With wider power comes a greater obligationIan Muirhead considers the implications of the wider investment powers granted to trustees by the Trustee Investment Act 2000.

The Trustee Act 2000, which will come into force on 1 February 2001, removes the irksome constraints of the Trustee Investments Act 1961 and in their place imposes positive obligations on trustees which reflect the reality of modern investment practices.Gone is the need to split trust funds between narrower and wider range investments unless specific extended powers are conferred by the trust instrument.

Gone is the restrictive definition of what constitutes a permissible investment.

Gone also is the prohibition against delegating responsibility to portfolio managers.

In their place we have a regime which permits a trustee to 'make any kind of investment that he could make if he were absolutely entitled to the assets of the trust'.This 'general power of investment' - which applies to all trusts, whenever created - is a 'default' power, additional to any other powers conferred on trustees, but subject to any restriction or exclusion imposed by the trust instrument.

It permits trustees to invest in assets which may be expected to produce either an income or capital return, in the same way as if they owned on their own account the assets which they hold in trust.

Being able to invest in non-income producing assets gives them the power, which could previously only be conferred by the trust instrument, to invest in life assurance bonds.

The only investments which are denied to trustees are those whose terms of issue confine them to private individuals investing in their own capacity, such as Personal Equity Plans, Individual Savings Accounts, Venture Capital Trusts, Enterprise Investment Schemes and Enterprise Zone Trusts.However, a number of safeguards exist to ensure that the general power of investment is exercised responsibly.

First, trustees remain subject to their fundamental duties to act in the best interests of present and future beneficiaries and to avoid any conflict between their duties as trustees and their personal interests.

Second, s.1 of the Act requires trustees to exercise reasonable skill and care.

Third, s.4 of the Act requires trustees to have regard to 'standard investment criteria' and to review investments from time to time and consider whether, having regard to the standard investment criteria, they should be varied.

Finally, s.5 requires trustees to take 'proper' advice on investment.In determining what is 'reasonable' skill and care, a subjective test is applied which can take account of the particular knowledge, experience and professional status of the individual trustee.

So higher standards will be expected of investment professionals, acting in their capacity as such, than of lay persons.The standard investment criteria for trusts laid down by s.4 mirror those contained in the draft Conduct of Business Sourcebook of the Financial Services Authority, and are twofold.

First, the need for trustees to ensure the suitability both of the type of investment being considered and the features of the particular example of that investment.

Second, the need to diversify between complementary investments as a means of risk control.

Trustees must seek to achieve a balance between income and growth which is appropriate to the needs of the trust in question; and they must keep investments under regular review.

S.5 of the Act requires trustees, when considering the exercise of a power of investment or carrying out a review of the investments of the trust, to obtain and consider proper advice, so as to ensure that account is taken of the standard investment criteria.

An exception is permitted in circumstances where the trustees consider that taking advice would be unnecessary or inappropriate - for example, where the investment is so small that the cost of advice would be disproportionate or where the trustees themselves possess relevant investment skills.

As a matter of good practice, trustees should ensure that advice received is confirmed in writing.The fact that the investments held by many existing trusts have not in the past been subject to proper review means that accumulated capital gains tax liabilities may often inhibit the wholesale reorganisation of neglected trust portfolios.

In these cases a progressive piecemeal approach may be appropriate, whereas with new trusts a fresh policy can be adopted from the outset.This will often favour the use of packaged investment products in preference to portfolios of individual securities, for a number of reasons.

First, securities portfolios are only economic where the values exceed 100,000 to 150,000.

Second, the requirement for diversification can be satisfied more effectively if the spread of investments encompasses not only individual securities but also different managers and styles.The third argument for packaged products is that of tax efficiency which, as the court pointed out in the landmark case of Nestle v NatWest ([1993] 1 WLR 1260) is an important factor when considering the suitability of an investment.

The return to beneficiaries may be prejudiced equally seriously by avoidable tax charges and administrative expenses as by inferior investment performance.

Two recent tax changes are particularly relevant, and each can be mitigated by the use of packaged investment products.

In April 1999 came the abolition of advance corporation tax and the consequent penalisation of dividend income distributed by trustees of discretionary and accumulation & maintenance trusts, which created a strong case for holding equities through life assurance bonds rather than directly.

The editor of Taxation conceded, not without a little reluctance, in the 9 December 1999 issue of that magazine: 'It really is true that single premium life assurance bonds are currently tax-efficient for discretionary trusts and indeed they appear to produce some strange quirks which offer other advantages to these types of trust.'This development came hard on the heels of the changes to capital gains tax, the complexity of which now presents a clear case for investing for interest in possession trusts through collective investments such as unit and investment trusts, in order not only to mitigate tax but also to save the administrative cost of accounting for tax.When the first post-1999 assessments began to arrive, in April 2000, trustees should have been prompted by the impact of these tax changes to review their investment policy.

With the passing into law of the Trustee Act 2000, such review has become an imperative.Ian Muirhead is the director of Solicitors for Independent Financial Advice