Plans to merge two trusts may have to be recalled from the health secretary's office this week and rethought - because the Department of Health appears to be unable to decide on the legal rules covering trust finances.

This extraordinary situation emerged last week when HSJ began looking at the merger of the Lifecare trust in Caterham, Surrey, with the Surrey Oaklands trust.

Both trusts are quite clear about the reason for the merger. They say that Lifecare, a specialist learning disability trust, is earning too much from social services contracts to remain a trust in its own right under NHS rules.

But experts say those rules have never been tested and there is simply a working assumption about how they apply.

Lawyers, external auditors and South Thames regional office all say that Lifecare is heading for an ultra vires situation because more than half its income will soon come from social services, rather than from the health service.

Nonsense, says the Department of Health. There seems to be a misinterpretation of DoH policy on trusts and finances.

'There is one statutory obligation and that is to balance the books. If there has been a misinterpretation and they don't want to merge, everything can be undone.'

The situation has arisen because Lifecare, one of the first-wave trusts, has gradually moved more and more of its patients from St Lawrence's Hospital, a large Victorian institution, into community homes.

This is, of course, in line with current thinking about best practice, which recognises that the vast majority of people with learning disabilities do not need healthcare except when they are ill.

But it means that a rising proportion of Lifecare's income comes from non-NHS sources and that, say the merger supporters, means it will fall foul of the rules on income generation.

Those rules were established when trusts were introduced and were intended to allow the new trusts to raise money through hospital shops, car park fees and other non-health activities.

The rules make it clear that giving trusts the power to generate income from non-NHS activities is conditional on those activities being ancillary to the main purpose of the trust.

This has been widely assumed to mean that for a trust to operate legally, more than half its income must come from the health service.

Lifecare cares for 1,000 highly dependent people with learning disabilities, 600 of whom are in residential homes.

Chief executive Ian Semple says he knew the trust was heading for trouble as more of its work was paid for by social services. But he points out: 'There is no change in the way we are doing this.'

External auditors warned Lifecare last year that it was heading for an ultra vires situation and that it must take action to bring itself into a legal position by the start of the next financial year.

Lawyers were consulted. The Audit Commission was approached. The view was taken that, short of a change in the law, the only course open to Lifecare was to merge with a trust with a sufficiently large health service income to allow it to continue its work with social services.

The proposal for Lifecare to be merged next April with the larger Surrey Oaklands nearby, a specialist mental health and learning disability trust, is now on the desk of health secretary Frank Dobson.

But the DoH insists that the proportion of Lifecare's income from non- NHS activities is 'irrelevant' to the merger proposal.

A spokesperson said: 'Lifecare is not illegal now. There is no statutory requirement for a ceiling on the amount of money from non-NHS activities. What we want is the best healthcare for patients and the best arrangement in order to deliver that. Where its income comes from is irrelevant to the decision to merge. There is no statutory limit. It might be a factor, but it is only one factor. The only statutory duty they have is to break even.'

This was news to South Thames regional office, whose policy advisers went into a huddle to discuss it last week, emerging wedded to their original line.

Mr Semple was bewildered. The external auditors had taken legal advice, he says. So had the trust. All the lawyers were giving similar advice.

'There would be no other reason why we should pursue a merger other than going outside our powers,' he says.

'We have more external accolades for quality than any other trust, we are a financially viable trust and we are well managed,' says Mr Semple.

He had also been told by the Audit Commission that no other trust in the country was ultra vires.

The Audit Commission declined to comment on this individual case, but said auditors had no powers to declare a trust ultra vires. They could refer a case to the health secretary for a view, which is what had happened.

But another trust facing a similar situation four years ago found a different solution, which has been accepted as an example of good practice and best value.

Oxfordshire Learning Disability trust also found that an increasing proportion of its work was with social services. Chief executive Yvonne Cox says the answer was to pool budgets with social services and become a joint commissioning body.

'Overnight, we became an integrated health and social services trust. We made no secret of that.'

The trust went to the Audit Commission, supported by the local authority, the health authority and the regional office.

The arrangement was accepted as following best practice, though

it was clearly understood that the trust was receiving more than 50 per cent of its income from social services.

Both Lifecare and Oxfordshire appear to be meeting the aims of Mr Dobson's famous exhortations to tear down the 'Berlin Wall' separating health and social services.

But it is not clear why one is being forced into a merger and the other has never been under such pressure.