Topic 8 - Tax compliance for trusts

Question 1

What is the income tax position and liability for an absolute/bare trust?

Answer 1

Absolute Trust

Beneficiary absolutely entitled to assets so normally liable for income tax. Although responsible can be paid by trustees on behalf of beneficiary as if it were the beneficiaries.

Question 2

What is the income tax position and liability for an interest in poessesion trust?

Answer 2

Trustees liable for basic rate. 7.5% dividends, 20% non dividends,

No personal allowance and not eligible for personal savings & dividend allowances.

Life tenant who is responsible for that tax.

Expenses cannot offset trust income but can wth beneficiaries income. First set against, dividends, interest then other non savings income.

Example:

Income Through Trustees

Trustees income - £1,000. Expenses of £110.

Tax liability of £200 income tax leaving £800 to distribute

Beneficiary could take expenses off net income so £690.

Deemed to have recieved £690 with tax credit of 20% (£172.50 so gross of £862.50.

Income added to beneficaries other income. Can use personal allowances, dividend allowances etc.

Income Direct to Beneficiaries ‘mandating’

Beneficiary liable to tax using thier tax rates & allowances

Question 3

What is the income tax position and liability for a disabled and bereaved minor trust?

Answer 3

Trustees account for all income and gains. Can make ‘vulnerable person election’ which allows trustees sole authority to decide on a year by year basis and pay taxes as if received by beneficiaries. Elections are irrevocable and ends when minor reaches 18 or death.

Question 4

What is the income tax position and liability for a discretionary trust?

Answer 4

Beneficiary no absolute right so tax paid on trustee rates.

Distributed income to beneficiaries will recieve 45% tax credit broadly equal to tax paid by trustees.

Rules:

Trustee Standard rate band of £1,000 -

• 20% for income and 7.5% for dividends.
  
  • Applies non dividend income first then dividends
  • mutliple trusts by same settlor then £1,000 is divided but not below £200 per trust

Excess of band. 38.1% on dividneds and 45% interest

Trustees have no personal, dividend or savings allownaces

Question 5

How are management expenses offset against discretionary and aboslute trusts?

What is the order that expenses are offset against the different types of income?

Answer 5

Calculating Management Expenses

• Unlike IIP trusts, management expenses can offset income.
• Still charged at basic rate but avoids higher trust rate
• Applies to expenses ralating to income so tax returns etc
• Set against dividends first, savings & interest, non savings to work out taxable income.

Expenses grossed up by basic rate by income type 7.5% or 20%.

Expenses deducted from of that type before tax calculated.

Tax calculated on net income at trust tax rates. First Standard Rate Band SRB and then balance on other rates.

Tax at basic rate band calculated on grossed up expenses and added to step 3. Result is trustees tax liability.

Absolute Trust Example

• Trust - Dividend income of £5,000 and maanagement epxenses of £925.
• Expenses grossed up - £925 / 92.5% (7.5% rate) = £1k
• £5,000 - £1,000 = £4,000 net dividends
• £1,000 at 7.5% = £75. £3,000 at 38.1% = £1,143.
• Total trustee tax liability is £1,218.

Discretionary Trust example

A discretionary trust has the following cash flow in 2019/20:

Income

• UK Rental Income - £9,000
• Dividends - £500
• Interest - £125

Expenses

Property Expenses - £1,000

Trustee Professional Fees - £350 (Grossed up £378)

Calculate the total income tax liability by the trustees

(NB: this is the only trust executed by the settlor)

Taxable

• Dividends £122 (Dividends minus trustee expenses)
• Property income - £8,000 (Rent minus property expenses)
• Interest £125

Tax Calculations

• FIRST STANDARD RATE BAND
• Interest £125 @ 20% = £25
• Property Income £875 @ 20% = £175
• SECOND TRUSTEE RATES
• Property Income £7125 @ 45% = £3,206.25
• Dividends £122 @ 38.1% = £46.48
• DIVIDENDS OFFSET AGAINST TRUSTEE EXPENSES AT LOWER RATE
• Offset Dividends of £378 @ 7.5% = £28.35
• TOTAL - £3,481.08

Question 6

What is a Discretionary Trust Tax Pool?

How does it work?

Answer 6

Sufficient income tax must have been paid when paying income to beneficiaries to cover 45% tax credit.

Tax Pool is a record of income tax paid at end of year.Shows difference between:

• Total income tax entering pool that year, plus any from previous years carried over.
• Value of 45% tax credits attached to income paid to beneficiaries

If trust pool cannot be covered by tax credit then difference payable by trustees and declarable on tax return. SA900.

How it works

• Trustee pay income to beneficiaries
• Tax pool is reduced by value of 45% tax credit
• Any balance at the end of hte year is carried forward

Question 7

What is the CGT Position of trusts?

Answer 7

• CGT may arise on sale/disposal of asset
• Some assets exempt
• Losses on non exempt can be carried forward
• Claim entreprenerurs’ relief up to £10m lifetime limit per beneficiary on certain business assets
• Value based on date assets were transferred into trust unless subject to Hold-Over Relief.

Question 8

What is the CGT position for a vulnerable person trust?

Answer 8

Trustees liable for any CGT

Trustees and beneficiary/guardian ‘vulnerable person election’ for special tax treatment.

Gives trustees authority to decide year by year whether to make election.

If a joint election is made, as with income tax, the trustees:

• calculate the CGT as though there is no special tax treatment;
• calculate the CGT as though payable directly by the beneficiary.
• They then deduct the difference between (a) and (b) from the tax that they pay.

Question 9

What is the CGT position of an interest in posession and discretionary trusts?

Answer 9

Trustees responsible for CGT

Trustees have annual CGT exemption of half individual £6k

Must be divided equally between all trusts created after 7 June 1978 by same settlor with minimum of 1/5 £1,200 for each trust.

Any gain in excess of exemption taxed at 20%. If on non-exempt residential property then 28%.

Death of life tenant not normally result in a CGT liability

If created on/after 22 March 2006, hold-over relief avaialble on transfers out of trust. Will require joint election.

Annual Exemption Example

George sets up three discretionary trusts.

The trustees of each trust will be entitled to an annual CGT exemption of £2,000 (£6,000 / 3).

Grace sets up six discretionary trusts. Dividing the exemption by the number of trusts would result in £1,000 for each trust, which is less than the minimum of £1,200. The trustees of each trust will be entitled to an annual CGT exemption of £1,200

Question 10

What is the IHT position of a bare/absolute trust?

Answer 10

Not in settlors estate but in beneficiaries so trust assets part of their estate on their death.

Question 11

What is the IHT position of a Discretionary Trust?

Answer 11

Fall under relevant property regime and are CLTs.

IHT was previously payable on transfers above NRB

Not included in beneficiaries estate as no absolute right

Question 12

What is the IHT position of an Interest in Posession Trust?

What are the three qualifying IIP Trusts?

Answer 12

Qualifying Interest in Posession Trusts

• Value of trust assets part of life tenant’s estate for IHT
• Trust is not subject to periodic or exit charges

1. Pre 22 March 2006
   
   1. Set up during settlors lifetime
   2. Gift was PET with no IHT payable after 7 years
2. Immediate Post Death Interest Trusts and IIPs
   
   1. ​Created thrugh Will. If life tenant was settlors spouse no IHT payable but otherwise would be chargeable transfer.
3. Disabled Person’s Trust
   
   1. ​Gift would be PET. On beneficiary’s death assets form part of their estate for IHT.

Relevant Property Interest in Posession Trusts

• If set up during settlors lifetime / after 22 March 2006.
• Gifts at CLTs so IHT payable up front if over NRB
• Not included in life tenant’s or remaindermaen estate
• Exit charge applies when assets passed onto surviving remaindermen

Question 13

What is the IHT position of a bereaved minor’s trust?

Answer 13

Do not form part of their estate for IHT until have absolute right to assets at age 18.

Question 14

When do periodic and exist charges apply?

Answer 14

Applied to assets or relevant property trusts (discretionary or interest in posession trusts) established after 22 March 2006.

Question 15

When are periodic charges applied?

How are they calculated?

Answer 15

Calculated on every 10th anniversary of trust

Charge of 30% of chargeable lifetime rate (max 20%) on excess over NRB on anniversary. So 6% (0.3x0.2) on excess over NRB.

Example:

• £600k trust fund
• £380k future NRB
• £600k - £380k = £220k x 20% x 30% = £13,200
• Effective rate of tax is 2.2% (£13,200 / £600,000)

Question 16

How are exit charges calculated?

