The new administrative system for settlor-interested trusts unnecessarily complicates the correct collection of tax, increases professional costs and adds to the work of HM Revenue & Customs without producing any extra revenue. This does not sit well with the Government’s focus on tax simplification.
What is a settlor-interested trust?
A person (the settlor) who places assets (money, land, etc) in a trust or who is treated as the investor, creates a settlor-interested trust if the people who benefit under it are or may be the settlor, or the settlor’s spouse or civil partner or the settlor’s minor children.
What is the income tax treatment?
The income of a settlor-interested trust is deemed to belong to the settlor for the purposes of income tax even though the income of the trust is received by the trustees and the settlor may not even be a beneficiary of the trust.
The trustees are required to pay tax at the trustees’ special rates on the income they receive (which may be 42.5 per cent on dividends and 50 per cent on all other income) but the settlor’s marginal rate of tax may be much less.
To avoid the same income being taxed twice any tax paid by the trustees is treated as having being paid by the settlor, so adjustments need to be made between the settlor and the trustees where the amount of tax paid by the trustees is different to the settlor’s liability.
What has changed?
Previously, the settlor received notification from the trustees of the trust’s income; included it in his personal tax return and paid the appropriate rate of tax on the income.
Under the new system trustees must encourage settlors to:
- obtain the repayment
- request a certificate from HMRC advising of the relevant amount
- pass on the repayment to the trustees
It is the introduction of this three-stage process which makes settlor-interested trusts an administrative burden.
The special trust rates for trusts increased to 42.5 per cent and 50 per cent from April 6, 2010 where trustees can accumulate the income. Most settlors of settlor interested trusts will not have a marginal rate of income tax of 50 per cent.
What are the practical problems?
The repayment due may not always be applied for by the settlor or be given to the trustees so in cases where the settlor and the trustees are not in close communication the amounts involved would probably remain unknown and in some cases not claimed. When the special trust rates were lower often only small amounts were at stake and the risks to trustees were negligible. However, this is no longer the case.
The settlor has to request the tax certificate from HMRC identifying the amount of tax repayable to the trustees; the trustees cannot insist on the settlor doing this or paying over the money.
It is likely that professional costs under the new system will increase because the trustees may well have to take professional advice to protect themselves from a claim in negligence by the beneficiaries if they do not pursue repayment.
What are the solutions?
I have written to Her Majesty’s Treasury to express the Law Society’s concerns about the practical implementation of the new system and have asked for changes to be made. We believe it would be simpler to return to the previous administrative system.
If the system is not changed, I have suggested a number of practical solutions as a way of assisting trustees in the fulfilment of their obligations to account for all monies due to the trust:
- Amend the settlor assessable additional sheet for the tax return to provide for the settlor to give permission to HMRC to send a copy of the certificate confirming the amount of the repayment direct to the trustees. This could be a simple “tick box” which, by providing positive consent, would overcome data protection concerns.There could also be space added to insert the trustees’ details; or
- Amend HMRC guidance to state that when a settlor is claiming a repayment he or she should also be required to provide the details of the trustees and be asked to consent to disclosure so that the trustees can be informed of the repayment details.
Section 646 Income Tax Trading and Other Income Act (ITTOIA) 2005 places a duty on the settlor to pay the money reclaimed to the trustees or some other person to whom the income is payable.
Without these practical solutions to ensure the trustees are aware of any repayment made to the settlor, how is HMRC intending to ensure that the settlor meets his duties? Is HMRC going to actively request each settlor to verify that the repayment to the trustees has taken place?
We believe it is appropriate for HMRC to assist settlors and trustees in fulfilling their duties by making information relating to repayments available to the trustees.