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A concept of protecting valuable items

Trusts and Income Tax

A concept of protecting valuable items

We explain six main types of trusts preferred by UK residents and the different Income Tax rates of these trusts.

In the UK, there are six main types of trusts, namely:

  • Bare trusts
  • Interest in possession trusts
  • Discretionary trusts
  • Accumulation trusts
  • Settlor-interested trusts
  • Mixed trusts

For non-residents who want to protect their assets here or want to make sure that their dependents living in the UK are taken care of, the type of trust applicable would be a non-resident trust.

Before we go into each trust type and their tax obligations, let’s get familiar with these terms:

  • A settlor is a person who puts assets into a trust
  • A trustee is a person who manages the trust
  • A beneficiary is a person who benefits from the trust

1. Bare trusts

Bare trusts refer to a simple structure where the trustee holds the assets and incomes of the trust on behalf of the beneficiary. The beneficiary of a bare trust is responsible for paying tax on income from the trust.

Here is an example: you want to provide for a young child, so you set-up a bare trust and create an investment account or a saving account. All funds in the account belong to the child. Once the child reaches 18, they have the absolute right to the money.

Whether your child is 8 or 18, they enjoy the same standard Personal Allowance as everyone else, which is £12,500 a year currently. Anything beyond this threshold is subject to Income Tax.

Here is a snapshot of the income tax bands:

  • No tax to pay if the taxable income is below £12,500
  • 20% basic rate for taxable income between £12,501 to £50,000
  • 40% higher rate for taxable income between £50,001 to £150,000
  • 45% additional rate for taxable income over £150,000

2. Interest in possession trusts

An interest in possession trust means the trustee must pass on all trust income to the beneficiary as it arises (less any expenses). Who pays the Income Tax depends on the arrangements. If the trustee ‘mandates’ the income to the beneficiary (meaning it goes to the beneficiary directly instead of being passed through the trustee), then the beneficiary will need to include the income on their Self Assessment tax return and pay tax accordingly.

If the income is passed to the trustee first, then the trustee will be responsible for paying the Income Tax.

The tax rate depends on the type of income:

  • Dividend-type of income is taxed at 7.5%
  • All other incomes are taxed at 20%

If the beneficiary is a disabled person, special tax rules may apply. It is best to speak to our personal tax accountants if you find yourself in a situation which you aren’t sure.

3. Discretionary trusts

Discretionary trusts are often used when you want to safeguard your assets for the future generations, including descendants who have yet born. Depending on the trust deed, usually trustees of a discretionary trust can decide:

  • What gets paid out (income or capital)
  • Which beneficiary to receive the payments
  • How often payments are made
  • Any conditions to impose on the beneficiaries

Trustees are also responsible for paying tax on income received by the discretionary trust and the tax rates are as follows:

  • Dividend-type of income is taxed at 7.5% (below £1,000) and 38.1% (above 1,000)
  • All other incomes are taxed at 20% (below £1,000) and 45% (above £1,000)

There are two accompanying notes here. The first is that if the settlor has more than one trust, the £1,000 threshold is divided by the number of trusts they have. But if the settlor has set up five or more trusts, each trust is allowed to have the standard rate band of £200.

In addition, trustees do not qualify for the dividend allowance (which is set at £2,000 a year currently). This means trustees must pay tax on all dividends depending on the tax band they fall within.

4. Accumulation trusts

In an accumulation trust, trustees can accumulate income within the trust and add it to the trust’s capital. They may also be able to pay the income out. For example, the beneficiary may be an infant, so the trustees will accumulate the trust’s income until the beneficiary is legally entitled to receive the capital and all incomes.

Accumulation trusts are subject to the same taxation as discretionary trusts discussed above.

5. Settlor-interested trusts

As the name suggests, a settlor-interested trust benefits the settlor or the spouse or civil partner. The trust could be an interest in possession trust, a discretionary trust, or an accumulation trust. Settlor-interested trusts are becoming popular, given that ageing is affecting health care and social costs. What most people do is that they set up a discretionary trust and put their assets in the trust – doing so will make sure that they have money in the future when they can no longer work.

When it comes to taxes, the settlor is responsible for Income Tax on these trusts, even if some of the income is not paid out to them. But because the trustee is the person managing the trust, they have to pay the Income Tax on behalf of the settlor first.

Here’s how it works:

  • The trustee pays Income Tax on the trust income by filling out a Trust and Estate Tax Return.
  • They give the settlor a statement of all the income and the rates of tax charged on it.
  • The settlor tells HMRC about the tax the trustees have paid on their behalf on a Self Assessment tax return.
  • How much tax to pay depends upon what type of trust the settlor-interested trust is.

Give our Personal Tax accountants a call on 020 8108 0090 when you want to make sure your Trust and Estate Tax Return is correct.

6. Mixed trusts

When you combine more than one type of trust, you are setting up what is called a mixed trust. In this situation, the different parts of the trust are treated according to the tax rules that apply to each part.

Non-resident trusts

If you a settlor and you don’t reside in the UK and are not domiciled in the UK, and you have a mixture of resident and non-resident trustees, or you have trustees who all live outside the UK, then you may have set-up a non-resident trust to protect your assets in the UK. The tax rules of non-resident trusts depend on many factors and can get complicated quickly. It is best to speak to one of our personal tax accountants and discuss your situations, so we could advise how to handle capital gains arise from a non-resident trust.

Experienced Trust and Income Tax accountants

When you set-up a trust, you generally have a few objectives which could be:

  • You want to look after someone who can’t manage their money
  • You want to safeguard your assets for your children and grandchildren
  • You want to have enough money to pay for health care and social costs when you can no longer work
  • You want to lower the Inheritance Tax your estate is liable for

Accordingly, you will need to choose a trust that can best address your needs and think about how the different tax rules may affect you. This is where our personal tax accountants can help. We will listen to your situations and explain the characteristics of each trust in detail, including:

  • Advising on the tax advantages and helping you to select the most suitable type of trust
  • Transferring assets into a trust
  • Advising on wills to ensure tax efficiency
  • Maximising inheritance tax reliefs and exemptions
  • Planning lifetime gifts and making full use of exemptions and lower tax rates available
  • Advising on adequate life assurance to mitigate any inheritance tax impacts

Call us today on 020 8108 0090 to discuss your situations and how a trust and its tax rules can best match your financial needs. The first meeting is free and no obligation.

Alternatively, you can also use the enquiry form to get in touch.

Important note
The Provision of Services Regulations 2009 requires us to advise you that our professional indemnity insurer is HCC International Insurance Company PLC, 35 Seething Lane, London, EC3N 4AH.

Our territorial coverage is worldwide except for any professional business carried out from an office in the United States of America or Canada and excludes any action for a claim brought in any court in the United States of America or Canada.

We are not authorised financial advisers but will introduce you to suitable firms or individuals when you are considering transactions that would benefit from authorised advice.

We are not regulated by the Financial Services Act and will refer you to an FSA-regulated provider if that will benefit you.

 

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