What are the 6 circumstances where an exit charge does not apply?

Answer 16

• Exit charges on trustee distributions.
• Tax based on effective rate of tax at last periodic review
• Multiplied by fraction (quarters since last periodic review or inception if in first 10 years (40 quarters)
• Fraction is quarters elapsed divided by 40.
• If payment in first ten years, effective rate is tax paid on entry as % of total gift.
• If transfer was below NRB then no IHT and no exit charge in first 10 years as effective rate is 0%

Does not apply if:

1. Capital distributions made within 3 months of setting up trust or after 10 year anniversary
2. Income payments to beneficiaries as liable for income tax not iHT.
3. distribution is made to pay trust costs & expenses
4. transfer of excluded property such as foreign assets owned by non-UK domiciled trust.
5. distributions within 2 years of creation of a discretionary trust in settlors will.
6. payment is made to settlor under a discounted gift trust or loan trust

Question 17

To maximise IHT efficiency, what order should gifts normally be made?

How can the order of gifts effect the periodic charge?

Answer 17

Order of gifts can affect periodic charge.

Order should be exempt gifts, CLTs before PETs.

Because 10 year periodic charge on trust depends on what other chargeable transfers were made in 7 years before trust set up.If a PET in previous 7 years and it failed through death it is included in trust’s tax calculation even if trust didn’t benefit from PET.

If, however, the PET is made after the CLT, it will not be included in the calculation, even if it fails.

Example

A client fully utilises her annual exemptions, but has made no other transfers until in September 2018, she made a gift (PET) of £285,000 to her daughter and in October 2018 she put £285,000 into a discretionary trust for her grandson (and any future grandchildren). She effected gift inter vivos (a gift made during someone’s lifetime) assurance to cover any IHT liability on the transfers in the event of her death within seven years. A gift inter vivos assurance policy is a seven-year term policy designed to cover a potential liability on a PET. The sum assured remains level for the first three years and then reduces by 20% each year to match the reducing liability on a PET.

The client dies in December 2019 and leaves her estate to her husband.

Assuming that the NRB for 2028/29 is £370,000 and the discretionary trust fund has grown to £480,000 over ten years, the ten-yearly periodic charge will be calculated as:

The failed PET takes £285,000 of the NRB, leaving £85,000 for the CLT (discretionary trust). Discretionary trust £480,000 less NRB £85,000 = £395,000 taxed at 6% = £23,700. However, if the discretionary trust was set up before the PET, all of the £370,000 NRB would be available for the discretionary trust. The ten-yearly periodic charge will be calculated as:

Discretionary trust £480,000 less NRB £370,000 = £110,000 taxed at 6% = £6,600.

Clearly, from an IHT position, if the individual has a choice, the best order for gifting will depend on the amount to be gifted, the total potential death estate, the timing and the specific circumstances. In some cases, taking the 14-year rule into account, it may be more efficient overall to make a gift into a PET before the CLT to reduce the IHT payable on death.

Question 18

What is the IHT position for an 18-25 trust?

What periodic and exit charges apply to 18-25 trusts?

How are exit charges calculated within an 18-25 trust?

Answer 18

Until absolute right to assets then not part of beneficairies estate.

No exit charges if below or at 18.

After 18 exit charge applies if distribution of £3k+ made when age of absolute right, death of beneficiary or capital distribution for beneficiary’s benefit.

No periodic charges apply as trust runs for max 7 years.

The Calculation

Exit charge calculated using same effective rate for distribution of discretionary trust within first 10 years.

Effective rate multiplied by later of quarters elapsed since trust set up or beneficiaries 18th birthday divided by 40.

Maximum fraction is 28/40 due to the shorter length of trust

Example

Jack is the beneficiary of an 18–25 trust, set up by his father when Jack was exactly 19, and the trustees have decided to distribute all the trust assets (£300,000) to him at age 23. The effective rate has been calculated as 1.8%. The exit charge would be £300,000 x 1.8% x 16 / 40 = £2,160

Question 19

What were the options given to trustees regarding the tax position of accumulation & maintenance trusts?

