Taxation of investment bonds held in trust

Trustees administering an investment bond in trust must be aware of who is liable for the tax charge when a chargeable event gain (CEG) arises. It is important to note that various factors determine who is assessed for income tax on the CEG.

Investment bond taxation falls into the ʻChargeable Eventʼ regime. Investment bonds are non-income producing assets and are capital in nature but certain transactions are treated as chargeable events.

When a chargeable event occurs, a calculation is done to establish if there is a gain (or CEG). Despite being capital in nature, when a CEG arises on an investment bond, it is assessed for income tax as deemed income, not capital gains tax. Chargeable events occur on:

• Death of the sole or last life assured and the death benefit becomes payable
• Assignment or transfer of ownership for money or moneyʼs worth (assignments by way of gifts are exempt).
• Adding or removing a life assured once the policy has been set up.
• Maturity
• Excess withdrawals taken which are more than the available 5% tax-deferred allowance
• Surrender or encashment of the bond or individual policies within it

The underlying funds of onshore investment bonds are subject to a special rate of corporation tax (or the ʻpolicyholder tax rateʼ) determined by the basic rate of income tax. As this policyholder tax rate corresponds to the basic rate, currently 20%, life funds are not affected by changes to corporation tax rates, such as the recent rise to 25% (tax year 2023/24). The tax paid on the life fund is not paid directly by the investor but as tax is deemed to have been suffered on the fund, the investor receives a non-refundable tax credit equivalent to the basic rate of income tax. Therefore, where a CEG arises for an onshore investment bond, it is treated as having already paid notional income tax at 20% on the gain.

Offshore bond underlying funds are not taxed, except for a small amount of withholding tax on dividends from non-UK equity funds. This means that the fund will grow virtually free of tax and this is known as gross roll up.

CEGs are taxed as savings income within the income tax calculation. The CEG will sit in a different position within the order of income tax calculation depending on if the CEG arises for an onshore or offshore bond.

While this basic rate tax credit cannot be reclaimed, it can be set against other taxable income where there is tax charged at the basic rate on income received. For individuals who are only liable at the starting rate for savings or the savings nil rate on that income (s530 ITTOIA 2005; s17 ITA 2007; PAYE130060), the tax credit can reduce their overall income tax liability.

Where an investment bond is held in trust, the trustees are the legal owners of the trust property and they administer/ manage it for the benefit of the beneficiaries, as directed by the trust provisions. Trustees also need to be aware of who is liable for the tax charge when a chargeable event gain (CEG) arises and there are various factors to consider when determining this, including:

• the type of trust
• when the trust was established
• if the settlor(s) are still alive, and if not when they died
• if the beneficiary(ies) are minors and/or vulnerable or incapacitated

Try our interactive tool to determine who is potentially liable for income tax on the chargeable event gain. This tool does not cover the taxation of:

• Personal Injury Trusts
• Vulnerable Personʼs Trusts
• 18 to 25 Trusts
• Trusts for Bereaved Minor

Notes

1. Dead settlor provisions for trusts established before 17 March 1998

Before 17 March 1998, only the settlor was liable to a tax charge for a chargeable gain. The settlor would only be liable if a chargeable event occurred whilst they were alive or in the tax year of their death. However, if the settlor died before 17 March 1998, in subsequent tax years there would be no-one available to be assessed for a gain and therefore no tax liability would exist. Where there were two settlors only one had to die before 17 March 1998 for there to be no tax liability to exist in a subsequent tax year.

This was referred to as the ʻdead settlor ruleʼ.

This rule changed on 17 March 1998 to the regime we are familiar with today, but the rules are not retrospective. Therefore, the dead settlor rule can still apply providing:

• the trust was created, the investment bond set up, and the settlor, or at least one of them died, before 17 March 1998; and
• the investment bond has not had any “top-up” premiums or been altered to increase the benefits or extend the term, on or a er 17 March 1998.

2. Bare or absolute trust

A bare/absolute trust is one in which the beneficiary(s) has an absolute and vested interest in income and capital of the trust. The trusteesʼ duty is to hold the legal title to the trust property on behalf of the beneficiary and transfer it to the beneficiary as required. Whilst the beneficiary is a minor the trustees can manage the property for their benefit, in accordance with the provisions of the trust deed. The person(s) who creates the trust &/or who contributes property/funds to it, is referred to as the donor(s). If a bare trust is established by the beneficiaryʼs parent(s), the parental settlement anti-avoidance rules will apply. The rules apply where the child is absolutely entitled to income (for example if money was simply paid by the parent into a childrenʼs deposit account or the childʼs entitlement is under an absolute or an interest in possession trust set up by the parent). Where this applies, parent(s) will be assessed for any income arising from that trust while the parent is alive and the beneficiary is below the legal age of majority. If the CEG exceeds £100 then the whole amount will be taxed as the parent(s) income. This £100 limit is per parent, per child (including stepchildren, s629 (7)(a) ITTOIA 2005).

