Politics: HOW TRUSTS CAN AND CAN'T BE OF BENEFIT

Trusts are often seen as mysterious entities, which by their very existence help you to minimise vast tax liabilities. When coupled with the seemingly exotic word "offshore", they assume an even greater fascination for those of us with no assets to protect.

What are trusts?

Trusts are a way of disposing of your assets in the way that you wish. They are brought into existence when a person (the settlor) transfers assets to trustees for the benefit of third parties (the beneficiaries).

How can you avoid paying tax through a trust?

Tax rules on trusts can be fiendishly complicated depending on the nature of the trust involved.

Put simply, if you want to minimise a future inheritance tax bill, for example, they are a way of passing on assets so that the full benefits will not take effect until some time in the future.

For example, by allowing your children to have income from your assets but not the capital, if you survive for seven years after the settlement, they will be exempt from inheritance tax.

Is any tax payable by a trust?

Yes. Income distributions from a trust are normally net of income tax at the lower (20 per cent) or basic tax band of 23 per cent, because the bill has already been paid by the trust. However, if the income paid to the beneficiaries takes them into a higher tax bracket, when added to any other income, they must pay tax at the higher 40 per cent rate on any sum over pounds 26,100. Where trustees are allowed to pick and choose how they allocate income to potential beneficiaries or simply to reinvest the income, this is known as a discretionary trust, and tax is payable at 34 per cent.

What happens if the person setting up a trust remains a beneficiary of its income or assets?

He or she will be assessed on the income even if it is not paid out and if the income is paid to others, it is the settlor, not the recipient who is liable to tax .

Clearly, if the trust holds shares which pay little or no dividend income, the tax bill will be little or nil.

What if you sell shares held in a trust?

Under normal rules, if shares are "realised" (sold off), capital gains tax of 23 per cent applies - except for discretionary trusts, where the rate is 34 per cent.

Is there any difference if the trust is held offshore?

Once upon a time, offshore trusts were a nifty way of avoiding capital gains tax levied in the UK. But since March 1991, if you have an interest in the income or assets of a trust, you will be liable to capital gains tax at 34 per cent, although any capital gains or losses before then may escape in some cases.

So are trusts not the best way to cut tax after all?

Without knowing exactly how a trust has been set up, when and where, who the trustees and beneficiaries are and what income is payable to whom and when, it is hard to say whether a person has gained any tax benefits.

But experts say that offshore trusts can confer one big advantage: timing. For instance, when you receive an income you may be able to declare it in your country of residence the year after receipt, allowing you to earn interest on it for up to 18 months before paying tax. Any tax delayed is a consequence of skilled tax planning not tax evasion, which is completely different and, of course, illegal.