One of the key parts of advising trustees on their investments is helping them out with tax considerations.
So in this part I’ll look at …
What is the tax treatment of investment bonds and OEICs held by trusts?
What we’re looking at here is income tax, capital gains tax and chargeable event rules.
Tax on income
Income tax liability generally follows entitlement to income which will be either dividends or interest. In a bare trust the beneficiary is entitled to the income, so they are fully liable for the tax on it. With an IIP trust, the trustees are liable to basic rate tax on income which they must account for. The IIP beneficiary is fully liable at their marginal rate with a credit for the basic rate tax paid by the trustees. For ease of administration, it is possible with an IIP trust for the trustees to mandate income to a beneficiary so that the beneficiary receives it and the trustees do not. The mandated income is then excluded from the trustee tax return. With a discretionary trust there is no one with entitlement to income so the liability would fall on the trustees. The first £1,000 is taxed at standard rate i.e. basic rate, and the rest at additional rate.
With a discretionary trust, it should be noted that dividends and interest change their nature to become trust income when paid to beneficiaries, so they are liable to tax at 20/40/45%. The trustees need to ensure HMRC gets 45% tax on the dividend and interest the trust receives. Trust income is paid to the beneficiary with a 45% tax credit some or all of which the beneficiary will be able to reclaim. With IIP and bare trusts, dividends and interest maintain their character so the beneficiary will be liable at their full marginal rate but they will be able to benefit from the starting rate for savings, personal savings allowance and dividend nil rate where applicable.
Trustees could, where they have the powers to do so, create a temporary interest in possession for one or more beneficiaries. This would soften the tax blow and the taxation would follow the principles of the IIP trust above. This would allow the beneficiary to access the dividend nil rate and savings allowances.
Two final points:
Settlor interested trust – where the settlor has retained an interest, then the income arising is treated as the settlor's income for tax purposes whether paid out or not. A settlor has retained an interest if the property or income may be applied for the benefit of the settlor, a spouse or civil partner.
Parental settlement - where the beneficiary is a minor unmarried child, the parent is the settlor and income paid or made available to, or belongs to the child, exceeds £100, the full amount is treated as the parent’s income. With a discretionary trust this only applies where the income is paid out to the beneficiary.
Capital Gains Tax
Much simpler. There are only two types of trust – bare and other. With bare trusts the beneficiary is always liable, settlements rules do not apply, and their annual exempt amount (AEA) is available. For all other trusts the trustees are liable. They pay CGT at 20% and have an AEA of half the individual rate (£6,150 20/21). Where the settlor has multiple trusts the AEA is reduced for each trust. Where there are 5 or more each trust has an AEA of £1,230 (20/21). The settlor interested and parental settlement rules described above do not apply.
Chargeable event gains
This follows CGT to a degree in that there are only two types of trust – bare and other.
With bare trust the tax liability on a chargeable event gain almost always falls on the individual, unless they are an unmarried minor child of the settlor where it would fall on the settlor if the gain was over £100. The 5% tax deferred allowance and top slicing are available.
For other trusts it’s a bit more complicated. When chargeable events arise, we first look to the settlor. If they were alive and UK resident in the tax year of the event, they are liable. They can top slice and can also reclaim the tax paid from the trust. Failing settlor liability, the trustees are liable if they are UK resident. They cannot top slice, only have the £1,000 standard rate band and will be liable at 45%. They will have a 20% tax credit if it is an onshore bond. Finally, where neither settlor nor trustee are liable the liability will fall on any UK beneficiary who receives proceeds. Top slicing relief is not available.
Parental settlement is not applicable for “other trusts” as gains would fall on the settlor in the normal course of events
Trustees can assign some or all of the bond to a beneficiary, or appoint some or all of it absolutely to them if they have the power, without triggering a chargeable event. The beneficiary will then be taxed based on their individual circumstances on any subsequent chargeable event.
So, the taxation of trustee investments is fairly involved. Added to that we have the other duties and responsibilities. We’ve identified the type of trust and what they can invest in.
Which leaves the key question what should they buy? That’s part 4!
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