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A suitable case

Advisers have a strong opportunity to contact solicitors and accountants when reviewing investment trusts

Tony WickendenTax Planning

Last week, I looked at the taxation of income generated by trustee investments and reflected, in particular, on the increase in the rate of tax that trustees of discretionary trusts will suffer on trust income from the next tax year – 50 per cent on non-dividend income and 42.5 per cent on dividend income.

These rates represent a 25 per cent increase on the rates of tax payable in the current tax year. Accordingly, there is both a strong opportunity for advisers to contact solicitors and accountants with a view to reviewing trustee investments and a need to carefully consider the impact on the “tax suitability” of investments that could underly “new” trusts.

I have also referred, in this series of articles, “to the impact on taxation that the inclusion of the settlor or the settlor’s spouse can have on the taxation of trustee investments”. Save for excluded property trusts for non-UK domiciled settlors, the settlor will usually (but not always) need to be excluded from benefit to avoid the IHT gift with reservation of benefit provisions. This is not so for the settlor’s spouse. However, the inclusion of the settlor’s spouse in the class of potential beneficiaries under a discretionary trust will cause the anti-avoidance provisions in respect of trust income to come into play.

Under a trust where the spouse of the settlor may benefit (that is, where the settlor has decided to include the spouse as a beneficiary under a discretionary trust), all trust income is taxed as the settlor’s (even if the settlor’s spouse does not actually receive any benefit from the trust).

Since 2006, when the settlor is assessed under these provisions, trust income retains the character it would have in the hands of the settlor.

his means that the income tax liability of the settlor is calculated in the same way as would have been the case had the income arisen directly to the settlor.

However, despite the settlor being assessed, the trustees will still be liable at the trust rates described above (but without the benefit of the standard rate band), effectively paying tax on behalf of the settlor, and the settlor is then entitled to a credit for the tax paid by the trustees. If the settlor is not a higher rate taxpayer (or, from April 6, 2010, an additional rate taxpayer), any excess tax paid by the trustees may be reclaimed from HM Revenue and Customs. However, any recovery of income tax by the settlor will need to be paid back to the trustees.

Because trustees pay income tax at the equivalent of the higher rate (and, from April 6, 2010, the additional rate), for those settlors who are not higher-rate/additional-rate taxpayers, the inclusion of the settlor’s spouse may result in a reduced overall income tax liability. However, it will not reduce the amount of administrative work for the trustees. Of course, there may be practical reasons why the settlor may wish to include a spouse or registered civil partner among the beneficiaries.

If, in the circumstances described above, the trustees actually distribute income to another beneficiary at their discretion, that beneficiary will not have any further tax liability on such a payment.

It will be essential to ensure that one balances tax efficiency with the need to properly reflect the investor’s attitude to risk and the appropriate resulting asset allocation when selecting the right underlying investment for a trust

The position in relation to trust capital gains is a lot simpler. The introduction of the 18 per cent rate triggered the removal of the “settlor-interested” provisions. The rate payable on gains realised by trustees under all but bare trusts is thus 18 per cent, regardless of who is included in the class of beneficiaries. Under bare trusts there is a “look through” and all gains will be assessed on the beneficiary regardless of age.

Trustees of non-bare trusts will qualify for an annual exemption equal to one-half of that available to individuals – £5,050. However, this amount will be reduced proportionately to the extent that the settlor has established other trusts (other than bare trusts).

For example, if the settlor has established two discretionary trusts, then each trust would qualify for an exemption of £2,525. The minimum exemption that a trust can qualify for, regardless of the number of trusts established, would be £1,010, especially with the introduction of the additional rate of 50 per cent from the next tax year and the application of this 50 per cent tax rate to the income of all discretionary trusts, there should be accelerated interest in the tax planning advantages of investing for capital growth – 18 per cent is, after all, significantly less than 50 per cent (42.5 per cent for dividends).

Of course, as for investments by individuals, it will be essential to ensure that one balances tax efficiency with the need to properly reflect the investor’s attitude to risk and the appropriate resulting asset allocation when selecting the right underlying investment for a trust, existing or new.


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