This article aims to provide a brief overview of the Income Tax and Capital gains tax regime for trusts, it does not cover all of the complexities and reliefs which can be available.
For income tax purposes there are two types of trust; Interest in possession (IIP), where the beneficiaries have an absolute right to the income of the trust, and Discretionary (DT) where distributions to beneficiaries are entirely at the trustees’ discretion.
Interest in Possession
An IIP trust is subject to income tax at the basic rate of 20% on Savings & non-savings income and at 7.5% on Dividend income.
The gross trust income is apportioned to the beneficiaries according to their entitlements and they are then taxable on this income.
It is important to note that the income retains its identity, e.g Dividend income in the trust is taxable on the beneficiary as dividend income, and is therefore subject to the appropriate tax rates.
The income brings with it the associated credit for the tax paid by the trust and so if the beneficiary is a basic rate taxpayer no further liability will arise.
In contrast a DT is subject to income tax at the trust rates of 38.1% on dividend income and 45% on everything else.
There is however a ‘standard rate band’, meaning that the first £1,000 of income (starting with nonsavings, savings and then dividends), is taxable at basic rates.
When a discretionary distribution is made to a beneficiary there is once again a tax credit attached, this time at 45%, with the beneficiary being taxed on the gross distribution. e.g. if a distribution of £2,750 is made the beneficiary is taxed on £5,000 with a £2,250 tax credit.
Therefore unless the beneficiary is taxed at the top rates of income tax, there is likely to be a tax repayment available, and in the case where the distribution falls entirely within their personal allowance (£12,500 for 2019/20), as is often the case with minors, then the full 45% tax credit will be repayable increasing the distribution received to £5,000.
It should be noted that these distributions are taxable as non-savings income regardless of the nature of the income of the trust.
Trust Management Expenses (TMEs)
There is potential for relief against these tax rates in the form of TMEs but they must relate to management of Trust income not capital.
For an IIP they are a deduction against the income taxable on the beneficiary and are deducted against Dividend income first.
In the case of a DT they increase the amount of income that is taxable at the basic rates, again starting with dividends.
Capital Gains Tax
Capital gains within Trusts, in excess of the annual exemption (half that of an individual), are taxed at 20% (except for gains arising on residential property which are taxed at 28%).
As for individuals there are a number of reliefs which may be available but these need to be reviewed on a case by case basis.
Please note that both this annual exemption and the standard rate band for DTs can be apportioned if there is more than 1 trust with the same settlor.
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