Chapter 11 – Taxation Of Trusts (2 OR 3 MARKS) Flashcards
The individual who creates the trust is known as the settlor
The settlor can also be (and very often are) one of the trustees
They can also be, but very rarely are, one of the beneficiaries
What is the downside of being a beneficiary and settlor?
By being a possible beneficiary, one of the key tax benefits of placing property in trust (that of the settlor potentially limiting or avoiding IHT on the property) is lost
Trust ‘property’ - . It doesn’t just include bricks and mortar (land and buildings) property. It also includes:
money
investments
other assets, such as paintings, furniture, jewellery etc.
The trust property is the trust assets.
Why are investment bonds commonly used as investment vehicles in trusts (ie, the trust assets are held in an investment bond)
What are the downsides of this arrangement?
As far as investments are concerned, life assurance-based investment bonds are often used as the vehicle to be put in trust. This is because they are not deemed to be ‘income producing’ assets. ‘Income’ paid is treated as a return of capital, with 5% per annum cumulatively allowed on a tax deferred basis (as we saw in chapter 10)
Benefits
Saves a lot of administrative work for trustees, as one of their responsibilities is filing a tax return on behalf of the trust and paying any tax due if applicable (or arranging for the tax to be paid
A non-income producing asset therefore saves this issue until a specific tax-event is created
DOWNSIDES
No scope to use either the beneficiaries’ or trustees’ annual CGT exemption as CGT is not charged on investment bond gains
No scope to use the beneficiaries’ dividend allowance, which may be available on certain trusts as investment bonds do not pay out dividends.
Collective investments such as Unit Trusts and OEICs could also be used as an investment by trusts.
What are the advantages and disadvantages of this arrangement ?
The advantage of collective investments are that it is possible to use:
the beneficiaries’ or trustees’ annual CGT exemption, as CGT is charged on gains
the beneficiaries’ dividend / personal savings allowance on certain trust types
The major downsides to collectives as trust investments are:
extra administration, ongoing tax returns and a need to account for income and/or gains as they arise.
See 11.1 for an overall on 3 main trust types
What are disabled trusts?
Trusts for vulnerable people
If a trust is set up for a vulnerable beneficiary, special treatment for income tax and CGT can apply, which we will explain in the tables that follow.
Vulnerable beneficiaries’ are defined as either:
A person who is mentally or physically disabled; or
Someone under 18 (a ‘relevant minor’) who has lost a parent through death
How are bare trusts taxed?
Income tax = Beneficiary responsible on income received by trust and to pay tax. Can be paid by trustees if beneficary is minor. ‘£100 rule’ applies
CGT = Treated like trust assets are held directly in beneficiaries name. CGT applies normally. Taxed at 10 /andor 20% like normal, or 18 or 24 % if the trust assets is residential property
IHT = Any transfer in is treated as a PET. Beneficiary is responsible for tax due
How are interest in possession trusts taxed?
Income tax =
If income is sent into trust.
Trustees responsible for declaring and paying income tax on income received by trust. Pay at following rate;
20% if source of income = Rent, trading & Savings
8.75% if source of income = dividends
If income is sent directly to life tenant =
If income is mandated (sent directly) to life tenant, it is their responsibility. Trust expenses can be offset against income sent. The calc to offset this specific.
Life tanants can reclaim tax if non taxpayer
If BRTP no further liabilty
If higher and additional , they have a further liabilty
READ REST OF THIS IN 11.2
CGT = Trustees are liable on trust CGT rates (20%) or 24% if residential property. Trusts have max annual exemption of £1500
IHT =Transfers in are treated as CLTs (20% if over NRB)/ have exit charges and periodic fees in relation to IHT. READ 11.4 IMPORTANT!!!!
How are discretionary trusts taxed?
Income tax = Trustees responsible for declaring and paying income tax on income received by trust
Income is taxed at special trust rates (SEE RATES IN EXAMPLE)
Trust expenses can be offset against income
CGT = Trustees are liable on trust CGT rates (20%) or 24% if residential property. Trusts have max annual exemption of £1500
IHT = Transfers in are treated as CLTs (20% if over NRB)/ have exit charges and periodic fees in relation to IHT. READ 11.4 IMPORTANT!!!!
There is unique rules if the beneficiary is classed as a vulnerable (ie disabled trusts) - SEE RULES
What is the £100 rule’?
What are bare trusts
What are interest in possession trusts
What are discretionary trusts?
What is a life tenant
What are the remaindermen
Income paid to a beneficiary from an interest in possession trust ‘retains its original nature’, so; interest stays as interest, dividends stay as dividends, etc. The income does not get ‘converted’ to trust income.
This differs to discretionary trusts where the income ‘loses its original nature’ and is distributed as trust income, not as dividend nor savings income.
