Trust income within the standard rate band is not taxable at the rate applicable to trusts, but bears the rate of tax appropriate to that type of income – savings income at 20%, dividends at 10%.
Trustees are liable at the rate applicable to trusts and the related dividend rate if they have power to accumulate income or have discretion over whether the income is made available to beneficiaries.
Income taxed on the settlor of a trust, rather than the trustees is taxed as the settlor’s top slice of income. This normally arises when the settlor has retained an interest in the trust, but also applies where the trust is for the benefit of his infant children. Settlors will be required to pay any refund of tax on deemed trust income back to the trustees.
Capital invested on behalf of an infant unmarried child is treated as a settlement and the income is taxed on the settlor parent if it exceeds the exempt amount.
The annual exempt amount is divided by the number of settlements created after 6 June 1978, subject to the minimum amount. There is no annual exempt amount available when the gains are taxable on the settler under the settler interested trust provisions.
Where a trust has vulnerable beneficiaries, including a minor child who has lost a parent, the trustees may claim to reduce their tax liability (income and capital gains tax) to that which would be borne by the beneficiary. This gives the trustees the benefit of the beneficiary’s personal allowances and basic rate band
Bare trusts established for the settlor’s children benefit from CGT annual exemption. Income is subject to the £100 limit then taxed on the parent as their top slice of income.
A trust (settlement) arises when a person (the settlor) transfers assets to trustees, who hold the assets for the benefit of one or more persons (the beneficiaries), who will receive income and/or capital from the trust.
The income tax position
Income received by the trustees is currently chargeable on the trustees at 45% (UK dividends at 37.5%) where the trustees have the power to accumulate income or have discretion over distribution of income. The 10% tax credit on UK dividends cannot be used to cover any part of the trustees’ liability. There is a standard rate band of £1,000 for which income is treated as taxable at the personal rate of tax for the underlying
Any income paid to beneficiaries who are under eighteen and children of the settlor is treated as the settlor’s own income for income tax purposes.
Where income is paid to beneficiaries it is deemed to be after deduction of tax at 45%. Thus income of £330 net is equivalent to gross income of £600 from which £270 tax has been deducted. This applies notwithstanding the existence of the standard rate band.
A repayment of tax can be claimed (by the parent or guardian while the beneficiary is under eighteen) to recover the additional tax, entitlement to have income taxed at 10 or 20%, and any otherwise unused personal allowances of the beneficiary.
Accumulated income passing to the child on reaching the appropriate age is treated as capital and hence not subject to income tax.
Capital gains treatment
Transfers into the trust are treated as a disposal at open market value by the settler. The settler will be liable to capital gains tax, subject to gifts holdover relief.
Capital gains tax at 28% is payable on disposals of chargeable assets by the trustees, subject to the annual exemption of £5,550.
When a beneficiary becomes absolutely entitled to any chargeable assets of the trust, they will be deemed to be disposed of at market value, and capital gains tax will be payable accordingly. In certain circumstances the trustees’ gain can be held over to the beneficiary.
Inheritance tax implications
Transfers into the trust may be immediately chargeable to inheritance tax at the lifetime rate of 20%, subject to exemptions.
Property remaining within the trust will be subject to the periodic (on a 10-yearly basis) and exit charges.
Tax planning points
If the gift is to the settlor’s own children, it is not advisable for the trustees to pay income to a beneficiary for his or her maintenance etc. while the child is unmarried and under eighteen (in these circumstances it will be treated as the settlor’s own income).
Duty on premiums is the same as for transfers of land (except that the zero rate does not apply where rent of over £600 annually is also payable).
Different rules apply to trusts that: