Hidden tax is threat to trusts

Thousands of people with millions of pounds invested in trusts set up for inheritance tax purposes are to be subject to a sudden unexpected tax because of a hidden provision in this year's finance bill.

The provision will hit the inheritance tax packages offered by many insurance companies. The products affected are those where the individual made an interest free loan to the trust. The money was then invested in an insurance bond and up to 5 per cent income drawn down every year as tax-free income.

Tony Foreman, tax partner with Pannell Kerr Forster, said: " The proposed legislation will impose an income tax charge from 6 April 1995, through the individual's interest free loan to the trust.'' He pointed out that the new rules mean that people will be taxed on notional interest each year - currently set at 8 per cent of the remaining loan to the trust.

They will have to pay this tax regardless of whether they are drawing down any income or not.

On a £50,000 trust, the extra tax would cost £1,000 a year. Peter Timberlake, Legal & General director, said: "The Finance Bill will hit all loans made to trusts. It will particularly hit the ''gift and loan'' trusts. Perhaps they have been taken as a means of tax avoidance.'' He said that there were several practical problems involved in the Inland Revenue's plan to raise the extra tax. Anybody who has a plan, but who is not drawing any income may not be aware that they are liable for the extra tax liability. He added: "It also very unusual for the Inland Revenue to make any tax retrospective.''

The Association of British Insurers, the trade body representing the insurance industry, is believed to be lobbying the Inland Revenue to have this clause in the Finance Bill changed.

Mr Foreman said: "My firm is already making representations that the Chancellor's proposals go too far. Imposing a charge on notional income may be fair enough where the trustees actually have taxable income. However, it really is unacceptable for the legislation to create taxable income out of thin air, where the trust which has received the interest free loan has no income for tax purposes whatsoever.''