Topic

Income Tax and the Administration of Trusts

Rates of Tax 

The rates that apply depend upon the type of trust in question and whether they are within or exceed the standard rate band.  The rates of tax are: 

  • Life Interest Trusts and tax within the Standard Rate Band – basic Rate (20%) and dividend income (7.5%)  
  • For Discretionary Trusts where the income exceeds the standard rate band – non dividend income (45%) dividend income (38.1%) 
  • Trusts for the Vulnerable (see later notes). 

Section 479 of the 2007 Act sets out that trustees of Discretionary Trusts are taxed at the higher rates. 

The Standard Rate Band for Discretionary and Accumulation Trusts 

The standard rate band is £1,000 but this has to be shared if the Settlor makes more than one settlement. 

The standard rate band is applied in the following order of priority: 

  • Non savings income 
  • Savings income 
  • Dividend income 

There are special rules for Trusts for the Vulnerable as well as Settlor Interested Trusts neither of which are dealt with here. 

(See Sections 463, 491 and 492 of the 2007 Act). 

Trust Management Expenses 

Only expenses chargeable to income under the general law are deductible for income tax.  Trust Management Expenses are not deductible for the purpose of assessing tax on trustees (Aikin v MacDonald Trustees CES 1894; Inverclyde’s Trustees v Millar CS 1924). 

Tax Returns 

The rules about when the tax return must be submitted and the time limits are the same as for personal representatives.   HMRC can raise assessments in the name of any of the Trustees in a tax year on income as it arises (Section 30AA of The Taxes Management Act 1970) 

Deduction of Trustee Expenses 

Where a beneficiary is entitled to the income from the trust, the  trustees deduct the general management expenses from the net income in the prescribed order provided that they are income expenses under the terms of the Trust or under general Trust law. (See Chapter 8 of the 2007 Act). 

Where there is no right to income the general management expenses are grossed up at the relevant rate and deducted from the gross income. (See Chapter 4 of the 2007 Act for more detail). 

The prescribed order for deducting general trust expenses in all cases is as follows: 

  • UK dividend income 
  • Foreign dividend income 
  • Savings income 
  • Other income

Trustees can deduct allowable asset specific expenses in the usual way, e.g. in respect of rental income. 

HMRC has published guidance on Trust Management expenses (See Trust Management Expenses (TMEs) 2018 (HS392) updated 6 April 2019). 

Interest in Possession  or Immediate Post Death Interest Trust  

The beneficiary has an immediate right to receive the income of the trust fund subject to the deduction of proper administrative expenses.  The trustees are taxed  at the basic or dividend rate as applicable on the income they receive.  If trust administration expenses are deducted before the income is distributed, it is deducted firstly out of dividend income, then other savings income.  The trustees provide the beneficiary with a tax deduction certificate Form R185 (Trust Income).   

EXAMPLE  

In 2018/19  the Trustees of the Fred Brown Will Trust receive Bank interest of £375  and Dividend income of £1,000; the Trustees expenses that are chargeable to income amount to £500.   Alice Brown is the life tenant of the Trust Fund.   

The Trustees will be assessed to tax on the interest at the rate of 20% and dividends at the rate of 7.5% and will pay the tax to the Inland Revenue (£150). 

Alice as the life tenant is entitled to receive the trust income, which is calculated as follows: 

Dividend Income (Gross) 1,000.00 

Bank Interest (Gross) 375.00 

Less (75.00)(75.00) 

Tax paid by Trustees 

Less 

Admin. Expenses (500.00) 

Net Income 425.00300.00 

The Income Grossed up is: 

Dividend:       425 x 100 / 92.5   =  459.46 

Bank Interest:  300 x 100  / 80  =  375.00 

Alice will receive a tax deduction certificate showing: 

Gross Div. Income   –      £459.46 with tax credit of £34.46 

Gross Inv. Income   –      £375.00  with tax deducted of £75.00 

If Alice is a higher rate taxpayer, she will have to account to the Inland Revenue for the balance of tax due. 