Answer 19

Set up before 22 March 2006, trustees could exercise before 6 April 2008 either:

1. Distribution of capital & income to beneficiary at age 18 so no periodic or exit charges.
2. Amend to 18-25 trust so would be exit charge.
3. If no choice made then becomes a discretionary trust

Question 20

What is the basic principle of the Rysaffe Judgement?

How does it normally work?

What was it affected by the Same Day Addition (SDA) rule?

Give some examples to how the principle and SDA rules apply?

Answer 20

Basic Principle

• 2003 case of CIR v Rysaffe Trustee Company (CI) Ltd
• Possible to avoid periodic charges on large relevant property trust settlements with careful planning.
• As long as trusts set up on different days, each trust entitled to own NRB when calculating the periodic and exit charges

How does it work

• Settlor with £1m for discretionary trusts
• 4 trusts with £250k set up on different days
• Avoids periodic charges completely if at 10 year point assets were below NRB
• HMRC ‘associated operation’ so same transaction
• Won case but in 2003 appeal court ruled it was not
• Most commonly used by setting up pilot trust with ‘de minimis’ of at least £10 during lifetime with view to adding to trust in future, mainly on death. Small amount to fall within annual exemption so no impact on current IHT position.

Same day additions

• Finance Act 2015 - Same Day Additions rule
• Trusts and SDAs on or after 10 December 2014
• Additions made to more than one such trust on same day added together and share one NRB.
• Most SDAs occur on death and so cannot be spread
• Therefore Pilot Trusts now less attractive
• Can still be used for lifetime gifts but will attract CLT
• Additional payments to multiple trusts aggregated
• Additional payments of £5k or less not treated as SDAs

Examples

• Brian - 3 trusts on consecutive days with £100k each
• Not subject to 20% transfer charge as below NRB
• Still taken into equation if death within 7 years
• After 10 years each trust worth £200k each
• Each trust assessed differently and has NRB of £325k so no periodic charge

Example 2

• Brian - 3 trusts on consecutive days with £50k each
• Not subject to 20% transfer charge as below NRB
• Taken into account if death within 7 years
• 8 Years later he dies. Leaving each trust with share of £150k life assurance policy
• After 10 years value of each trust is £150k
• As trust recieved additional payments on same day through life assurance policy then taken as 1 NRB
• Periodic charges of £7,500 would then apply
• Issue can be overcome by setting up smaller policies set up on different days with it’s own trust

Question 21

What is the income, CGT & IHT tax position of trusts which carry a Settlor Interest?

Answer 21

Trusts where the settlor has the potential to benefit, these are subject to specific regime:

Income -

• Deemed interest if income is / could be paid to them or spouse. Or dependent child actually recieves income.
• Any icnome recieved by trust regarded as settlors whether distributed or not.

Capital Gains

Deemed interest if Settlor, spouse, dependent child could benefit from trust.

Trustees subject to normal trust CGT regime, but gift relief could not be claimed meaning previous gains cannot be deferred.

Inheritance Tax

Each gift made to trust treated as CLT. 20% charge if cumulative transfers over NRB over last 7 years.

Gifts will be treated as Gifts with Reservation so won’t be out of settlor’s estate.

If death within 7 years, potential for double charge. Up to 20% payable for the CLT and trust assets form part of estate and IHT payable for up to 40%.

Can use Double Charge Rules. HMRC calculates IHT in two situations and he charge payable on lowest of two:

1. Market value of gift with reservation included in estate but initial gift is not. More commonly higher charge.
2. Initial gift (Chargeable Lifetime Transfer) included

If no longer deemed to have interest when alive then will be out of estate if survives further 7 years.

Question 22

What are the general tax rules and processes for offshore / non resident trusts?

Answer 22

• Historically provided potential tax advantages.
• Particularly for those UK Resident but non UK Domiciled
• Changes to these trusts from April 2017 & April 2018
• Changes partciularly relevant for ‘settlor interested’ trusts
• Interest in possession trust can be offshore but specific beneficiary to recieve income few tax advantages

Complex rules so for these purposes we are looking at Discretionary Offshore Trusts with No settlor interest

• Income & gains from non UK assets - not taxable
• Accumulate in trust & tax payable only on distribution
• Payments to beneficiaries - regarded as capital payments and first matched to income and then gains.
• Ensures original income or gains do not avoid tax when paid
• Matching means the distribution is covered by balance in either the ‘income tax’ or ‘capital’ tax pool at the time
• If balance cannot be covered, set against future income and gains

Question 23

What are the rules to determine whether a trust is resident or non-resident in the UK:

Answer 23

• if all the trustees are non-UK resident, the trust is non-UK resident;
• if at least one trustee is UK resident, the trust will be UK resident;
• if one or more trustees are UK resident but the settlor was non-resident and non-domiciled when the assets were settled into the trust, the trust will be non-UK resident.

