Changes to the tax treatment of trust arrangements were quietly slipped into the smaller print of the Chancellor's March 2006 Budget. These changes are now law, contained in the Finance Act 2006.

The broad effect is to move the payment of Inheritance Tax on most Trust arrangements to the point when the Trust is set up, rather than waiting until the death of the person setting up the Trust (the Settlor).

The initial reaction to the changes was one of uproar, as it was felt that the rules were an attempt to make a tax raid on previously legitimate inheritance planning.

After the dust settled, the changes do not look anything like as severe for most people. However, there could be a significant effect on large transfers of wealth into trusts, which means that wealthier families will need to be very careful about how assets are handed down.

How are trusts affected? Any new trust that allows flexibility as to how and when the income and capital are distributed, are now subject to the rules that have always applied to Discretionary Trusts.

In brief, if an individual sets up such a trust and gifts money or assets into it, tax could be payable immediately on the value of the transfer plus the value of any other similar gifts made by the same person in the last 7 years. If the total amounts gifted exceed the prevailing Nil-Rate Band, tax of 20% of the excess is payable.

If the individual was then to die within 7 years of that gift, the whole amount given (including the prior gifts), would be counted as part of the estate, and subject to IHT in the normal way. Any tax already paid would be credited against the full amount due.

What other tax might be payable?

If a Discretionary Trust is still in place after 10 years, a tax calculation is made at that point. Generally speaking, tax will be payable on the value of of the Trust's assets in excess of the Nil-Rate Band prevailing at the time. This is known as the Periodic Charge, and is potentially payable every 10 years.

There may also be a tax charge (called an "Exit Charge") when some or all of the assets are distributed.

The calculation of Periodic and Exit Charges is complex, and professional advice should be sought in all cases.