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The Taxation of UK trusts FAQs

The ICAEW Tax Faculty presented a webinar on the tax treatment of UK trusts on 10 November 2016. It was well attended and several questions were raised that we did not have time to answer. A selection of the key questions are answered below.

Webinar questions answered

What are the most common uses for discretionary trusts and interest in possession trusts being set up today?

Trusts are usually set up to offer protection for certain assets. For example, the surviving spouse of the deceased spouse remarries and the deceased wants to ensure the assets pass to their children rather than the surviving spouses step-children. They are also used for inheritance tax planning, as an example a married couple can set up a trust by transferring £325,000 each to the trust and after seven years it is outside of their estate and they could transfer their nil rate bands again.

What is the point of having a settlor interested trust? Is there any benefit?

They can be used for inheritance planning.

How is the 10 year principal charge accounted for to HMRC? Does HMRC prompt the trust to make the payment?

The inheritance tax charges are reported on form IHT100 in sections G and H. If you would like HMRC to calculate the charge for you then it is possible to leave these sections blank. You must provide HMRC with all the relevant information to be able to calculate the charge. The tax and the form must be sent to HMRC by the end of the sixth month after the event. HMRC will not prompt the principal charge.

Does the principal and exit charge apply to IIPs?

It can do. The principal and exit charges apply to relevant property trusts (discretionary trusts and interest in possession trusts set up on/after 23 March 2006). IIP trusts set up before 23 March 2006 and IPDI trusts are qualifying IIPs and are not within the IHT regime.

When calculating the exit charge before the first ten year anniversary, as well as BPR not being available is it the same for APR?

Yes it is. To calculate the exit charge it is necessary to recalculate the tax charge on the creation of the trust using the rates applicable at the time of the exit charge. It is when recalculating this entry charge that the APR or BPR is not allowed. If the APR/BPR asset settled in the trust is still held and still qualifies for the relief and it is that asset being transferred out of the trust then the relief can be claimed.

If a discretionary trust is set up on death as a 1/3 share out of the residual assets, how is the nil rate band allocated to the beneficiaries (2/3) and the discretionary trust (1/3)?

The will may specify how the tax is to be borne. If not then it depends on whether any of the beneficiaries are exempt, such as a surviving spouse or a charity; if all are chargeable then the nil rate band will in effect be allocated equally between them as it is the net after tax estate that is divided.

If beneficiary payments are paid to grandchildren of the settlor of a discretionary trust, will a tax repayment claim have to be made on behalf of the minor? Can this be done online with no UTR?

The tax repayment claim has to be made using a R40 form which is not part of the self assessment regime so a UTR is not required.

What records should trustees keep to show whether a distribution is income or capital from a discretionary trust?

The trustees should keep minutes recording their decision to make a distribution and there should be sufficient income to match an income distribution. A distribution made out of trust capital is normally regarded as capital of the beneficiary and so is not taxable. This view was supported in the case of Stevenson v Wishart and Others (59 TC 740).  Trustees should keep records of R185 forms which report the trust income paid to beneficiaries.

If a settlor can't benefit from a discretionary trust the tax is only assessed on the trustees?

Even if the settlor has retained an interest the tax is always assessed on the trustees in their capacity as trustees, it is their liability.

In a discretionary trust if the trustees distribute the income balance and it results in a tax pool charge is the payment of the tax charged to capital account as no income left?

It would still be an income charge but in this situation the funds would have to be “borrowed” from the capital fund. The trustees should endeavour not to over distribute, they could be in danger of breach of trust.

You said that assets in a new IPDI for a non-spouse form part of the beneficiary's IHT estate. Is this correct - or is the trust subject to a 10 year charge?

An IPDI can be set up for a surviving spouse or anybody else the testator chooses. The trust is not part of the relevant property regime and so will not suffer 10 year charges; the value of the trust will be liable to IHT on the death of the life tenant and will be aggregated with the free estate in order to calculate the IHT. If the IPDI is for a person other than the surviving spouse there will potentially be an IHT charge on creation.

Can you explain how income is mandated?

The trustees need to arrange for the income to be paid direct to the beneficiary, so for example if it is a share portfolio they need to arrange with the broker for the income to be paid directly to the beneficiary.

How will the trust know the tax credit claimed by the beneficiary to deduct from the tax pool?

The tax credit is always 45% of the gross distribution and it is this that is deducted from the tax pool regardless of how much is reclaimed by the beneficiary.

What are the rates of tax payable for 20162017 by a bare trust

The bare trust is transparent for tax purposes and any income and capital gains are taxed directly on the beneficiary at their appropriate rates of tax.

What if the trust management expenses exceed the dividends?

In that case you would then offset the trust management expenses against the interest, followed by the non savings income (typically property income). If there is no other income the excess trust management expenses can be carried forward to the next year.

Are accountancy fees deductible as trust management expenses?

Trust management expenses includes expenses which are exclusively incurred for the benefit of the income beneficiary. Accountancy fees are allowable provided they are incurred in calculating the trust’s income, returning the trust’s income, making income tax repayment claims, or getting advice in relation to the preparation of the trust’s income tax return. Other examples of allowable expenses are summarised on HS2392.  Two tax cases have helped formulate what expenses are allowable, Carver v Duncan [1985] STC 356 and H M Revenue & Customs v Trustees of the Peter Clay Discretionary Trust [2009] STC 469, the HMRC manuals should also be checked. Expenses cannot be deducted for calculating the income in settlor interested trusts.

Example 4 shows her getting £150 credit for tax suffered at source on the dividend income from the trust, but she had no tax to pay on her dividend income; is this correct?

Yes. The trust suffers tax at the rates applicable to the trust (the additional rate of tax). If the individual is only a basic or higher rate tax payer (or has the £5,000 0% band for dividends) then they are entitled to a deduction to their tax liability.

If assets pregnant with a capital gain are transferred to a beneficiary then both beneficiary and trustees need to elect for the gain to be held over until sale by the beneficiary. Can a capital loss also be held over until sale by the beneficiary?

To avoid paying the capital gains tax then the trustees and beneficiary can elect to hold over the gain until the sale of the asset. When a beneficiary becomes absolutely entitled to an asset that is standing at a loss then if the trustees cannot use the loss against gains arising in the year the loss can be transferred to the beneficiary, but it can only be used against gains arising on the disposal of that asset.

If a PPR property is transferred into a (discretionary) Will trust on death does the property still qualify for family home allowance if the children and their issue are the only beneficiaries of the Trust?

We think you are referring to the residence nil rate band, the new additional nil rate band for IHT. If the property transfers into a discretionary trust then it is not closely inherited and so will not be eligible for the residence nil rate band.

Are the trustees who have a life interest trust allowed the benefit of the £5,000 0% dividend rate this year if the income has not been officially "mandated" to the beneficiary?

The trustees are not entitled to the £5,000 0% dividend rate whether the income is mandated or not. If the income is not mandated the trustees will pay the tax which the beneficiary can then set against their personal liability. They may be entitled to a repayment if they are no or basic rate taxpayers or they may have an additional liability if they are higher/additional rate taxpayers. If all the income is mandated it is reported directly by the beneficiary and there is no need for the trustees to report the income  and account for the tax.

Can the beneficiary claim the tax reducer for mortgage interest paid by the trustees?

Yes, the beneficiary of an IIP can claim the tax reducer. The trustees of a discretionary trust can claim the reducer in calculating their tax liability.

Does a discretionary trust become an interest in possession trust when conditions are met and the potential beneficiaries become absolutely entitled?

We are not sure what you mean by when conditions are met.  A discretionary trust can be changed, provided it is not barred by the trust deed, by appointing a life interest to one or more of the beneficiaries. The appointment can be revocable, that is it can be reversed, or irrevocable, permanent.

The tax pool shows tax paid £1,622 x 7.5% which is the income used for the trust expenses so is this tax actually paid?

When the draft clauses were first published regarding the change to the taxation of dividends they did not allow for the 7.5% element of the dividend tax charge of 38.1% to be added to the tax pool, echoing the fact that the 10% notional tax credit could not be added to the tax pool. This was amended such that the 7.5% could be used to augment the tax pool. In the example in the webinar we mistakenly added the 7.5% attributable to the expenses paid, this has now been corrected on the slides on the website. The 7.5% tax on the dividends used to pay the expenses does have to paid it is just not added to the tax pool. The income used to pay the trust management expenses is liable to the basic rate tax (7.5% or 20%) but not the additional rate.

Can trustees pay trust tax to HMRC directly (ie outside trust) or must it be paid by trust?

The tax liability is that of the trustees in their capacity as trustees, not in a personal capacity. If the trustees pay a trust liability they will be a settlor for the trust with all the accompanying issues of being a settlor.