The taxation of trusts |
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Laurent Vaughan talks about the taxation of trusts
Hundreds of pages have been written about this topic since it is quite complex so this article contains a general overview as to how Inheritance Tax, Capital Gains Tax and Income Tax apply to trusts.
Inheritance Tax
The two main types of trusts are Relevant Property Trusts and Interest in Possession Trusts (‘IIP’). The former is taxed in the following
manner:
1. An entry charge. Lifetime gifts to Relevant Property Trusts are chargeable at the lifetime rate of 20%. If a settlor (i.e. the person who creates the Trust) dies within seven years of a lifetime transfer, the lifetime charge is recalculated at the death rate of 40%.
2. A ten-year anniversary charge. This is a charge on the value of the trust fund at each ten-year anniversary of its creation, at a maximum rate of 6%.
3. An exit charge. This is a charge that takes place when trustees distribute assets to beneficiaries.
With regard to IIP, a life tenant is treated as if he owns the trust assets and on his death, the value of the trust assets is aggregated with the value of his estate, both of which is then chargeable at 40% unless the life tenant is the testator’s spouse, in which case, there is no Inheritance Tax payable.
Capital Gains Tax
Capital Gains Tax is charged on capital gains made on the ‘disposal’ of assets by the Trustees. A disposal takes place when the trustees sell an asset or a beneficiary becomes absolutely entitled to a trust asset. Trustees have an annual allowance but this is
generally half the personal allowance. Should a settlor create several trusts, each trust will not qualify for its own capital gains tax allowance. Instead, that allowance is divided equally between the trusts.
From 23 June 2010, the rate of Capital Gains Tax that applies to Trustees is 28%, having previously been 18%.
Income Tax
Income tax is charged on any income arising from trust assets, for example, savings income, rental income and dividends.
Different tax rates apply to IIP and Relevant Property Trusts.
Turning my attention first to IIP, income is taxed on the basis that it belongs to the life tenant. Trustees do not have a personal allowance so all income is liable for tax at either the basic or trust rates. Trustees pay income tax at the rate of 20% on savings income and rental income, and 10% on dividend income.
The trustees then pay the income to the life tenant (net of tax) and will provide him with details of the amount of tax paid on that income. Meanwhile, the life tenant declares the net income he actually receives and the tax paid on that income by the trustees in his own
tax return. He must pay tax on the net income at his personal rates, so he may have to pay more tax or may receive a tax refund.
As for non-IIP trusts, the trust rate can be two different tax rates depending upon the type of income received. Dividends are taxed at 42.5% with all other income taxed at 50%.
The first £1,000 of income is not taxed at the trust rates but is charged to the rate of tax that would normally apply to that income source. The balance is then taxed at the trust rates. If a settlor creates more than one trust, the£1,000 band is divided among the number of trusts created, subject to a minimum of £200.
January 2013
Disclaimer:
Hundreds of pages have been written about this topic since it is quite complex so this article contains a general overview as to how Inheritance Tax, Capital Gains Tax and Income Tax apply to trusts.
Inheritance Tax
The two main types of trusts are Relevant Property Trusts and Interest in Possession Trusts (‘IIP’). The former is taxed in the following
manner:
1. An entry charge. Lifetime gifts to Relevant Property Trusts are chargeable at the lifetime rate of 20%. If a settlor (i.e. the person who creates the Trust) dies within seven years of a lifetime transfer, the lifetime charge is recalculated at the death rate of 40%.
2. A ten-year anniversary charge. This is a charge on the value of the trust fund at each ten-year anniversary of its creation, at a maximum rate of 6%.
3. An exit charge. This is a charge that takes place when trustees distribute assets to beneficiaries.
With regard to IIP, a life tenant is treated as if he owns the trust assets and on his death, the value of the trust assets is aggregated with the value of his estate, both of which is then chargeable at 40% unless the life tenant is the testator’s spouse, in which case, there is no Inheritance Tax payable.
Capital Gains Tax
Capital Gains Tax is charged on capital gains made on the ‘disposal’ of assets by the Trustees. A disposal takes place when the trustees sell an asset or a beneficiary becomes absolutely entitled to a trust asset. Trustees have an annual allowance but this is
generally half the personal allowance. Should a settlor create several trusts, each trust will not qualify for its own capital gains tax allowance. Instead, that allowance is divided equally between the trusts.
From 23 June 2010, the rate of Capital Gains Tax that applies to Trustees is 28%, having previously been 18%.
Income Tax
Income tax is charged on any income arising from trust assets, for example, savings income, rental income and dividends.
Different tax rates apply to IIP and Relevant Property Trusts.
Turning my attention first to IIP, income is taxed on the basis that it belongs to the life tenant. Trustees do not have a personal allowance so all income is liable for tax at either the basic or trust rates. Trustees pay income tax at the rate of 20% on savings income and rental income, and 10% on dividend income.
The trustees then pay the income to the life tenant (net of tax) and will provide him with details of the amount of tax paid on that income. Meanwhile, the life tenant declares the net income he actually receives and the tax paid on that income by the trustees in his own
tax return. He must pay tax on the net income at his personal rates, so he may have to pay more tax or may receive a tax refund.
As for non-IIP trusts, the trust rate can be two different tax rates depending upon the type of income received. Dividends are taxed at 42.5% with all other income taxed at 50%.
The first £1,000 of income is not taxed at the trust rates but is charged to the rate of tax that would normally apply to that income source. The balance is then taxed at the trust rates. If a settlor creates more than one trust, the£1,000 band is divided among the number of trusts created, subject to a minimum of £200.
January 2013
Disclaimer: