Taxation of trusts (United Kingdom)

Trusts in the United Kingdom are subject to a complex system of taxation, encompassing income tax, capital gains tax (CGT), and inheritance tax (IHT). The specific tax rules that apply depend on the type of trust, the residence and domicile status of the settlor, trustees, and beneficiaries, and the nature of the trust assets.

Types of Trusts for Tax Purposes:

For tax purposes, trusts are broadly categorized into:

• Bare Trusts (Absolute Trusts): The beneficiary has an absolute right to both the income and capital of the trust. The beneficiary is treated as the owner of the assets for income tax and CGT purposes.
• Interest in Possession Trusts: The beneficiary has a right to the income arising from the trust assets as it arises. The beneficiary is taxed on this income as it is received.
• Discretionary Trusts: The trustees have the discretion to decide how income and capital are distributed among the beneficiaries. These trusts are generally subject to a higher rate of income tax on undistributed income and may face IHT charges.
• Accumulation and Maintenance Trusts: A specific type of trust for children which accumulates income for their benefit until a specified age. Tax treatment can vary depending on the specific circumstances.
• Settlor-Interested Trusts: Trusts where the settlor (the person creating the trust) or their spouse/civil partner can benefit. These trusts are often subject to special tax rules, particularly concerning income tax.

Income Tax:

The income arising within a trust is taxable. The applicable tax rate depends on the type of trust and the type of income. Undistributed income within a discretionary trust is typically taxed at the trust rate (currently 45%). Income distributed to beneficiaries is taxed at their individual rates, subject to potential credit for tax already paid by the trust. In interest in possession trusts, the income is taxed as the beneficiary's income.

Capital Gains Tax (CGT):

Trustees are liable to CGT on the disposal of trust assets. The CGT rate applicable to trustees is higher than the standard rate for individuals. Trustees have an annual exempt amount (AEA) for CGT, which is significantly lower than the individual AEA. The AEA reduces each year.

Inheritance Tax (IHT):

IHT is a significant consideration for trusts. The creation of a trust can be a chargeable lifetime transfer for IHT purposes if the value of the assets transferred exceeds the settlor's available nil-rate band. Certain types of trust (e.g., those created during the settlor's lifetime into which assets are placed that are not immediately available to beneficiaries) may be subject to periodic IHT charges (every ten years) and exit charges when capital leaves the trust. Bare trusts and trusts benefiting vulnerable persons generally avoid these periodic and exit charges. Gifts to some trusts are Potentially Exempt Transfers, meaning that if the settlor survives seven years, the gift is outside their estate for IHT purposes.

Residence and Domicile:

The residence and domicile status of the settlor, trustees, and beneficiaries can significantly impact the tax treatment of the trust, particularly for international trusts. Non-UK resident trustees may not be liable to UK tax on certain types of income and gains. Non-domiciled settlors may be able to create trusts that are excluded property trusts, offering potential IHT advantages.

Anti-Avoidance Legislation:

A range of anti-avoidance legislation exists to prevent the use of trusts for tax avoidance purposes. These rules are complex and constantly evolving.

Professional Advice:

Due to the complexity of trust taxation, it is essential to seek professional advice from a qualified tax advisor or solicitor. The tax implications of creating or administering a trust can be significant and depend on individual circumstances.