The draft legislation amends the definition of a disabled person for tax purposes. The definition is to be set out in a new Schedule 1A to the Finance Act 2005 (which first introduced a special income tax and CGT treatment for trusts for vulnerable persons). The existing definition has been widened to include those in receipt of the following:

The following categories of disabled person will continue to come within the definition:

Of particular significance is HMRC's change of stance following the consultation to include all those entitled to the daily living component of PIP rather than just those entitled at the enhanced rate. As the equalities impact assessment accompanying the draft legislation suggests and the Summary of responses, December 2012 reveals, confining eligibility to those claiming the enhanced rate might have pushed as many as 770,000 individuals moved from DLA to PIP outside the boundaries of the disabled person definition (paragraph 2.7, Summary of responses).

HMRC's response document discusses a proposal made in the consultation document that the current mental disorder criterion for a disabled person for tax purposes should be based on the definition of incapacity in the Mental Capacity Act 2005 (MCA 2005) rather than the MHA 1983 definition. In HMRC's view the MCA 2005 definition would not be suitable because it has to be applied specifically to each decision an individual makes. This would be unworkable in the tax context where certainty of tax treatment over a long period has to be established. Therefore this proposal has been rejected.

The response document lists some of the clinically recognised conditions that are referred to in the Code of Conduct on the MHA 1983. In the past there was some uncertainty about which conditions HMRC would accept as qualifying for disabled status. The reference to the MHA 1983 Code of Conduct suggests that anyone with a listed condition will be treated as disabled for tax purposes so long as the condition means that they are incapable of administering their property or managing their affairs.

The draft legislation attempts to harmonise the restrictions placed on the application of capital and income from trusts for vulnerable persons across all the taxes. The new restrictions will be as follows:

The draft legislation is designed to harmonise restrictions on capital and income for all trusts for vulnerable persons. Therefore, the changes relate not only to disabled trusts but also to the following:

For more information about these types of trust for vulnerable persons, see Practice note, Taxation of UK trusts: overview: Trusts for vulnerable beneficiaries.

Concerns were raised during HMRC's consultation about applying too tight a restriction on the application of capital and income from a vulnerable person's trust. This was in recognition that it might be important for trustees to have the power to apply funds for someone other than the vulnerable person. An example might be to pay for a respite holiday or transport costs for a carer. In many cases, this sort of expenditure would be of indirect benefit to the vulnerable person.

Responding to this, the draft legislation allows trustees to apply small amounts for the benefit of persons other than the vulnerable person despite the income and capital restrictions. The limit is set at £3,000 or 3% of the value of the trust fund, whichever is lower (paragraph 3.7, HMRC response document). HMRC's response document says that this provision will be introduced by secondary legislation to be published in early 2013 (paragraph 4.2, HMRC response document). However, in a subsequent announcement on 17 January 2013, HMRC has published amended draft legislation incorporating this allowance. The amended draft legislation makes room for the Treasury to introduce secondary legislation limiting or applying this allowance in specific circumstances and providing for transitional and saving provisions. In the absence of such secondary legislation, as trusts set up before 8 April 2013 will be grandfathered, any existing arrangements allowing the payment of capital and income to non-vulnerable beneficiaries should not breach the rules for vulnerable beneficiary trusts (clauses 2(3), 3(3), 4(3), 5(5), 9(3), 10(3) and 13(3), draft legislation).

The draft legislation takes into account that pre-existing trusts will have provisions that may be in breach of the new restrictions on the application of capital and income. There was some concern, during the consultation period, that trusts established before the changes came into force but where further assets were added afterwards might straddle the two regimes with some assets being subject to more restricted income and capital requirements. Thankfully, the draft legislation provides that funds added after 8 April 2013 (inheritance tax) or 6 April 2013 (income tax and CGT) to pre-existing trusts will be subject to the old rules.

(Clauses 7(2), 10(7) and 15(2), draft legislation.)

Currently, where a trust does not expressly disapply the statutory power to advance capital to beneficiaries under section 32 of the Trustee Act 1925, the restrictions on the application of capital and income for vulnerable persons' trusts are said not to be automatically breached (see, for example, section 89(3) of the Inheritance Tax Act 1984). As the draft legislation introduces a rule across all taxes that all capital and income must be applied for the vulnerable person's benefit during his lifetime, the provisions relating to the statutory power are to be removed (clauses 2(4), 3(4), 4(4), 9(5) and 10(4), draft legislation). HMRC's response document suggests that removal of this rule would require future trust deeds to expressly disapply the statutory power of advancement during the vulnerable person's lifetime. One comment on the consultation pointed out that, as a power is involved, there would be no breach of the capital and income conditions unless the power were actually used to apply capital or income during the vulnerable person's lifetime for the benefit of a non-vulnerable person. However, the terms of the legislation are that a trust must secure that the restrictions will not be breached. This suggests that it would not be possible to wait until a power of advancement is used in breach of the restrictions. The mere possibility that it might be used in this way would be enough to contravene the capital and income restrictions.

The removal of the current escape clause for trusts that have not expressly excluded the statutory power of advancement will only apply to trusts established after 8 April 2013 (see Grandfathering provisions). The removal of this provision seems odd given that the draft legislation will allow small amounts to be applied to benefit non-vulnerable persons. Although the draft legislation leaves existing trusts unaffected this will not be the case for existing wills containing disabled trusts, trusts for bereaved minors and 18 to 25 trusts. Given the large impact this could have it must be assumed that this aspect of the draft legislation has not been fully thought through. Attention has been drawn to this issue by professional bodies such as the Society of Trust and Estate Practitioners (STEP) and it is to be hoped that HMRC will reconsider how section 32 of the Trustee Act 1925 will impact on the proposed harmonisation of the restrictions on capital and income.