK resident. Where there is a mixture of UK resident
and non-UK resident trustees, the trust would be UK resident if the
settlor was UK resident or UK domiciled at the time the trust came
into existence. Needless to say, there is some resistance to using
this as the common test for residence. There will be a 12-month
transitional period, during which non-UK resident trustees for CGT
purposes will retain their existing residence status before the
harmonised single test is applied to them. This will allow them to
reassess whether or not they should retain their non-UK resident
status and make the necessary arrangements.
Comment The
changes that are due to come into effect on 6 April 2005 are
potentially far-reaching.The consultation process should be
monitored closely to keep track of the final proposals, as these
develop.