Question 24

A settlor will be deemed domicile if?

Answer 24

they are resident in the UK for 15 out of the 20 tax years prior to the current year; or

they were a ‘formerly domiciled resident’ (FDR) and return to the UK. A formerly domiciled resident (commonly referred to as a ‘returner’) is one who was born in the UK and had a UK domicile of origin but acquired a domicile of choice in another country. A returner will be deemed domicile during any tax year when they are tax resident in the UK; an FDR will lose their deemed domicile status in the first full year of non-residence, as long as they keep their non-UK domicile and are not caught by the 15/20 year rule.

Question 25

How is income tax dealt with in Offshore (Non UK Resident) Trusts?

Answer 25

UK sources - Trust special rates. 20%/7.% on first £1,000 SRB then 45%/38.1%

Income payments to UK domiciled & resident treated as untaxed and taxed on beneficiaries marginal rate.

HMRC Extra Statutory Concession B18 may allow beneficiary to claim credit for tax paid by trustees.

Those on remittance basis, taxed on foreign income if remitted back to UK.

Foreign income sources - Not liable to UK income tax but deemed to accumulate in tax pool. Therefore, UK resident beneficairies and non uk residents under the arising basis liable for income that can be matched from pool.

Those on remittance basis, taxed on foreign income if remitted back to UK.

Non domiciled & Non UK Residents not liable for UK tax.

Question 26

What is the CGT position of an Offshore (Non UK Resident) Trust?

Answer 26

Not liable for CGT.

Gains accumulated in CGT pool. If capital payment made to UK resident & domiciled beneficiary or non domiciled under arising basis then gain is treated as their own - 10%/20%.

If payment after year of gain, additional delay charge applies of 10% of their CGT rate for maximum of 6 years.

If non uk domiciled or deemed domiciled only liable if taxed under remittance basis and capital remitted back to UK. Also doesn’t reduce tax pool so can still be covered if paid to UK beneficiary.

From 6 April 2015 non resident trust trustees liable on gains from UK residential propert. Calculated on lower liability of disposal price minus either the value at 6 April 2015 or purcase price.

Principal Private Residence Relief may be available if the property meets the general criteria for the relief.

Question 27

What is the IHT position of an Offshore (Non UK Resident Trust)

Answer 27

Non UK situs assets not included in IHT on death or exit/charges etc. Treated as excluded property if settlor not domiciled.

Settlor’s status when trust is established that defines the IHT position. Not on death. So if settlor becomes domiciled later then won’t affect status.

Exception to this is if settlor’s domicile of origin is the UK. Then if become deemed domicile again trust loses excluded property status.

Can avoid UK situs by holding assets indirectly through offshore company, wholly owned by offshore trust. Shares in the company won’t be UK situs.

Changes to rules from April 2017 mean that if trust holds UK property directly or indireclty then not excluded property. So value of trust attributable to property subject to periodic & exit charges under relevant property IHT regime.

Question 28

What is a Protected Trust?

What ways can such a trust lose it’s protected status?

What happens to the tax position when a trust loses it’s protected status?

Answer 28

Protected Trust = established by non-UK domiciled settlor, beore settlor becomes deemed domiciled (15/20 year rule).

Once deemed domiciled then trusts loses protected status and income & gains taxed as if settlor was UK domiciled.

A non-resident trust will be tainted (and lose its protected status) if, after it is set up, the settlor:

• adds property to the trust;
• increases the value of a trust asset – an example would be waiving dividends on a share owned by the trust;
• is the life tenant of the trust and does not take the income due from the fund, instead leaving it in the trust;
• otherwise increases the value of the trust – examples would include paying excessive income on a loan from the trust, waiving interest on a loan to a trust, setting up a loan to the trust on non-commercial terms. A loan made at arm’s length on commercial terms would not taint the trust.

