Tax Treatment of Trusts

Tax Treatment of Trusts

Trust Types

Bare trusts

Assets in a bare trust are held in the name of a trustee. However, the beneficiary has the right to all of the capital and income of the trust at any time if they’re 18 or over (in England and Wales), or 16 or over (in Scotland). This means the assets set aside by the settlor will always go directly to the intended beneficiary.

Bare trusts are often used to pass assets to young people – the trustees look after them until the beneficiary is old enough.

Interest In Possession Trusts

These are trusts where the trustee must pass on all trust income to the beneficiary as it arises (less any expenses).

Trusts For Vulnerable People

Some trusts for disabled people or children get special tax treatment. These are called ‘trusts for vulnerable beneficiaries’. A vulnerable beneficiary is either:

  • someone who has a mental or physical disability
  • someone under 18 whose parent has died

Income Tax

If a trust has at least one trustee resident in the UK, there is a liability to income tax.
Trustees are jointly and severally liable – not just a share of it.

Bare trusts

Beneficiaries are responsible for paying tax on income from it on a Self Assessment tax return.
If beneficiary is settlor’s child and gross income >£100, the settlor is responsible. If grandparent or anyone else then parents aren’t liable and income is taxed at normal rates with personal allowances.

Interest In Possession Trusts

If beneficiary is settlor’s child and gross income >£100, the settlor is responsible.
If not, the trustees are responsible for paying Income Tax without the benefit of a personal allowance:

Dividend-type income: 10% (covered by tax credit)
All other income: 20%. If income received net then no action need; if gross, trustees need to pay 20%.

Beneficiaries pay the difference at their marginal rate:
Savings = Non-tax payers can reclaim tax, Higher rate tax-payers pay extra 20%, Additional rate tax-payers pay extra 25%
Dividend = Higher rate tax-payers pay extra 22.5%; Additional rate tax-payers pay extra 27.5%

Discretionary Trusts

If beneficiary is settlor’s child and gross income >£100, the settlor is responsible. If not, the trustees are responsible for paying Income Tax without the benefit of a personal allowance and the first £1,000 is taxed at the standard rate.

If the settlor has more than one trust, this £1,000 is divided by the number of trusts they have. However, if the settlor has set up 5 or more trusts, the standard rate band for each trust is £200.

TRUST INCOME UP TO £1,000

Dividend-type income -10%

All other income – 20%

TRUST INCOME OVER £1,000

Dividend-type income -37.5%

All other income -45%

Trust Income Tax Example

Dave is a basic rate tax (BRT) payer and received £3,000 discretionary trust income.
£3,000 was net of 45% so to gross up = £33,000 ÷ 0.55 = £5,454.55 x 20% (BRT rate) = £1,090.91.
£2,454.55 was deducted by the trustees (£5454.55 – £3,000) so Dave can reclaim £1,363.64 (£2454.55 – £1,090.91) via self assessment.

Trusts And Dividend Tax Credit

There is a 10% tax credit on dividends from UK companies (and some non-UK companies) because the dividends come from profits on which the companies have already paid tax. This means:

  • dividends that fall within the standard tax rate band won’t be taxed as the tax credit covers them
  • dividends above the standard rate band will be taxed on the trustees at 27.5%

Trusts and Capital Gains Tax

Bare Trusts

Settlor: Can claim holdover relief if gift is business asset.

Beneficiary: pays tax at 18% / 28% after 11k annual exemption and declares on self-assessment.

Interest in Possession Trusts

Settlor: Can claim holdover relief if on any gain when property goes into trust.

Trustee: pays on 28% on disposals within fund or transfers to beneficiary after annual trust exemption of £5,500 (spread across all trusts to minimum of £1,100).

No CGT is due on death of life tenant unless holdover relief was claimed when property was placed under trust.

Discretionary Trusts

Settlor and Trustee: as above

Beneficiary: Can claim holdover relief on receipt of asset and can have losses transferred to them.

IHT

Bare trusts

Settlor: Any tax due < 7 years is paid by trustees.

Trustee: Gift into trust is a PET. If beneficiary dies, the value of the trust asset is added to their estate on death and the trustees are liable of the proportion of tax due.

Interest in possession trusts

Trusts created earlier than 22/3/06 – gifts were classed as PETs and so no IHT to pay now.

Trusts created after 22/3/06 – gifts are treated as Chargeable Lifetime Transfers.

Discretionary Trusts

Chargeable Lifetime Transfers of 20% (25% if paid by settlor) of assets if greater than nil rate band of £325,000 (2014/15).

10 year charge @ 30% of CLT rate (40 x 30% = 6% ) if greater than nil rate band of £325,000 (2014/15).

Exit charge @ % according to number of months since immediate or 10 year charges