Trusts - New Vulnerable Beneficiaries´ Legislation

The Finance Act 2005 has introduced a new regime for certain trusts with vulnerable beneficiaries, which takes effect from 6 April 2004 (or the date on which the Settlement first qualifies under the legislation if later). The legislation introduces special tax treatment for these trusts.

There are two types of vulnerable person who can benefit from the special tax treatment:

• Someone who is either mentally or physically disabled; or

• A child below the age of 18 who has lost a parent through death - referred to as a ‘relevant minor’ (only one parent needs to have died).

The broad aim of the special tax treatment is to ensure that the amount of tax charged on income and gains arising to the trustees is not more than it would have been had the income and gains arisen directly to the vulnerable beneficiary.

There must be a ‘qualifying trust’.

A ‘qualifying trust’ is one where property is held on trust for the benefit of a disabled person and the terms of the trust provide for the property to only be applied for the benefit of that person during their lifetime and either that person is entitled to all the income arising from the property or if not so entitled, none of the income can be applied for the benefit of anyone else.

A ‘qualifying trust’ is one where property is held on trust for the benefit of the relevant minor and:

• The minor becomes entitled to the property absolutely at 18;

• Until the age of 18, the property is only to be applied for the benefit of the minor;

• Until the age of 18, the minor is either entitled to all the income arising from the property or if not so entitled, the income cannot be applied for the benefit of anyone else.

The powers that trustees have of making payments of income to parents or guardians or otherwise for the child's benefit and the application of the section 32 Trustee Act1925 statutory power of advancement do not prevent the trusts from qualifying.

In order for the trustees to claim the special tax treatment, the trustees and the vulnerable person (if a child - their parent or guardian) need to jointly make an election. Once made, an election is irrevocable. The election must be made on the prescribed form.

An election can be made at any time up to 12 months after the filing date for the trustees' tax return - i.e. 12 months after the 31 January following the end of the tax year in question.

The trustees are entitled to a deduction for tax against the amount they would otherwise pay so that the final amount payable by them reflects the particular circumstances of the vulnerable person.

The trustees therefore calculate what their tax liability on the income arising from property held on qualifying trusts would be in the absence of a claim for special tax treatment, and then what the vulnerable person's tax liability would be on this income if that income had arisen directly to him, taking into account his other income, capital gains and allowances. The trustees then claim the difference between these two figures as a deduction from their own tax liability.

The trustees are not chargeable to CGT on capital gains arising on the disposal of property held on qualifying trusts. Instead the vulnerable person is chargeable to CGT on capital gains which are treated as arising to him in a similar way to the way gains may become chargeable on a settlor of a settlor-interested trust.

The vulnerable person can set any unused personal losses against the gains. Taper relief is applied to all the vulnerable person's gains and account is taken of the person's annual exempt amount in determining any liability. No account is taken of the trustees' annual exempt amount. The vulnerable person should include the net gains in his personal tax return. The vulnerable person then has a right of recovery against the trustees for the amount of any tax he has paid in respect of those gains.