Question 29

What is the income tax position of non resident settlor interested protected trusts?

Answer 29

Settlor liable on UK income on arising basis through self assessment

Foreign income - not regarded as settlor’s so not taxed.

Foreign income - part of relevant income pool and settlor taxed on benefits that can be matched in pool.

Arising basis includes payments to ‘close family member’ either not resident in UK or using remittance basis and benefit is not remitted back to UK.

Settlor deemed UK domiciled when benefit paid, liable to tax on arising basis on income that matches tax pool.

Question 30

What is the CGT position of Non Resident Settlor Interested Protected Trusts?

What rule and when changed the way that UK residents could benefit from lower gains with the help of Non UK Residents?

Answer 30

Gains added to CGT pool. Each distribution matched to funds in pool.

Payments to UK Resident Beneficiaries - Subject to CGT in beneficiaries hands.

Payments to settlor or their close relative taxed in their hands.

Before 5 April 2017, pool was reduced by payments and as long as beneficiary was non-UK resident it was not taxable meaning once used up, leaving lower value pool of gains subject to tax when UK resident beneficiaries recieved them.

Since, distributions to non-UK resident beneficiaries not dudcted from CGT pool. Only exception is if beneficiary temporarily non-resident (under 5 years).

Question 31

What is the Onward Gift (anti-conduit) rule?

What is it designed to do?

When does it apply?

Answer 31

If beneficiary recieves income/capital payment that’s non taxable due to non-resident status or remittance basis and later make gift from that capital to UK resident.

Prevents money leaving trust being recycled to avoid tax.

Applies if all the following requirements met:

1. Not taxed on original gift due to non residency/remittance basis and didn’t remit back to UK
2. Original beneficiary not close family member of settlor as would have bene taxable if this was the case.
3. Onward gift made within 3 years of recieving gift or earlier distribution if made before trust distribution in anticipation.
4. Intention for onward gift to be made to person will be or expecting ot be UK residence at time of payment.
5. Onward payment can be traced to original payment.
6. Onward payment whole/part or derived from distribution

If the rule applies then final recipient liable to tax on gift.

Question 32

What is the IHT position of a Non Resident Settlor Interested Protected Trust?

Answer 32

Same as offshore non resident trusts

• Non UK situs assets not included in IHT on death or exit/charges etc. Treated as excluded property if settlor not domiciled.
• Settlor’s status when trust is established that defines the IHT position. Not on death. So if settlor becomes domiciled later then won’t affect status.
• Exception to this is if settlor’s domicile of origin is the UK. Then if become deemed domicile again trust loses excluded property status.

In addition:

• Settlor not excluded from benefitting from trust.
• Value of trust assets attributable to UK residential property included in estate on death if still in trust.

Question 33

If a settlor has six similar discretionary trusts set up, how much will the CGT exemption be for each trust?

Answer 33

The CGT exemption is split equally over the trusts, with each entitled to a minimum of one fifth of the trust exemption - £6,000 / 5 = £1,250.

Question 34

What rates of income tax are paid in a discretionary trust for income over the standard-rate band?

Answer 34

In excess of the standard rate band dividends are taxed at 38.1% and interest at 45%.

Question 35

When income is paid from a discretionary trust to a beneficiary it is considered to carry what percentage of tax credit?

Answer 35

It is considered to carry a 45% tax credit regardless of the income source

Question 36

John is the income beneficiary of an interest-in-possession trust that was set up two years ago. He is an additional-rate taxpayer and has received dividend income from the trust. What is his additional liability on this?

Answer 36

With an interest-in-possession trust, the trustees are liable for basic-rate tax on the income, which will be 7.5% on dividends. As John is an additional-rate taxpayer he is liable for a further 30.6% (ie 38.1% – 7.5%) of the dividend income that he receives.

Question 37

James established three discretionary trusts on consecutive days in May 2013, each with a gift of £200,000. He died in November 2018, having made no further gifts, leaving the balance of his estate to his son.

In November 2028, the NRB was set at £400,000 and each trust was valued at £350,000.
How much, if any, of the trusts’ value would be subject to the periodic charge in November 2018?

Answer 37

James set up his trusts before 10 December 2014, and made no further payments to his trusts, so the Rysaffe rule applies. As each trust would be below the NRB at the 10 year periodic review, no periodic charge would apply