Otherwise, the beneficiary(ies) will be assessed for income tax on a CEG as they have an absolute entitlement to the trust assets. If there is more than one beneficiary, the CEG will be proportioned in line with each beneficiaryʼs share of the trust fund. This share of the CEG will be added to the individual beneficiaryʼs other income to be assessed for income tax.

Beneficiaries who are non-UK resident for tax purposes will not usually have a UK tax liability but should take appropriate tax advice in their country of residence.

3. Settlor(s)

The settlor is any person(s) who has transferred property or contributed funds to the trust - either directly or indirectly - both at the time the trust was created and at any later date. It is possible for a single trust to have multiple settlors. Where a trust is created by means of a Deed of Variation, the person(s) making the Variation will be treated as the settlor(s) for the purpose of assessing to tax any CEG(s) subsequently arising under the trust.

4. Discretionary and interest in possession trusts – settlor(s) alive

CEGs are firstly assessed on the settlor provided they are UK resident and alive during the tax year that the CEG arises. Top slicing relief will be available in respect of any CEG assessable on the settlor (as it will for CEGs attributable to beneficiaries as described in 2. above).

If there is more than one settlor, the CEG will be proportioned in line with each settlorʼs contribution to the trust. For example, joint settlors would usually contribute the investment amount equally, so the CEG would be split 50/50. This share of the CEG will be added to the individual settlorʼs other income to be assessed for income tax and normal top-slicing relief rules would apply.

The settlor (or his personal representatives) has a statutory right to recover, from the trustees, any additional income tax they pay in the tax year in question as a result of being assessed on any CEG arising in the trust. If the settlor does not exercise this right then, to the extent that the amount not reclaimed exceeds any available annual IHT exemption, they will be treated as having made a further transfer of value for IHT purposes.

5. Discretionary and interest in possession trusts – settlor(s) deceased

If a settlor died in a previous tax year, or is not UK resident, then their share of the chargeable gain is assessed on the trustees at the rate applicable to trusts. You can find guidance on determining UK residence for tax purposes here – Residence, domicile and the remittance basis: RDR1 - GOV.UK (www.gov.uk).

The proportional split between more than one settlor still applies where there are joint settlors. If one settlor died in a previous tax year, and the other is still alive, then the CEG will be split and assessed 50% on the surviving settlor and 50% on the trustees.

From 6 April 2024 the £1000 standard rate was abolished and a new regime will be introduced for low income trusts.

This applies to trusts where trustees are liable for the income tax and the total income of the trust is below a ʻde minimus trust amountʼ for the tax year. If this is the case, then no income tax is due on the net income.

The ʻde minimus trust amountʼ where the settlor created one trust is £500. Where the settlor created more than one trust, then the de minimus amount is reduced by dividing the £500 available by the relevant number of trusts. The amount available cannot be less than £100 per trust.

Where trust income is above £500 for the tax year, it will not qualify for this regime and income tax will be payable on the full amount at the trustee rates:

• 45% for non-dividend income
• 39.35% on dividend income

CEGs are taxed at the rate applicable to trusts, which is currently 45%. There is no top slicing relief available in this instance.

6. Residence of trust

A trust is UK resident for income tax purposes if either; a) all the trustees are resident in the UK or, b) there is a mixture of resident and non-resident trustees (where at least one trustee is UK resident and another is not) and the settlor was UK resident, ordinarily resident or domiciled at the time they transferred property to the trust (or immediately before his/her death in the case of a trust arising on the settlorʼs death). A professional trustee who is not resident in the UK is treated as resident for income tax purposes if they are carrying on the business of a trustee through a branch, agency or permanent establishment in the UK (TSEM10020).

If the trustees are not UK resident when the CEG arises, any UK resident beneficiary who receives a benefit under the trust which is derived from the CEG will be taxed on the amount so received at his/her tax rates but without the benefit of either top-slicing relief or any credit for the tax paid within the underlying funds in which the onshore bond is invested.

To avoid the tax assessment falling on either the settlor or the trustees, or to secure top-slicing relief where the beneficiary is otherwise liable as in (6), the trustees could first assign the bond (or one or more of its constituent policies) to a beneficiary free of the trust. When the assignee beneficiary subsequently triggers the chargeable event, any resulting CEG would be taxed on him/her as the outright owner. In this way full top-slicing relief will be available to help minimise the exposure to higher and/or additional rate tax and, if any such liability should arise, the 20% nonrepayable tax credit (onshore bonds) will serve to reduce the amount of tax actually payable by the beneficiary on the CEG realised.