Discretionary Trusts 

Discretionary Trusts are trusts where there are one or more potential beneficiaries but none of them has an immediate right to either income or capital of the Trust. The Trustees pay income tax at the higher rates where income exceeds the standard rate band. Income which is within the standard rate band is taxed at 20% or 7.5%. Income exceeding the standard rate band  is taxed at 45% or 38.1%. 

Trustees may deduct allowable expenditure in calculating their liability to tax in the usual way (e.g. allowable expenditure in relation to rental income is deducted from that income). 

General expenses must be grossed up at the relevant rate and deducted in the prescribed order referred to above.  Therefore, if the expenses are deducted from dividend income then they must be grossed up at the dividend rate of 7.5% and for all other income at the rate of 20%.

Once the expenses have been deducted, the tax is charged at the relevant rate depending upon whether the income is within or exceeds the standard rate band. 

EXAMPLE 

The Trustees of A’s Discretionary Will Trust have the following income in 2018/19: 

Bank Interest – £1850  

Dividend Income – £1,350  

Their expenses are as follows: 

General expenses – £150 

2018/19 

Taxable Income

Savings income

Dividend income

Bank Interest  1,875.00 

Dividend income1,350.00 

Less general expenses  

(grossed at 100/92.5)(162.16) 

Taxable Trust Income 1,875.001,187.84 

Tax Charge and Liability 

Savings income 

Standard rate band (1,000 x 20%)200.00 

Higher rate (875 x 45%)393.75 

Dividend income (1,187.84 x 38.1%)452.57 

Tax payable by the trustees1,046.32 

The income distributed to the discretionary beneficiary is not distinguished between the various sources received by the trustees and it is deemed to be received net of tax at the rate of 45% (2018/19).   

Income of Beneficiaries and Tax Deduction Certificates 

Beneficiaries with a Life Interest 

If a beneficiary has a life interest in the Trust Fund, his income for tax purposes is the grossed up amount of the net income after deduction of outgoings payable out of the income by the trustees.  

EXAMPLE 

Bert Smith is the life tenant of the Al Smith Will Trust.  In 2018/19 the trustees received the following income: 

Rental Income – £2,000 

Bank Interest – £1,500 

Dividends – £ 2,500 

The Trustees pay Trust Management Expenses of £500 

Dividend Income 2,000.00 

Bank Interest 1,500.00 

Rental Income 2,000.00 

Less 

Tax paid by Trustees (150.00)(300.00)(400.00) 

Less 

Admin. Expenses (500.00) 

Net Income 1,850.001,200.001,600.00 

The Income Grossed up is: 

Dividend:        1,850  x 100 / 92.52,000.00 

Bank Interest:   1,200 x 100 / 80  =  1,500.00 

Rental Income:  1,600 x 100 / 80  =  2,000.00 

Bert’s Tax Certificate will show: 

Gross Div. Income   –  £2,000.00 with tax credit of £150.00 

Gross Inv. Income    -£1,500.00 with tax deducted of £300.00 

Gross Other  Inc.    – £2,000.00 with tax deducted of £400.00 

If Bert is a higher rate taxpayer, he will have to account to the Inland Revenue for the balance of tax due.  N.B. Even if Bert does not receive the payment until a later date, he will be assessable in the tax year that the income arises. 

Discretionary Trusts  

The beneficiary  is only assessable on receipt of a distribution.  The distribution received is net of the Rate Applicable to Trusts and has a tax credit of 45% rate.   

EXAMPLE: 

Beneficiary A receives a distribution from a discretionary trust of £3,000 on 7 April 2019.  He is treated as receiving it in the tax year 2019/20 and the tax deduction certificate will be as follows: 

 Income Received Tax Paid Taxable Amount 

3,000.002,454.555,454.55