The Trustee Act 2000 (England and Wales) and similar legislation for Northern Ireland and Scotland widened the investment options for nearly all trusts. But it also puts more responsibilities on the trustees to: seek appropriate advice from suitably qualified individuals, to review the investments on a regular basis, and to ensure suitability of trust investments and consider the need for diversification.

Trustees and their financial advisers need to understand the tax consequences of investments held within the trust, and the options available to try and reduce the tax burden. The introduction of a flat rate of capital gains tax of 18% and a top rate of income tax of 50% has refocused this need.

This section addresses income tax, capital gains tax and inheritance tax for the trustees and where applicable, the beneficiaries and settlor(s).

Special tax rules apply to investment bonds. The main circumstances which create a tax liability are when:

• the investment bond (or individual policies within it) is fully encashed
• assignment of all or part of the investment bond for consideration
• if withdrawals in a policy year exceed either: 5% of the single premium (5% allowance), the available cumulative allowance, or the total amount invested
• the investment bond comes to an end because the last of the lives assured dies.

Under the chargeable event regime, gains made by investment bonds are charged to income tax, not capital gains. Therefore any gain will be assessed alongside other income. For age-related allowances and the loss of personal allowance for those with incomes over £100,000, the sum of any chargeable gains is added to their income, not the relevant slice.

For UK bonds, life fund taxation applies which cannot be reclaimed by the settlor, trustees or the beneficiaries. It does, however, provide a ‘tax credit’ equivalent to 20%.

Absolute or Bare

HMRC’s view is that gains are assessed on the beneficiary of the trust, even where the beneficiary is a minor, and tax is due at the highest rate. However, where the trust was created by a parent of the minor beneficiary, under the potential settlement rules the chargeable gain will be assessed on the parent whilst the beneficiary is an unmarried minor.

Capital gains tax does not generally apply to investment bonds held inside Absolute or Bare, Interest in Possession and Discretionary trusts.

Absolute or Bare

Gift into trust would be a Potentially Exempt Transfer (PET) to the extent that it is not exempt. Value of trust assets would be part of beneficiaries’ estate.

Where the trustees assign the investment bond, in part or all, to a beneficiary (who must be over 18), under current legislation the assignment is not a chargeable event; any future chargeable event gain will be assessed on the beneficiary at their own tax rates. Given the significant increase in trust taxation, trustees may wish to consider this route if capital is to be distributed to a beneficiary from the trust. This is because the beneficiary’s highest rate of income tax may well be lower than the rate that would be suffered should the gain arise within the trust, or by the settlor as applicable.

With trusts now being liable to income tax rates of up to 50%, financial advisers should make sure that the trust holds its investments in the most tax efficient manner. Understanding the beneficiaries’ need for income, rights to capital and the investment objectives of the trustees will enable financial advisers to minimise tax and maximise planning and investment opportunities.