Hundreds of thousands of trusts have been hit by the rise in capital gains tax (CGT), with family trusts set up for young children particularly at risk, tax experts have warned.

Trustees are now reviewing their arrangements and lawyers expect some people to take assets out of trust to avoid the high tax charges.

Capital gains tax was left at 18 per cent for basic rate taxpayers in last month’s Budget but increased to 28 per cent for higher-rate taxpayers. The capital gains tax-free threshold stayed at £10,100 a year.

However, any gains on assets held in trust will be taxed at the full 28 per cent, regardless of the income of the beneficiaries. The only exemption will be for trusts that can take advantage of the 10 per cent “entrepreneur’s relief” rate on CGT.

Experts have called the move “unfair” and say it harks back to 2006 when the Finance Act clamped down on trusts through the introduction of tighter measures to prevent tax avoidance.

Stephen Pallister, trusts partner at Wiggin Osborne Fullerlove and a member of the tax committee for the Law Society, says: “The government is too focused on trusts as vehicles for tax avoidance. We would like to see them thinking about the benefits that trusts bring to families.

“We are recommending that people review their arrangements and really think about whether it is now worthwhile continuing with the trust.”

The Law Society said it feared the move could see the end of trusts. “There is a real danger of trust assets being eroded through a combination of income tax at 50 per cent, CGT at 28 per cent and the impact of the changes to the inheritance regime introduced in 2006,” says Robert Heslett, Law Society president.

He said will trusts, created by parents of young children or vulnerable adults, were particularly exposed to the new regime. “Many hard-working families will often look to create a protective tax regime for their children in the event that they are orphaned at a young age by leaving assets in trust until the children are old enough to manage the assets without the guiding hand of their parents,” he says.

The introduction of the 50 per cent income tax rate earlier this year means any income earned in the trust will also be taxed at this rate, although taxpayers earning under £150,000 can reclaim the surplus tax after income has been paid out. Another anomaly in the trust system is that the CGT-free threshold – which for individuals is £10,100 – is half that for trusts at £5,050.

Stephen Herring, senior tax partner at accountancy firm BDO, says: “Over the years, governments all seem to have taken a very negative position on trusts and appear to think they are some kind of tax scam but many people use them as a way of controlling assets for their children.”

He highlights the anomaly with the example of a 20-year-old male university student who is the beneficiary of a trust. “If he had investments, he would pay 18 per cent CGT on the sale of any assets and would have a £10,100 annual tax exemption,” says Herring. “But as a beneficiary of trust, he would be hit with a 28 per cent charge on anything above £5,050.”

He says the increase in CGT will also have an impact on trusts that include so-called “stockpiled gains”, where the settlor of the trust has transferred an asset into it – often a family trust established for children or grandchildren – and has “held over” that gain on the asset to be paid at a later date.

The price paid for “holding those gains over” is that when the trustees realise the gains they must pay CGT on the amount plus a further 60 per cent of the CGT due. Under the old CGT rate, this tax paid would have been 18 per cent plus 60 per cent of 18 per cent, so 28 per cent in total for basic rate taxpayers. Following the rise of CGT to 28 per cent, the tax has, therefore, risen to 44.4 per cent.

“I would not be surprised if there were not thousands of trusts which still had stockpiled gains as transferring assets and holding over the gains where possible was fairly common practice for families seeking to pass wealth to the next generation while retaining control,” says Herring.

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