Taxation of trusts (United Kingdom)

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The taxation of trusts in the United Kingdom is governed by a different set of principles to those tax laws which apply to individuals or companies.

Contents 1 Attribution 2 Income tax 3 Capital gains tax 4 Inheritance tax

[edit] Attribution

Trusts are divided into those which can be attributed to an individual human being, and those which cannot. Trusts which can be attributed are taxed in parallel with that individual's tax affairs, while those which cannot have their own regime. The rules apply differently depending upon which tax is in question. Attribution can have one of two effects:

1. The trust's tax affairs may be attributed directly to an individual. For example, if an individual settles money on his or her spouse or minor children, the trust's income and gains are reported on the settlor's own personal tax return, they are aggregated with the settlor's income and gains, and the settlor pays the tax.
2. The trust is taxed in parallel with an individual's tax affairs. For example, if an IPDI or TSI (defined below) comes to an end during the beneficiary's lifetime, the trustees are charged to inheritance tax as if it were a gift made by that beneficiary: if it comes to an end as a result of the beneficiary's death the trustees are charged to inheritance tax as if the trust were aggregated with that person's estate.

Where there is no attribution, the trust will have its own separate tax affairs, and be taxed under its own regime.

In some cases, the attribution rules may affect the tax residence of a trust: for example a trust settled in Bermuda may be subject to UK tax rules by reason of having a UK settlor.

[edit] Income tax

[edit] Capital gains tax

No capital gains tax is levied within the unit trust, but the investor may be liable to capital gains tax on any gain made when the units are encashed. The annual expemtion allowance, the indexation allowance and taper relief, if applicable can be used to reduce any liability to capital gains tax.

[edit] Inheritance tax

See main article Inheritance tax (United Kingdom).

The inheritance tax ("IHT") treatment of trusts was substantially revised by the Finance Act 2006, with effect from 22nd March 2006.

There are three types of inheritance tax treatment:

1. Bare trusts are simply treated as if they are not trusts at all. Their assets are taxed as those of the beneficiary.

2. Relevant Property Trusts are taxed:

• • On creation:
    • If the trust is created inter vivos (i.e. during the settlor's lifetime):
      • It is taxed at half of the current death rate for IHT. The death rate is 40%, and the 2006/7 IHT "nil-band" is £285,000. Therefore if the settlor has made no gifts and settled no trusts in the seven years prior to settling a trust in 2006/7, it would be taxed at nil rate (0%) on the first £285,000 and 20% on the balance.
      • If the settlor dies within seven years of the settlement, the initial 20% charge will be recalculated as if it were a PET, and if that is more than the tax already paid, the balance will be due (but there is no repayment if the recalculation produces a lower result).
    • If the trust is created on death (i.e. a testamentary trust) it will usually suffer IHT at creation under the normal rules, because of the death. There is therefore no need for the trust to be taxed separately on creation.
  • To "ten-year charges", on each tenth anniversary of the settlement (or of the date of death, in the case of a testamentary trust). The rate is 6% on the value of the the trust's assets exceeding the nil-band at that time.
  • To "exit charges" when money leaves the trust: most usually by appointment to a beneficiary. Simplifying a little, the rate of IHT is that proportion of what the next ten-year charge would have been, that the time which has elapsed since creation or the last ten year charge bears to ten years.

3. Interest-in-possession trusts are taxed by attributing the trust's value to the beneficiary who is currently entitled to the income. Accordingly:

• • The value of the trust's assets is taxed at death rates upon the death of a beneficiary with a right to income. It aggregates with that beneficiary's estate, and the trust and the estate share the nil-band between them, in proportion to their values.
  • The value of the trust's assets is taxed as if it was a "PET" where a beneficiary's right to receive income ceases in his or her lifetime.

Generally, before 22nd March 2006, all trusts which had an "interest-in-possession" (that is, a beneficiary with a right to income) were taxed under the interest-in-possession rules, and other trusts were usually either:

• taxed under the rules described as "mainstream" above; or
• were "accumulation and maintenance trusts": a less rigorous regime, which is now obsolescent.

Now, however, all inter-vivos trusts and most testamentary trusts created on or after 22nd March 2006 will be taxed under the "mainstream" rules. The testamentary trusts which are exceptions are:

• Fistly , some trusts which have a less rigorous treatment (not discussed in detail in this article):
  • Disabled trusts
  • Trusts for bereaved minors
  • Age 18-to-25 trusts
• Secondly, some trusts which are taxed under the "interest-in-possession" rules:
  • Immediate post-death interests ("IPDIs")
  • Transitional serial interests ("TSIs")

There are some transitional rules, to deal with trusts which existed before 22nd March 2006. This article does not cover them in detail, but broadly speaking - depending upon the type of trust involved - they either:

• retain the tax treatment they had before the changes were announced, or
• the trustees have a choice either:
  • to bring the trust to an end, or change its nature, before 6th April 2008, or
  • to become subject to the new rules on 6th April 2008.

Source: Schedule 20 Finance Act 2006.