When income is paid to say a discretionary trust where the settlor or his spouse is a potential beneficiary, under section 660A ICTA 1988, gross income arising to the trust would be taxed on the settlor for income tax purposes.
In these cases, the income is not subject to tax at the trustees' rate (ie. 25% on dividend income; 34% on other income).
Therefore, if the trust receives £80 building society interest (net of 20% tax), the grossed-up interest of £100 is taxed on the settlor giving rise to a liability of £40 less the £20 already paid meaning that £20 is payable. The settlor can recover this £20 from the trustees. The trustees are left with £60 which they can distribute, without further tax implication to the beneficiary(ies). The beneficiary will have no further tax liability or ability to recover tax if a non-taxpayer.
If the settlor was not liable to tax, he could claim repayment of the £20 suffered by the trustees (at source) but would then have to refund it to them. They would then have £100 to distribute to the beneficiary.
Therefore if the trust receives £90 of UK dividend income (net of 10% tax), the grossed-up income of £100 is taxed on the settlor giving rise to a liability of £40 less the £10 already paid meaning that £30 is payable. (It should be noted that because this counts as trust income (ie. not dividend income) the settlor pays tax at 40% and not 32.5%.) The trustees are left with £60 which they can distribute, without further tax implication to the beneficiary(ies). The beneficiary will have no further tax liability or ability to recover tax if a non-taxpayer.
Two points should be noted:
income to the trust is taxed on the settlor as trust income – not dividend income or other savings interest
once the income is taxed on the settlor, the tax position of the beneficiary receiving the income is irrelevant – no reclaim or further tax is payable.