Trusts may hold different assets producing income of differing sources and amounts and thus will attract different tax rates. For example, a trust holding a property that produces rental income will also need a bank account, which may produce bank interest. Other assets such as shares may be held which may produce dividend income and, of course, there may be cash deposits.
Interest and dividends are received gross by all taxpayers (including trusts), but unlike individual taxpayer's, the ‘Dividend Tax Allowance’ and 'Savings Allowance' are not available to trusts as trustees are not individuals for the purposes of income tax. Trusts are also not entitled to personal allowances for the same reason. The two annual tax allowances of £1,000 available to individuals as from 6 April 2017, namely the 'Trading Allowance' and the 'Property Allowance' are not available to trusts.
Rates of tax:
Trustees are liable to pay tax at 7.5 per cent on the gross amount of dividend income and at the basic rate tax (20 per cent) on other income received (including rental income, if any) unless the income is paid directly to the beneficiary, whereby the payment is declared on their personal self-assessment tax returns and taxed accordingly.
'QIIP' trusts cannot make a deduction for any expenses incurred in managing the trust. The only expenses that can be deducted are those relating specifically to a source of income e.g. mortgage interest when calculating the profit or loss on rental income.
The first £1,000 of income is charged either at 7.5 per cent if dividend income or 20 per cent if non-dividend income. Any income above £1,000 is taxed at either the dividend trust rate of 38.1 per cent or at the trust rate of 45 per cent. Should the settlor create more than one trust, this £1,000 is divided by the number of trusts they have. However, if the settlor has set up five or more trusts, then the standard rate band for each trust is restricted to £200.
If income is mandated directly to the trust beneficiaries then the trust is not required to complete a tax return. As such, there may be an argument in favour of mandating income direct to the beneficiary to reduce the compliance costs of tax return submission.
With a 'QIIP' trust, the full amount of income is the beneficiary’s by right and as such will need to be declared on their personal self-assessment tax return. The trustees provide the beneficiary with a form R185 showing the income and tax details to be declared. Credit is given for any tax paid on the trust income received. Therefore, should the beneficiary be a ‘non’ or ‘basic’ rate taxpayer, he/she may be entitled to receive a tax refund, the actual amount being dependent upon the type of income. In addition, a refund will be possible should the beneficiary have any unused 'Dividend Allowance' and/or 'Savings Allowance' available.
If the beneficiary is a ‘higher’ rate tax payer, further tax will be due on the trust income received, being the difference between the 40 per cent rate less the amount of tax paid by the trust, depending upon the type of income; if an ‘additional’ rate taxpayer, the tax rate is 45 per cent with deduction for the trust tax paid.
There may be instances where the beneficiary does not wish to receive the income to which he is entitled (e.g. because that income may use up his personal allowances). If the income is not to be mandated to the beneficiary, then the following are suggestions:
• Should different types of asset be held within the trust, then it might be possible to change the investments away from income to capital growth if the trust terms permit.
• Similarly, again if permitted, any dividends could be withheld from distribution, being allowed to accumulate and held within a single premium bond, for example.
The problem with both of these actions is that although the trustees will have no income tax to pay, there will be no income from which to pay management expenses - unless planned carefully.
• Should there be more than one beneficiary then the trustees of a 'Discretionary' trust could consider whether they would be able to distribute the interest or dividend income to those beneficiaries who can take advantage of the 'Dividend Allowance', if dividends, or the 'Personal Savings Allowance', if interest.
By Jennifer Adams
This article was first printed in Tax Insider in April 2018.