The recent UK Budget statement included the new tax rates for 2018/19, changes to legislation and announcements regarding future consultations. In the recent Budget Philip Hammond, the Chancellor of the Exchequer, stated that the government are planning to review the taxation of trusts; to make them ‘simpler, fairer and more transparent’. Now this is quite a broad statement and could be a review of a specific area of taxation or a wider review covering trusts as a whole.
It is important for trustees of a UK discretionary trust to be aware of the various taxes that they may be liable to as they need to make sure they make correct returns to HMRC and pay the correct tax. There could be liabilities to UK inheritance tax through entry charges, ten year anniversary charges or exit charges, and UK capital gains tax (CGT) on any gains, which after offsetting against losses brought forward, exceed the annual exempt amount.
Capital gains tax
For trustees the annual exempt amount for CGT is half the personal amount (£11,700 / 2 for the 2018/19 tax year) divided across the discretionary trust set up by the same settlor, with a minimum of £1,170 for each trust. So, for example, if an individual settled money into two trusts, one holding an investment bond and another holding collectives, each trust would be entitled to (£11,700 x 50%) / 2 = £2,925.
Discretionary trustees would then pay 20% CGT, or 28% if the gain was realised from residential property.
Whilst gains from investment bonds are chargeable to income tax they are covered by the chargeable events legislation. This means that the gain is assessed on the settlor if they were alive during the tax year and UK resident, failing which the tax liability falls on the trustees. Although we are talking about UK trusts, if the trustees were non-UK resident then the gain would fall on any UK resident beneficiaries. Other income is assessed on the trustees.
For other income such as interest and dividends, where it is assessed on the trustees there is the concept of a ‘tax pool’ to consider and this is one of the main reasons why many trustees use an investment bond wrapper.
When the trustees receive income the trust has a basic rate band of £1,000, again divided across the trusts settled by the same individual, with a minimum of £200 for each trust. Any income in excess of this is subject to additional rate tax.
This may sound relatively straightforward, however complications can arise when any income is distributed to a beneficiary, as the payments out are treated as if income tax of 45% has been paid. The beneficiary is then able to reclaim any overpayment of tax, based on their own tax position. The trustees have to keep track of the income tax they have paid and the amount due – this is known as the tax pool.
If trustees pass income to a beneficiary then it comes with a 45% tax credit, however in reality they may not have paid 45% tax on that income. Part of the income may be taxed at basic rate and dividend income over the basic rate band would only have paid 38.1%, so when making the distribution the trustees need to pay the additional tax to make up the difference.
Joan has settled money into a discretionary trust and this is the only discretionary trust of which she is a settlor. The trustees have received dividend income and £10,000 and want to pass this to a beneficiary of the trust, Eric.
- Eric has pension income of £20,000 and no savings or dividend income.
- The trust gets a full £1,000 basic rate tax band as it is the only trust Joan has set up.
- When receiving the income, the trustees pay the following tax on the dividend income:
- £1,000 x 7.5% = £75
- £9,000 x 38.1% = £3,429
- Total income tax = £3,504
- The net dividend received by the trustees is £10,000 - £3,504 = £6,496
- The amount credited to the tax pool is £ 3,504
- On the subsequent distribution to Eric
- The tax suffered on the dividend income was £3,504
- The distribution is subject to 45% tax, so £10,000 x 45% = £4,500
- The trustees have to pay an additional £4,500 - £3,504 = £996 to HMRC when making the distribution.
- Eric receives a net distribution of £5,500 from the trust
- Tax due by Eric on the dividend income of £10,000 x 20% = £2,000
- Tax suffered on the dividend income is £4,500
- Eric can reclaim the difference between the £4,500 paid and the £2,000 due through his self-assessment.
- As this income will be classified as ‘trust income’ the dividend allowance will be available to offset against it.
It is uncertain what areas the proposed consultation will look at, but these complications for trustees can be removed by the use of an investment bond wrapper to hold any investment. There is also the added flexibility of being able to assign segments from a bond.
The use of a non-UK provider based in a low tax jurisdiction such as the Isle of Man or Ireland can not only offer the trustees tax advantages and the benefit of gross roll-up, but all offer a wide range of investment options. International bonds can offer access to thousands of collective investments, investment platforms, discretionary fund managers and even direct holdings in certain circumstances.