This section explains briefly how different types of trusts are charged to income tax and capital gains tax. Inheritance tax is covered in the IHT series of booklets obtained from Direct.Gov.uk
Different tax rules apply to settlor interested trusts, non-resident trusts and special trusts, and are not covered in this guide.
Depending on the type of trust, when income and capital gains arise in a trust, tax might be charged on
- the trustees
- the beneficiaries
- the settlor
How is a bare trust taxed?
Bare trusts are treated for tax purposes as if the beneficiary holds the trust property in his or her own name. Income tax and capital gains tax are charged on the beneficiary, as if the trust did not exist.
The beneficiary must declare any income and capital gains on his or her personal tax return. Although trustees can pay income tax on behalf of a beneficiary, it is the beneficiary who is chargeable to tax.
How is an interest in possession trust charged to income tax?
The trustees are normally chargeable to income tax on income received, so
- rent and trading income are chargeable at the basic rate (currently 20%)
- UK dividend income is chargeable at the starting rate for dividends (currently 10%) and the tax credit attached to the net dividend meets the trustees' liability
- savings income, such as bank interest, is chargeable on the trustees at the lower rate (currently 20%) Such income usually has tax deducted at source by the bank or building society, and this is taken into account in taxing the trustees.
The beneficiaries are entitled to the income from the trust after tax and expenses, and are taxed on this in the normal way. They are entitled to credit for tax paid by the trustees or deducted at source.
If beneficiaries are starting rate taxpayers or non-taxpayers they will be able to reclaim some or all of the tax paid, though tax credits on dividends cannot be paid. If they are liable at higher rates, further tax will be due.
How is a discretionary trust charged to income tax?
The trustees are liable to tax on income received at the rate applicable to trusts (currently 45% ), but dividends and other similar income are chargeable at the trust rate that applies to dividends (currently 27.5%).
All income paid to the beneficiaries carries a credit at the rate applicable to trusts. So, the payment is treated as if it had been made after the deduction of tax at that rate. If beneficiaries are basic or starting rate taxpayers, or non-taxpayers, they will be able to reclaim some or all of the tax paid. If they are liable at higher rates, further tax will be due.
If the trustees also have power to accumulate income, they can choose to do so and that income becomes additional capital of the trust. If, in later years, the trustees distribute some of the accumulated income to the beneficiaries the payment is a capital distribution, and not an income distribution. Beneficiaries are not taxable on capital distributions.
What is a 'tax pool'?
When trustees of a discretionary or accumulation and maintenance trust pay income to beneficiaries they have to ensure that they have paid enough tax to cover the tax credit at the rate applicable to trusts. Trustees, therefore, need to keep a record of tax payments, known as the 'tax pool'.
The tax pool consists of tax paid by the trustees on income they have received, and tax deducted at source, for example by banks or building societies on interest. It does not include non-payable tax credits, such as the tax credit on dividends. When the trustees pay income to beneficiaries the tax pool is reduced by the tax credit on that income.
If the tax in the tax pool is not enough to cover the tax credit needed for the payment to beneficiaries the trustees must pay the difference in their Self Assessment Tax return for the year.
How is an accumulation and maintenance trust taxed?
In the period during which the trustees can accumulate income, the trustees and beneficiaries are taxed in the same way as in a discretionary trust, as described above.
When the accumulation period ends, the tax treatment depends on what happens to the trust property. For example, if:
- an interest in possession trust is formed, then the tax treatment for trustees and beneficiaries of interest in possession trusts will apply
- it becomes a discretionary trust, then the tax treatment for trustees and beneficiaries of discretionary trusts will apply
- the trust comes to an end, and the trustees pass the trust property to the beneficiaries, the trustees may have to pay capital gains tax on any gain arising at that point, but will not have any liability on future income or gains.
How is a mixed trust charged to income tax?
For both trustees and beneficiaries, in a mixed trust the income for each part of the trust will be taxed under the rules for that type of trust. For example, the part of the trust in which there is an interest in possession will be taxed as such, while the discretionary part will be taxed as a discretionary trust.
Trusts and capital gains
Trustees are liable to tax, at the rate applicable to trusts, on any capital gains above an annual exempt amount arising for:
- interest in possession trusts
- discretionary trusts
- accumulation and maintenance trusts, and
- mixed trusts
The beneficiaries are not taxed on any trust gains and do not get credit for tax paid by the trustees.
The annual exempt amount is normally equal to half the annual exempt amount for an individual. Trustees of trusts for the benefit of people who are mentally handicapped or in receipt of certain specified allowances may be entitled to the whole annual exempt amount for an individual.
Where there is more than one trust made by the same settlor, the annual exempt amount is reduced proportionally on the basis of the number of settlements made since 6 June 1978 and still in existence.
I am a trustee. When will I receive a Self Assessment tax return?
Self Assessment is the method for calculating and paying tax. If you are a trustee (except a trustee of a bare trust) you are responsible for completing and sending back a tax return for trust income and gains and paying the tax on time. Failure to do so may result in automatic interest, surcharges and penalties.
Self Assessment tax returns are generally issued each year in April, and ask for details of income and capital gains for the tax year ended on 5 April. You must complete and send us the Trust and Estate tax return by:
- 30 September, if you want HMRC to calculate the tax due, or
- 31 January in the following year if you intend calculating your own liability
If HMRC receive tax return after 30 September, they cannot guarantee to let you know how much you owe in time for you to pay by 31 January. This means that you have to estimate how much to pay. If you pay too little, you will have to pay interest and possibly a surcharge.
When do I have to pay any tax due?
As trustee, you may need to pay the tax due for any one year in three instalments:
- a payment on account on 31 January in the tax year
- another payment on account on 31 July after the end of the tax year, and
- a final payment on the following 31 January, if there is any more due
The first and second payments on account are usually equal to half of the total liability for the previous year (excluding capital gains tax), while the final payment is a balancing payment.
I am not the only trustee. Are we all liable to pay tax due?
All trustees of an individual trust are jointly liable for any tax due, not just a share of it. However, where there is more than one trustee acting you normally arrange for one person, known as the 'principal acting trustee', to deal with the Inland Revenue on your behalf.
The actions of the principal acting trustee are treated as actions of all of the trustees, so
- if he or she deals with everything properly, all of you will be treated as fulfilling your tax obligations
- if he or she fails to fulfil the tax obligations, then you are all treated as failing to meet those obligations
HMRC can recover any tax or interest on tax from any trustee if the principal acting trustee does not pay. Any trustee can be held liable for penalties or surcharges incurred during the period he or she was a trustee.