This week I am going to look at the taxation fundamentals underpinning trustee investment. For income tax purposes, most relevant is whether there is a beneficiary entitled to the trust income as it arises.
Generally, if there is a beneficiary entitled to the income from a trust (and the income is not assessed on the settlor), the beneficiary will be assessed to tax on trust income at their marginal rate(s), that is, as if that income were directly theirs and not payable under a trust.
Trustees of such trusts are only taxed at basic rate on any income they actually receive without a tax credit and the beneficiary then receives an equivalent tax credit. From 6 April, the beneficiary has been entitled to a personal savings allowance and dividend allowance. Until 5 April, interest would have normally been paid net of basic rate tax with an equivalent 20 per cent tax credit, and dividends were paid with a tax credit of 10 per cent so that trustees would have no tax to pay on interest or on dividends.
From 6 April, bank and building society interest has been paid gross, as have dividends. Therefore, trustees will now have to pay basic rate tax (20 per cent on interest and 7.5 per cent on dividends) on such income unless the income is paid directly to the beneficiary.
As a concession for tax year 2016/17 HM Revenue and Customs has announced trustees will not need to notify it of savings interest income if the trust has no other income and the tax liability on the savings interest income is under £100.
If no beneficiary is entitled to income, the trustees are taxed at the special trust rates of 38.1 per cent (37.5 per cent until 5 April) on dividend income and 45 per cent on other income above the first £1,000 of gross income in a tax year (the standard rate band).
Income within the standard rate band is taxed at the basic rates, that is, 7.5 per cent on dividends and 20 per cent on interest. Until 5 April interest would normally have been paid net of basic rate tax with an equivalent tax credit and dividends were paid with a tax credit of 10 per cent. As we know, from 6 April bank and building society interest have been paid gross, so have the dividends. Therefore, trustees will have to pay basic rate tax on such income received within the standard rate band. Trustees are not entitled to the PSA or the dividend allowance.
If the trustees accumulate any dividend income in the trust, they pay tax at the appropriate rates of 7.5 per cent within the standard rate band and 38.1 per cent on the remainder as stated above.
However, if they want to distribute that income to a beneficiary, they have to account for tax at 45 per cent, which means they will have some additional tax to pay. The beneficiary will then receive the trust income with a credit of 45 per cent. For example, if the trustees have paid tax at 38.1 per cent on dividends of £1,000 (that is, £381) they will have to pay an extra 6.9 per cent tax (£69). The beneficiary will then receive the trust income of £550 with a credit of £450 (45 per cent). As this income will be classified as “trust income”, neither the PSA nor the dividend allowance will be available to offset against it.
Special rules apply if the settlor or settlor’s spouse can benefit or if the settlor’s minor children, who are neither married nor in a civil partnership, are entitled to, or actually receive, any income from the trust. In such cases any trust income will be treated as the settlor’s for tax purposes, although if the trust is a discretionary trust the trustees still have to account for tax at the trust rates, effectively paying tax on behalf of the settlor, who receives an equivalent tax credit. In such cases the settlor will be entitled to use their PSA and/or dividend allowance.
Investment bonds are subject to their own special taxation regime (the “chargeable event” regime). Where an investment bond is held in trust, the settlor (if living and resident in the UK) will normally be liable to tax on trust gains. The exception to this is where there is an absolutely entitled beneficiary who is not the minor child – neither married nor in a civil partnership – of the settlor (when the absolutely entitled beneficiary will be liable). If the settlor is dead or non UK resident, the trustees are liable.
Trustees are liable to a single rate of capital gains tax at 20 per cent on realised gains (regardless of trust type or whether the settlor has an interest in the trust) unless the asset in question is property that is not the principal private residence of a beneficiary, in which case the rate is 28 per cent. A rate of 28 per cent applied to all trust gains from 23 June 2010 until 5 April 2016. The exception is a bare or absolute trust, which is ignored for CGT purposes (that is, the gains are treated as those of the beneficiary). Trustees have an annual CGT exemption normally equal to one half of the exempt amount for an individual.
The occasion of a beneficiary becoming absolutely entitled under a trust (for example, on attaining a specified age) is a disposal for CGT purposes, although hold-over relief may be available to defer the tax charge in some circumstances.
Under the rules for trusts with vulnerable beneficiaries the trustees may elect to be taxed according to the beneficiary’s tax position where certain conditions are satisfied.
Tony Wickenden is joint managing director of Technical Connection. You can find him tweeting @tecconn