Taxation of Trusts - A brief overview
What is a trust?
A trust exists where one ‘person’ holds property for the benefit of someone else. This Trustees of a
Trust effectively own the property (which can include shares, investments etc), however any income
or ongoing benefit belongs to the beneficiaries. The Trustees are responsible for managing the
assets held by the Trust and appointing income to the Beneficiaries. There are various different
types of Trust that can exist, with various different legal and tax consequences.
Discretionary Trusts
A discretionary trust is a separate legal entity that holds the property and is run and managed by the
Trustees. The Trustees may choose how much income arising in the Trust should be distributed to
which beneficiary or they may have power to accumulate income. These are popular flexible trust
arrangements which allow a person to make provision for someone whilst retaining a level of
protection and control over assets. The Trustees can decide to appoint assets absolutely to the
Beneficiary if they feel this is appropriate subject to the underlying Trust Deed and the tax
consequences.
Discretionary trusts are subject to Inheritance Tax charges based on the value of the trust assets
when they are set up, if assets are extracted at any stage and on every 10th anniversary of their
creation. The rate of tax will depend on the circumstances and assets involved. They also pay
income tax on any income arising in the trust at 45% but a tax credit is passed to beneficiaries when
distributions are made. Capital Gains tax is due on the disposal of assets at a rate of 28%, with an
annual allowance of £5,550.
Interest in Possession Trust
An interest in possession exists where a beneficiary (the life tenant) has the right to income or
enjoyment of trust assets, but the ownership of the underlying asset belongs to another. The
ultimate beneficiary generally takes ownership of that asset on the death of the life tenant.
The trustees are obliged to distribute the trust income to the beneficiary. Since 2006, Interest In
Possession Trusts that are set up during an individuals lifetime are subject to Inheritance Tax in the
same way as Discretionary Trusts with limited exceptions. As a result these are now less common
except where the trust is created by a will.
Interest In Possession Trusts set up on a Will fall into the estate of the life tenant for Inheritance Tax
purposes. The income tax arising is taxed on the trustees at the basic rate, however if the income is
‘mandated’ to the beneficiary it should be included on their own tax return. Capital gains are taxed
on the trustees at the trust rate of tax.
Will Trusts
A will trust is simply a trust created by the Will of a deceased person. These can be in any form but
commonly are interest in possession trusts. E.g. a Will may provide for a spouse to receive an
interest in the income of the estate for life with the capital passing to the children on death. This kind
of immediate post death interest is not subject to Inheritance Tax until the beneficiary with the life
interest dies. There are no 10 year or exit charges as apply to discretionary trusts.
Bare Trusts
These are also sometimes called nominee holdings and are ignored for all tax purposes. They exist
where a person lacks the capacity to hold property personally. E.g. where a person is too young or
lacks mental capacity. They are also used where there are multiple property owners as no more than
four people can be registered on the title deeds for property.
For all tax purposes the income and capital gains are deemed the beneficiaries and are reported on
their tax return accordingly.
Other Trusts
There are numerous other types of trust including trusts for bereaved minors, disabled persons and
people aged 18-25 to which special rules apply.
There are also a number of special categories of trust including charitable trusts which do not
generally pay tax.
Summary
In summary therefore, trusts can provide a useful mechanism of holding property for the benefit of
others but retaining an element of control over the underlying asset.
Each type of trust has different tax consequences and different restrictions that will not suit every
case. Every situation will be different and you should take advice in respect of your own
circumstances.
www.davisons-uk.com
May 2015
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