This means that it is not possible to apply dividend allowances nor personal savings allowances to distributions from a discretionary trust.
What is the deminimus allowance
What are the different trust income tax rates
Transferring assets into a trust is a disposal for CGT purposes for the settlor. True or false
True
The market value of the assets at the date of the transfer is used to calculate the gain, and therefore the potential CGT payable by the settlor.
Holdover relief is available for any property being placed into trust (but not into bare trusts)
Interest in possession and discretionary trusts are known as ‘Relevant Property Trusts’
What does this mean?
Any transfers into them are classed as Chargeable Lifetime Transfers for IHT purposes
It also means that they have exit charges and periodic fees in relation to IHT. READ 11.4 IMPORTANT!!!!
There is unique rules if the beneficiary is classed as a vulnerable (ie disabled trusts) - SEE RULES
11.4.2: Interest in Possession and Discretionary Trust (‘Relevant Property Trusts’) Examples
DO ACTIVITY 11.1!!!!!!!!!!!!!
LOOK AT SUMMARY 11.5
Michael, a basic rate taxpayer, is the beneficiary of a bare trust. Pam, also a basic rate taxpayer, is a beneficiary of an Interest in Possession Trust where the trust income is paid to the trustees. With regard to income produced by the assets within the trust, they should be aware that (Choose more than one answer)
Neither will have an income tax liability on trust income
Michael can reclaim tax paid within the trust
Only Pam’s liability will be met by the trustees
Both beneficiaries will receive an R185 form completed by the trustees
Only the trustees of Pam’s trust can offset trust expenses against income produced
c & e
Michael will be liable for income tax based on the income produced within the trust. He cannot reclaim any tax paid, as the trustees would not have paid any. Only Pam will receive an R185 from the trustees, which details the categories of income and expenses.
When offsetting expenses against trust income within a discretionary trust, the correct order is
UK dividends, foreign dividends, savings income, other income
Other income, savings income, UK dividends, foreign dividends
Savings income, UK dividends, foreign dividends, other income
Foreign dividends, UK dividends, savings income, other income
UK dividends, foreign dividends, savings income, other income
This order also applies to offsetting expenses against income within Interest in Possession Trusts.
The assets within the Robinson Family (Discretionary) Trust consist of a rental property, producing £6,000 per annum of income, and a share portfolio producing £1,000 of dividend payments. It is true to say that the trustees themselves will pay tax at
0%, 20%, 39.35% and 45%
0%, 39.35% and 45% only
39.35% and 45% only
8.75% and 45% only
39.35% and 45% only
There is a de minimus allowance of £500 (or a minimum of £100 if shared amongst the maximum number of trusts) that is completely tax free if that is the only income. However if the income received by the trust exceeds £500 then it is ALL taxed at the highest rates. The rental income of £6,000 will be taxed at 45%. The dividends will be taxed at the trust rate of 39.35%.
Belinda is the trustee of a bare trust, Isabel the trustee of an Interest in Possession Trust and Dawn the trustee of a discretionary trust. All the trusts have disposed of assets in this tax year that have created liabilities to Capital Gains Tax. It is true to say that, in their role as trustees
Belinda’s trust will always be responsible for more CGT than either Isabel’s or Dawn’s
Isabel’s trust will have the largest annual exempt amount available
The tax rate that applies to Isabel and Dawn’s trusts will be the same
The three trusts will be subject to exactly the same CGT treatment
The tax rate that applies to Isabel and Dawn’s trusts will be the same
The CGT treatment of Interest in Possession and Discretionary Trusts is the same – paid at a rate of 20%/24% (depending on the nature of the asset) with a maximum annual exempt amount of (currently) £1,500 a year and a minimum of (currently) £300 a year.
Under the discretionary trust IHT regime, a periodic charge is due on each 10th anniversary of the trusts start date. The MAXIMUM charge that will be applied to the trust is
6%
20%
30%
40%
6%
Technically the charge is ‘30% of the lifetime transfer charge’. Given that the lifetime transfer charge is currently 20%, 30% of this amount is 6%.
Yousif transferred £500,000 into a trust during his lifetime and there was no tax due at the time of transfer. This was because
he had previously been widowed
the transferred money all qualified for Quick Succession Relief
he transferred the money into a flexible family trust
he transferred the money to a Bare trust
he transferred the money to a Bare trust
The transferable nil rate band and Quick Succession Relief are topics that are only relevant following an individual’s death. As Yousif hasn’t died, the differentiator in this case is whether the transfer is a Chargeable Lifetime Transfer (which the transfer to the ‘flexible family trust’ would be – basically, any flexibility indicates a form of discretionary trust) or a Potentially Exempt Transfer, which this is as it is to a Bare trust. There is no lifetime tax due on a PET.
