7 - Taxation of Trusts

Question 1

Trust Taxation

How is trust taxation assessed, administered and paid?

Answer 1

Trust taxation uses self assessment, same as an individuals self assessment.

Two interim payments in 31 Jan and 31 July, balancing payment in 31 Jan after tax year end which includes CGT.

Question 2

Trust Taxation

Who has liability for the trust tax?

Answer 2

Trustees are joint and severally liable.

Question 3

Trust Taxation

What are the consequences for trustees if trust income tax isn’t paid?

Answer 3

• They are personally liable;
• It can be collected from them personally by HMRC;
• HMRC can impose penalties for late and non-payment;
• Trustees are personally liable for any penalties incurred while they are trustees.

Question 4

Trust Taxation

Is the creation of a trust considered a transfer of value?

Answer 4

Yes, value is transferred from the settlor to the trust.

Question 5

What are the main types of trust for tax purposes?

Answer 5

• Bare trusts - Where the beneficiary is absolutely entitled to the assets, or would be if they were over 18.
• Interest in Possession trusts (IIP) - Where one or more beneficiaries have a right to income.
• Discretionary trusts - Where no beneficiary has immediate access to income.

Question 6

Trust Taxation - IHT

What is the IHT charge on transfer into the trust?

Answer 6

• Bare trust - PET.
• IIP trust - CLT; although pre 2006 this was a PET.
• Discretionary trust - CLT.

Question 7

Trust Taxation - IHT

Are the trust assets within the beneficiaries estate?

Answer 7

• Bare trusts - Yes;
• IIP trusts - Pre-2006 the IIP was in their estate upon death, post-2006 it doesn’t enter their estate;
• Discretionary trusts - No.

Question 8

Trust Taxation - IHT

Which trusts are subject to annual charges?

Details of the charge

Answer 8

• Bare trust - No annual charge;
• IIP trust - Post 2006 they are subject to the charge;
• Discretionary trust - Yes.

Annual charge is up to 6% every 10 years

Question 9

Trust Taxation - IHT

When are capital exit tax charges made?

Answer 9

Discretionary trusts may have a capital exit charge of up to 6% of the excess above NRB.

The charge is basically a catch-up of the 10 yearly charge.

Count the number of quarters since the last anniversary (or settlement date if it’s under 10 years) and divide by 40. Multiply that by 6% and apply to excess over NRB.

NOTE: In exam the 6% is defined as 30% of the lifetime rate (i.e. the 20% CLT rate).

Question 10

Trust Taxation - Income Tax

How are bare trusts treated for income tax?`

Answer 10

Essentially the income is considered beneficiaries income, so they pay personal tax on all of it.

Question 11

Trust Taxation - Income Tax

How is IIP trust income taxed?

Answer 11

Trustees are liable for basic rate tax on all earnings (no allowances or bands).

So 7.5% on divs, 20% on other income.

If the settlor has an interest they are taxed personally, and can re-claim tax paid by the trustees.

Question 12

Trust Taxation - Income Tax

How are discretionary trusts treated for income tax?

Answer 12

Trustees pay the tax, rates are shown in tables.

They have a standard rate band of £1k split across all trusts the settlor has made (minimum £200 per trust).

That amount is taxed at basic rate (7.5% divs, 20% other).

The rest is taxed at 38.1% divs, 45% other.

Any distributions receive a 45% tax credit, regardless of how it was originally taxed. So if the beneficiary pays tax below the 45% rate they can claim the excess back.

Question 13

Trust Income Tax

Are trustee expenses allowable for income tax relief (IIP or discretionary)?

Answer 13

• IIP trusts: Expenses are not allowable for trustee tax, but are allowable for the income tax calculation on the beneficiary. Expenses need to be grossed up and deducted from trust income in the stated order (see slide).
• Disc. trusts: Expenses are allowable for trustee tax, but need to be grossed up by the appropriate basic rate (20%, 7.5%) before being deducted. Relieve in the stated order (see slide).

Question 14

Trust Income Tax

What is the order in which types of income are relieved against trustee expenses (where appropriate)?

Answer 14

• UK dividends;
• Foreign dividends;
• Savings;
• Other Income.

Question 15

Trust Taxation - CGT

Treatment of bare trusts

Answer 15

CGT charged on the beneficiary, so full annual allowance available.

Question 16

Trust Taxation - CGT

How are IIP trusts treated for CGT?

Answer 16

Trustees charged 20% (28% for resi.).

Get half of the usual annual allowance, divided by the number of settlors trusts (max 1/5th).

If the settlor has an interest it is taxed on the settlor who can reclaim from the trustees.

Holdover relief is available on disposal to a beneficiary.

Question 17

Trust Taxation - CGT

What holdover relief is available?

Answer 17

• Bare trusts - Business assets only;
• IIP - Pre 2006 was business assets only, post 2006 is all assets (unless settlor is interested then no holdover relief);
• Discretionary trust - Holdover relief on any asset (unless settlor interested).

Question 18

Trust Taxation - CGT

How are discretionary trusts treated for CGT?

Answer 18

20% (or 28% for resi) with half the annual allowance, divided by number of settlors trusts (max 5).

Unlike IIP trusts gains are not assessed on the settlor where they are a beneficiary.

Question 19

Trust Taxation - CGT

Other than when trustees sell assets within the trust (eg for re-balancing portfolio), when might CGT be payable?

How is CGT calculated?

Answer 19

When a beneficiary becomes absolutely entitled to their share of trust capital.

This is treated like a change in ownership (kind of like changing to a bare trust) so is a sale for CGT purposes, at the market value when they become entitled.

CGT paid by trustees based on trustee rules, deducting the value when assets were transferred into the trust and any costs incurred.

