Income tax#

Beneficiary taxable at own tax rates unless an unmarried† minor child of the settlor, in which case the settlor is liable where income exceeds £100 per annum.

Capital gains tax (CGT)

Beneficiary taxable at 18% or 28% and full annual exempt amount available.

Inheritance tax (IHT)**

Gift†† into trust is a potentially exempt transfer (PET). Assets are treated as inside the beneficiary’s estate for IHT purposes.

Income tax#

Trustees taxable at either 10% (dividend) or 20% (interest) depending on the nature of the income. Beneficiary entitled to reclaim tax on interest where they suffer a lower rate but not on dividends. Higher rate taxpaying beneficiary will have additional tax to pay.

Capital gains tax (CGT)

Trustees taxable at 28% on trust disposals and a maximum of half the annual exempt amount.

Trusts annual exempt amount is split between number of trusts (excluding bare trusts) established by settlor to minimum of £1,010 per trust for 2010/11.

Inheritance tax (IHT)**

Gift†† into trust is a chargeable lifetime transfer (CLT). Periodic and exit charges will also apply to the trustees. Settlement will generally benefit from its own full nil-rate band (NRB) at 10-year point.

Tax is payable at entry at one half of the death rates, 20%. Where the settlor pays tax, the gift is grossed up resulting in a tax rate of 25%. Tax is due on the element of the gift which is above the settlor’s available nil-rate band.

Income tax#

The trustees are liable to any income tax arising. The trust has basic rate band of £1,000 within which tax is payable at 10% or 20%. (£1,000 split between number of trusts (except bare trusts) established by settlor to a minimum of £200.)

Above this band income is taxable at 50% or 42.5% depending on source (tax deducted at source can be offset) from 6 April 2010. Where dividend income is distributed to beneficiaries this will be classed as trust income, not dividend income, and further tax may be due by the beneficiary. Beneficiaries may reclaim any overpaid tax at their own rates.

Capital gains tax (CGT)

Trustees taxable at 28% on disposals and maximum of half the annual exempt amount.

Trusts annual exempt amount is split between number of trusts (excluding bare trusts) established by settlor to minimum of £1,010 per trust for 2010/11.

Inheritance tax (IHT)**

Gift†† into trust is a CLT. Periodic and exit charges will also apply to the trustee. Settlement will generally benefit from its own full NRB at 10-year point.

Tax is payable at entry at one half of the death rates, 20%. Where the settlor pays tax, the gift is grossed up resulting in a tax rate of 25%. Tax is due on the element of the gift which is above the settlor’s available nil-rate band.

The CGT changes mean the rate of taxation of 28% applies to all trusts except Bare Trusts. The rate applicable to a bare trust will be based on the beneficiaries taxable income.

Income tax will depend on the nature of the income received by a trust. Where dividend income is distributed from a discretionary trust, the impact of the income being treated as trust income means that, for a higher rate taxpayer, the effective rate of tax is 46% and 55% for an additional rate taxpayer (2010/11). (This is because the beneficiary is unable to receive any credit for the notional tax credit issued with the dividend.) Where income is being received by trustees and rolled up for future capital distribution, trustees could consider non income-producing assets to reduce or mitigate any ongoing income tax charges.

For further details on the taxation of dividends please read 'Dividend taxation for trustees and beneficiaries of a discretionary trust’.

* HM Revenue & Customs have issued guidance that, where a chargeable event occurs under a life policy held in a bare trust for a minor beneficiary, the minor beneficiary will now be assessed for any income tax due and not the settlor (if alive) of the trust as previously understood. However, where either or both parents of the child are the settlors of the trust, the parental settlement rules will remain.
** To the extent that they are not otherwise exempt.
† And not in a Civil Partnership (as defined by the Civil Partnership Act 2004).
†† Unless exempt.
# Realised gains from life policies are taxed as income. They have special rules. Principally, where the settlor is alive, any chargeable event will be assessed on the settlor except under a bare trust where the beneficiary will be assessed, unless the trust is a parental settlement. There is no reclaim facility for the settlor or beneficiaries for any life fund taxation suffered.