1 - Income Tax (Trusts) Flashcards
Income tax liability of trustees
If a trust has at least one trustee who is resident in the UK, this generally means there is potentially a liability to income tax on its total income
Bare trusts
What is it?
Is the income taxable?
Are allowances permitted?
Include on SATR?
General position
With a bare trust, the asset is in the name of a nominee but the asset itself and the income belong to a beneficiary:
- the income is taxable as the beneficiary’s income, and at rates that depend on beneficiary’s other income
- the beneficiary (not trustees) is liable for the tax, but the personal allowances (tax, savings, dividend) & starting rate band can be claimed as relevant
- beneficiary must include trust income on their self-assessment tax return
Bare trust for a minor
When is income taxed as parent’s income? child’s income?
CGT advantages?
Bare trusts for a minor
Where a parent gifts money to their unmarried minor child either directly or indirectly (via trust structure), the trust is treated as the settlor-interested trust = usually taxed as the parent’s income = designed to prevent tax avoidance
- Where income exceeds £100/y = taxed as parent’s income on full amount, not excess
- Where income < £100/y = treated as child’s income
- Not taxed as parent’s income where the capital comes from grandparent/another relative = can be used to provide income to pay a grandchild’s school fees.
- Prior to Finance Act 2006, Accumulation & Maintenance (A&M) trust were preferred for minor beneficiaries as provided greater flexibility over beneficiaries and distribution of income
- The changes introduced by Finance Act 2006 means that if a trust is created in lifetime, unless it is a bare trust, in most circumstances, it is likely to be a discretionary trust. It is possible to create an interest in possession trust so the income would be taxable on a particular beneficiary in accordance with the beneficiary’s rate of tax.
A bare trust, which includes an ‘irrevocable designated account’ or ‘nominated account’ continues to have CGT advantages for an unmarried minor, even if the trust or account was created by their parent(s) = the gains are taxed as the child’s, so the child can use their annual exemption, which will be at least double that of a discretionary trust.
Trusts for vulnerable beneficiaries
The Finance Act 2005 created a new tax regime for trusts for the vulnerable
Was backdated to 6 Apr 2004
Aim to tax the income and gains of trusts for certain vulnerable beneficiaries on the basis of the beneficiaries’ tax position rather than under the usual relevant property trust rules.
Qualifying beneficiaries and trusts
What is definition of a disabled person?
Under what act should trustee ensure someone with mental illness check?
What 3 trusts eligible for a relevant minor child?
Two types of vulnerable beneficiary:
- Disabled persons
- ‘Relevant’ minor children
Not all trusts that benefit a disabled person or relevant minor qualify for special tax treatment since the individuals must fit within these definitions:
Disabled persons
Someone who is eligible for any of these benefits (but not necessarily receiving them)
- Attendance Allowance
- DLA (care component at middle or highest, mobility component at highest rate)
- PIP
- Constant Attendance Allowance
- Armed Forces Independence Payment (AIFP)
Note: Government hasn’t yet amended “mental illness” to take account of Mental Capacity Act 2005 (MCA) or Mental Health Act 2007 = trustee must ensure the trust qualifies for a vulnerable beneficiary, i.e. someone who can’t manage their own affairs because of a mental condition covered by Mental Health Act 1983
Relevant minor children
A child who hasn’t attained age 18 and at least one of whose parents have died.
Eligible trusts are:
- Statutory trusts for relevant minor under ss.46 and 47(1) of the Administration of Estates Act 1925, or its Scottish equivalent
- Trusts established under the will of a deceased parent of the relevant minor
- trusts established under the Criminal Injuries Compensation Scheme, which give absolute entitlement at age 18 and, before then, entitlement to income, or preclude any income being applied to any other beneficiary.
Qualifying beneficiaries and trusts
When will it be a qualifying trust?
Created on or before 8 Apr 2013
- if its terms include provisions that ensure that during vulnerable beneficiary’s lifetime, the trust income and capital can only be applied for the vulnerable person’s benefit.
- trustees can apply small amounts of income and capital (lower of £3,000 or 3% of trust fund each year) without having to prove that it is for the benefit of the vulnerable beneficiary.
- Subject to satisfying these criteria, the trust may be a discretionary trust, an interest in possession trust, or a bare trust
- where vulnerable person is a bereaved minor, the trust will only be ‘qualifying’ if it is created (by will/intestacy/under Criminal Injuries Compensation Scheme) on the death of a parent and the minor takes an absolute interest in the trust fund no later than age 18
Created prior to 8 Apr 2013
The limitations on how the income and capital of the trust could be applied varied according to the tax that was being considered.
FCA focus on vulnerable persons
FCA considers that such individuals may be at risk of poor customer outcomes and therefore, requires firms and advisers to ensure they receive an appropriate level of care, which may be different than what is required for other customers.
Vulnerability can come in many guises, including:
- N having to make purchases or financial decisions during stressful points in time, i.e. bereavement, choosing care arrangements
- N having personal characteristics:
- physical disability
- poor mental health
- compulsive/impulsive behaviour
- impaired cognitive skills due to illness or ageing
Vulnerability can affect N across all financial products/services, and may be long term or transient.
FCA has issued guidance for firms on treating vulnerable customers fairly (FG21/1:Guidance for firms on the fair treatment of vulnerable customers), which clarifies what the FCA considers is required under the FCA principles.
The election of obtaining favourable tax treatment (on the beneficiary)
To obtain favourable tax treatment (as if taxed on beneficiary), the trustees and vulnerable person must make a joint election not more than 12 months after 31 Jan following the end of the tax year in which the effective date of the election falls:
i.e. 31 Jan 2024 for treatment to be operative for 21/22
Once made, the election is irrevocable and remains in force until:
- the person the election made to ceases to be vulnerable person
- the trust in relation to which election is made ceases to be a qualifying trust
- the trusts are terminated
The relief
The special income tax treatment for trusts for vulnerable persons is governed by the Finance Act 2005
The trusts are allowed a deduction from the income tax that they would pay
This means two amounts need to be calculated:
1. The smaller (tax the vulnerable beneficiary would pay)
2. The larger (tax the trustees would pay)
The difference then represents the amount of relief by which the trustees’ income tax liability is reduced
Qualifying trusts income = income from assets held on trust for a vulnerable beneficiary
Life interest and interest in possession trusts
There is an ‘interest in possession’ where one or more beneficiaries have a right to the trust income as and when it arises.
Tax on the trustees
Although the beneficiary entitled to the trust income is taxed on the income as it arises, the trustees are liable for BR tax on any income they actually receive, effectively paying tax on behalf of the beneficiary:
- Savings income 20% (no personal savings allowance)
- B&BS interest paid gross
- Dividends 7.5% (no dividend allowance)
- Other income 20% usually paid by trustees via self-assessment tax
- It is possible to mandate income payments directly to beneficiary if paid directly to them (as if not, the trustees automatically become liable to pay the tax)
The trustees are no liable to higher rate tax
The beneficiary is entitled to a tax credit for any tax paid by trustees, and can offset own personal allowances again the income from the trust = if trustees paid BR tax on income covered by beneficiary’s personal allowance = can claim a refund of that tax.
Trustees expenses
Trustees aren’t entitled to tax relief for the expenses of managing the trust.
To save on admin costs, it is often worth asking for income to be mandated or paid directly to beneficiaries, where possible.
Trust expenses in an interest in possession trust have the effect of reducing the income paid to a beneficiary.
Any higher rate tax is paid by the beneficiary on the net income received, after the deduction of the expenses, grossed up at the appropriate rate.
Trust expenses are set against income before being paid to the beneficiary in this order:
- UK dividends
- Foreign dividends
- Savings income
- Other income
The trustees complete an R185 (Trust income), which details the income and tax deducted, and pass this to the beneficiaries, so they can complete their own tax returns.
The form R185 should show the separate categories of income, showing the gross amounts, and separating the 7.5% and 20% tax credits.
Tax on the beneficiary (life tenant)
The beneficiary must add the trust income from the R185 to their other income for that tax year to calculate their liability to pay tax.
If they are a:
- non-taxpayer, they may be able to reclaim some or all of the tax deducted from the income.
- BR tax payer = will have no further tax to pay
- HR/AR = will have further tax liability at the appropriate rate, less the tax already paid by trustees
Dividends from shares and unit trusts
For 21/22, each N is entitled to dividend allowance of £2,000.
Dividends in excess of this are subject to:
BR 7.5%
HR 32.5% (25% more)
AR 38.1% (30.6% more)
Trustees are not entitled to dividend allowance and their liability is for basic rate tax only, 7.5% = HR would have to pay 25% more, AR would have to pay 30.6% more
Direct payment to beneficiary (B)
For simplicity, trust income is sometimes mandated directly to B.
HMRC then only taxes B, not the trustees.
if beneficiary is liable to HR/AR, direct receipt of trust income may stop HMRC from allowing any deduction for trustee expenses from the amount charged at more than BR, even where the expenses are reimbursed to the trustees.
In this case, it would be preferable to complete trust tax returns.
Important: An interest in possession beneficiary will be assessed to tax on trust income at their marginal rate(s) of tax, i.e. as if that income were directly theirs and not payable under a trust. The precise tax position will depend on their other income and they would be entitled to a personal savings allowance and a dividend allowance.
Discretionary trusts and accumulation and maintenance (A&M) trusts
What is the income tax position?
With a discretionary or A&M trust, the trustees have a discretion over the distribution of income and capital.
The income tax position:
- The trustees have a standard rate band, which in 21/22 is £1,000 divided by the number of trusts created by the settlor that were in existence for any part of that tax year - subject to a min £200 per trust. Income within this band is liable to income tax at 7.5% or 20% depending on its source
- 38.1% for UK dividends
- Trustees don’t benefit from personal allowances
- In some circumstances, the income is treated as settlor’s income and is chargeable on the settlor rather than the B, even if paid to them
- If trust receives money from different sources, the £1,000 BR band is first applied to non-savings income, then savings income, then dividend income