Question 20

Trust Taxation - Beneficiaries

How are beneficiaries of an IIP trust taxed (income)?

Relevant form?

Alternative approach?

Answer 20

Trustees complete R185 form showing net of tax figures.

Beneficiary is then taxed personally and can re-claim tax paid by the trust (can get a credit or have more tax to pay).

Income is treated as savings/dividends income rather than trust income so they can use their personal savings allowance or dividend allowance.

Sometimes income can be paid directly to the beneficiary instead of the trust, in which case the beneficiary is simply assessed as an individual.

Question 21

Trust Taxation - Beneficiaries

How are beneficiaries of discretionary trusts taxed?

Answer 21

Trust deemed to have paid 45% tax on all income, so they can re-claim based on their own tax rate (up to 45% if non-tax-payer, 25% if standard rate, 5% if higher rate, 0 if additional rate).

Beneficiaries income is “trust income” not dividends or savings, so can’t use savings allowance or divs allowance, taxed like salary or pensions.

Note that the trustees may have originally paid less than 45% tax (due to basic rate allowance, or lower tax rate on dividends). They will have to make up the difference to 45% with HMRC, otherwise the tax credit to the beneficiary is too high.

Question 22

Definition of a vulnerable person

Answer 22

• Disabled person: Mental disorder or receiving disability allowance at middle or higher rate; or
• Relevant minor: Under 18 and at least one parent died.

Question 23

How is a vulnerable persons trust created?

Answer 23

The trustees must make a joint election to get the favourable tax treatment.

It must be made within 12 months of the 31 Jan after the end of the tax year.

It is irrevocable once made.

Question 24

Tax treatment of vulnerable persons trusts

Answer 24

Income tax and CGT get special relief. Calculate the tax due from trustees in normal case and tax due if the beneficiary got the income/gain themselves. The difference is allowable as a relief.

Gifts into a vulnerable trust are PETs and they are exempt from 10 yearly tax charges.

Question 25

What is an A&M trust?

Relevant dates

Answer 25

Accumulation and maintenance trusts which were used to gift to children and given special tax treatment.

This is a special type of discretionary trust which is exempt from periodic and exit charges.

Can’t be created after 22/3/06 and rules no longer apply on old trusts after 5/4/08.

Question 26

Treatment of A&M trusts following rule changes

Answer 26

The trustees need to change the trusts, otherwise periodic and exit charges will become due.

If the beneficiaries become absolutely entitled by age 18 then no periodic or exit charges will be due, same as before.

If entitled by 18-25 then exit charge only is applied after age 18.

If capital goes to the beneficiary after age 25 then all charges become due.

Question 27

4 considerations around taxation of offshore trusts

Answer 27

• If one or more trustees is UK resident then they are subject to UK income tax;
• If capital is distributed from an income accumulating trust, beneficiaries may be taxed;
• Although CGT isn’t due if trustees are non-UK resident, there is anti-avoidance legislation in place;
• A transfer by a UK domiciled settlor to an offshore trust is considered a transfer of value for IHT purposes.

Question 28

What are bereaved minors and 18-25 trusts?

Tax features

Answer 28

These are trusts created via a will or intestacy when a parent passes assets to children or step-children (not grand children).

If they give absolute interest at age 18 it’s bereaved minors trust, if absolute interest by 25 it’s an 18-25.

There are no periodic or exit charges.

No IHT on bereaved minors trusts. 18-25 trusts charged equivalent of 6% exit charge starting from age 18 (so max of 4.2% at age 25).

This is described as “the assets treated as being owned by the beneficiary up to age 18”.

Question 29

What is the tax treatment of a settlor interested trust?

What counts as a settlor interested trust?

Answer 29

Income is treated as settlor’s and they are taxed on it, but can reclaim from the trustees.

This is the case if the settlor or their spouse/CP is entitled to income, or if it’s for the benefit of their minor unmarried child (if over £100).

Capital is also treated as income if it can be matched against undrawn income.

Question 30

IIP Trusts

What is the IHT treatment of pre March 2006 IIP and life interest trusts?

Answer 30

• Transfers into these are PETs
• Assets are considered owned by the life interest (similar to a bare trust)
• So if the life interest gets passed on to somebody else (eg on death or by allocation) there will be an IHT charge on the trustees
• The charge on death would be a proportion of the estate IHT charge based on the proportion of the trust assets over total estate value.

Question 31

IIP Trusts

What is the IHT treatment of Post March 2006 IIP or life interest trusts?

Answer 31

• If they are a special type (eg disabled persons, bereaved minor, 18-25 etc.) then assets are treated as being owned by the beneficiary.
• Otherwise the trust is more like a discretionary trust, transfers in are CLTs and they will not be subject to IHT on the death of the life interest as they are not part of the estate of the life interest.

Question 32

IIP Trusts

For a pre-2006 IIP trust, what happens if the beneficiaries of the trust are amended?

Answer 32

For pre-2006 IIP trusts the trusts assets are considered part of the beneficiaries estate (similar to bare trusts).

Therefore if the beneficiary is alive this would be treated as a new gift into an IIP, and that portion of the IIP would be treated like a post-2006 IIP (i.e. CLT charged, plus periodic and exit charges).

However if the change is set up to become effective when the original beneficiary dies this is just a change to the serial interest of the trust. The gift continues to be treated as a PET and there will be no periodic or exit charges due.

Question 33

Two points to make on questions about how trusts are taxed

Answer 33

• Mention the tax treatment of each individual investment going into the trust (dividends on the shares taxed …, gains on the bonds not due CGT etc.);
• Mention whether trustee expenses are deductible or not.