Chapter 11 - Taxation of Trusts Flashcards
Benefits of using trust
- Speed (no need to wait for probate)
- Control (settlor as trustee)
- Bankruptcy protection
- Confidentiality
Main types
- Bare / absolute
- Discretionary
- Interest in possession
- Accumulation and maintenance
- Vulnerable beneficiaries
Parties to a trust
- Settlor – gifts property
- Trustee – legal owners
- Beneficiary – entitled to the trust property
Self-Assessment
- Complete tax return assessing income and gains
-Taxed under self- assessment
o Two interim payments (31 January and 31 July)
o Balancing charge due 31 January following the tax year as well as CGT
- All trustees jointly and severally liable for any tax that is due
- Creation of trust is transfer of value
Bare Trust
Income Tax:
Capital Gains Tax:
Inheritance Tax:
Bare Trust
Where the trustees act as nominees for the beneficiary who is absolutely entitled to the assets - or would be if they were aged 18
Income Tax:
Income belongs to beneficiary
Taxable at beneficiary’s rate
Unless money from parent in which case taxed on the parent if over £100pa and beneficiary unmarried minor
Beneficiary liable for tax, not trustees
Beneficiary must include on tax return
Capital Gains Tax:
The gift in is a disposal
Holdover relief available on business assets only
Taxed on beneficiary
Use of full annual exempt amount (double the trust exemption)
Inheritance Tax:
Gift into trust is a PET, remains in settlor’s estate for 7 years
Assets form part of beneficiary’s estate
Consider 7-year DTA / LTA to protect settlor’s gift and estate
respectively on death within 7 years
Trusts for Vulnerable Beneficiaries
Vulnerable person
o Disabled person - someone eligible for any one of a range of State disability benefits
o Relevant minor - under 18 and at least one parent died
Income and gains taxed on beneficiaries’ tax position
To obtain favourable tax treatment trustees must make joint election
Joint election no more than 12 months after 31 January following end of tax year in which effective date of election falls
Once made it is irrevocable
Trustees can make a deduction from the income tax.
Two amounts are calculated:
o The tax the vulnerable beneficiary would pay
o And the amount the trustees would pay
o The smaller is deducted from the larger and the difference represents the measure of the relief
Gift into a disabled trust is a PET
Interest in Possession
Income Tax:
Capital Gains Tax:
Inheritance Tax:
Beneficiary’s Tax Position
Interest in Possession
Where one or more beneficiaries has the right to the income arising in the trust
Income Tax:
Trustees have no personal allowance/or PSA/DA
Trustees liable for basic rate tax only/no higher rate
Savings and other income = 20%
Dividends = 7.5%
Not entitled to tax relief on expenses/are deducted prior to distribution (gross up)
Expenses set against income in order: UK dividends, foreign dividends, savings, other
If settlor interested taxed on settlor (can reclaim from trustees)
Capital Gains Tax:
Gift in is disposal
Settlor interested - taxed on settlor (can reclaim from trustees)
Pre 22/3/06 - hold over relief only on business assets
Post 22/03/06 - hold over relief on any asset (except if settlor interested - no hold over)
20% tax (28% res prop)
Half CGT annual exempt amount
If more than one trust exemption shared
Minimum 1/5
Disposal to beneficiary - hold over relief
Inheritance Tax:
Pre 22/3/06 gift into trust = PET
o Change of beneficiary = a PET
o Life tenant has IIP/in estate upon death
Post 22/3/06 gift into trust is a chargeable lifetime transfer
o No IIP on beneficiary
o Periodic charges/exit charges
Beneficiary’s Tax Position
Trustees complete R185 - shows net of tax figures
Beneficiary adds trust income to own income
Entitled to tax credit for tax deducted from trust income
Beneficiary may reclaim/pay extra at own rates
Sometimes trust income is paid directly to beneficiary instead of going through trustees’ hands - HMRC then assesses individual
Beneficiary can use their PSA and/or DA
Discretionary Trusts
Income Tax:
Capital Gains Tax:
Inheritance Tax:
Beneficiary’s Tax Position:
Discretionary Trusts
Where no beneficiary has an immediate right to the income arising from the trust The trustees have discretion as to who gets income and capital
Income Tax:
Trustees have no personal allowance/no PSA or DA
Trustees have standard rate band (£1,000 2021/22)
Taxed at 7.5% (dividend) or 20% (all other income)
Divided by the number of trusts created by settlor
Minimum £200 per trust
Thereafter trustees taxed at 38.1% (dividend) or 45% (all other income)
Distributions subject to a 45% tax credit
If income accumulated, then no tax liability for beneficiary
Trustee’s expenses are allowable in working out income chargeable, but income relieved remains charged at 7.5% or 20% - expenses are grossed up
Expenses set against dividend income, then savings income and finally other income
Capital Gains Tax:
Gift in is disposal
Holdover relief on any asset (unless settlor interested)
Rate of 20% (28% on residential property)
Half the normal CGT annual exempt amount
If more than one trust exemption shared
Minimum 1/5
Inheritance Tax:
Gift in is chargeable lifetime transfer
20% over the nil rate band
If settlor pays the tax = gross up
Periodic charge every 10 years - max 6%
Exit charge on capital distributions - max 6% with x/40 rule
Beneficiary’s Tax Position:
Distributions to beneficiaries deemed to be trust income and carry 45% tax credit
Non-taxpayers reclaim 45%
Basic rate taxpayers reclaim 25%
Higher rate taxpayers reclaim 5%
Additional rate taxpayers - no reclaim
Beneficiary cannot use PSA or DA as ‘trust income’
Trusts for Minors
Trusts for Bereaved Minors
18 - 25 Trusts
Trusts for Bereaved Minors
Can be created on death of a parent by will or intestacy or under the Criminal Injuries Compensation Scheme
Must give absolute interest at age 18
Until age 18 trust assets treated as child’s for IHT
No periodic or exit charges
18 - 25 Trusts
Created on death of parent by will or intestacy or under the Criminal Injuries Compensation Scheme
Specified beneficiary given absolute interest by 25
Beneficiary treated as if owns assets for IHT up to 18
Exit charges levied after age 18
A & M Trusts
Special type of discretionary trust exempt from periodic and exit charges
Not possible to create new A&M trusts post 22/03/06
Old A&M trusts rules only apply to existing trusts up until 05/04/08
If trust amended and beneficiary absolutely entitled at age 18 then no periodic or exit charge
If amended to 18-25 trust, then exit charge applied post age 18 (no periodic charge)
If trust unchanged and capital goes to beneficiary after age 25 treated as relevant property trust (discretionary trust) from 6/4/08 - periodic charges and exit charges apply
Offshore Trusts
Subject to UK income tax if there is a UK resident trustee
Beneficiaries can also be taxed where capital distributed from a trust accumulating income
Not subject to CGT if trustees not UK resident but anti-avoidance legislation
A transfer by a UK-domiciled settlor is a transfer of value for IHT
Excluded property trusts (a trust of overseas property settled by a non-UK domicile) means non-UK assets are protected from UK IHT on death.
Overseas trusts are subject to the tax laws of the country of residence.
Pre-Owned Assets Tax (POAT)
Income tax charge based on annual value of use of assets given away that aren’t classified as gifts with reservation
Or, can elect for tax not to apply and treat as gift with reservation instead
Life policies under trust
HMRC taxes settlor, if not settlor then trustee, if not trustee then beneficiary
Onshore bond, 20% deemed taken at source
Offshore bond, paid gross
Assign policy to beneficiary before encashment could save tax
