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.
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 investment.
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 settlor. The settlor will be liable to capital gains tax, subject to gifts holdover relief.
Capital gains tax at 20% is payable on gains on the disposals of chargeable assets by the trustees, subject to the annual exemption of £5,850.
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 decadal 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).
Different rules apply to trusts that:
- Are created on death by a parent for a minor child who will be fully entitled to the assets in the trust at age 18; or
- Are created either in the settlor’s lifetime or on death for a disabled person
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