Accounting, Taxation and Business Planning
The taxation of trusts can seem complicated, but by understanding the basics, you can make informed decisions about how to manage and distribute trust assets.
It’s wise to seek advice from an accountant or qualified tax professional to ensure that your trust is structured in the most tax-efficient way possible. If you're considering setting up a trust or need help with trust taxation, please reach out to us for guidance.
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UNDERSTANDING THE TAXATION OF UK TRUSTS:
Trusts can be a useful tool for managing assets and ensuring that wealth is passed on to the right people. But, if you're thinking about setting up a trust in the UK, it's important to understand the tax rules that apply to them.
We'll break down some of the basics of trust taxation in a way that’s easy to understand.
What is a Trust?
A trust is a legal arrangement where one person (the "settlor") gives assets, like money or property, to a trustee. The trustee then manages these assets on behalf of the beneficiaries, who are the people meant to benefit from the trust.
Different Types of Trusts
There are several types of trusts in the UK, but for tax purposes, we'll focus on the main ones:
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Bare Trusts – The beneficiary has full control over the assets and can take them at any time. These trusts are seen as look-through.
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Interest in Possession Trusts – The beneficiary has the right to receive income from the trust, but not necessarily the assets themselves.
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Discretionary Trusts – The trustee has the power to decide who gets the income and/or assets, and how much they get.
Taxation of Trusts
Trusts are taxed differently depending on the type of trust and how the income is distributed. Below is a breakdown of the key taxes that may apply:
1. Income Tax
Trusts are taxed on any income they generate, such as interest or rental income. If the income is paid to the beneficiaries, they may also have to pay income tax. However, trustees often pay tax at a higher rate than individuals, so it’s important to consider how income is distributed.
For discretionary trusts, the trustee pays income tax at the higher rate (45%) if the income is not distributed. If the income is distributed to beneficiaries, the trustees can "gross up" the payment to cover the tax that would have been paid. The beneficiaries then pay income tax at their own marginal rates.
2. Capital Gains Tax (CGT)
When a trust sells non-cash assets (like property or investments) for more than they bought them for, it has to pay capital gains tax on the profit. However, there are some exemptions available for certain types of trusts. Trustees generally pay CGT at a rate of 20%, but for residential property, the rate is 28%.
3. Inheritance Tax (IHT)
One of the main concerns for trusts is inheritance tax. If a trust holds assets that are transferred into it, these assets may be subject to IHT if the settlor passes away.
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For discretionary trusts: IHT is charged at a rate of 6% on the value of the assets transferred into the trust, at each 10 year anniversary from its creation, but there’s an allowance called the “nil-rate band” that can reduce the amount of tax due.
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For other types of trusts: The assets in the trust could be taxed on the settlor's death or when the trust’s assets are passed on to beneficiaries.
4. Tax on Trust Distributions
If the trust distributes income or assets to the beneficiaries, they might need to pay tax on what they receive. This is often based on the type of trust and whether the distribution is considered income or capital. Trustees should ensure the appropriate amount of tax is deducted before making payments to beneficiaries.
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What is self-assessment?Self-assessment is a system or regime by which Her Majesty’s Revenue & Customs (HMRC) assesses and collects direct tax in the UK.
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Should I complete a self-assessment tax return?Most people who pay income tax in the UK do not have to complete self-assessment tax returns. These are primarily employees whose tax is deducted at source under the Pay as you Earn system (PAYE). Self-assessment therefore applies to individuals such as the self-employed (sole traders) who earn in excess of £1,000, landlords that receive rental property income, individuals who receive income from savings, investments and dividends, foreign income, income from tips and commission and any other type of untaxed earnings.
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When are self-assessment tax returns due?The UK tax year starts on 6 April each year and ends on 5 April of the following year. Self assessment returns are due on the 31 January following the end of the tax year. For individuals who wish to submit paper returns, the deadline is 31 October following the end of the tax year.
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What are payments on account?Payments on account are amounts that some individuals are required to pay towards their estimated tax liability for the current tax year. They are calculated based on the previous tax years liability and are paid in two equal instalments of 50% each on the 31st January and the 31st July. These amounts are then deducted from the final liability for the year and a balance payment is usually made, together with a first payment on account for the following tax year.
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How do I get the ball rolling?As a starting point, you would need to register with HMRC in order to receive your 10 digit Unique Tax Payer Reference number (UTR). This number will enable you to submit your tax returns online by the 31st January deadline. If you are completing your own tax return, you would need to create an online account with HMRC once you receive your UTR number. Alternatively, if you need to help and support with getting your tax affairs complete and up to date then please get in touch for your free consultation.
How Can We Help?
Tax planning can be complex, but there are ways to help reduce the amount of tax your trust might have to pay such as:
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Distribute income to beneficiaries: In some cases, it may be more tax-efficient for income to be distributed to beneficiaries, as they might be taxed at lower rates.
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Use allowances: Make sure to use any tax-free allowances, such as the nil-rate band for inheritance tax.
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Consider the type of trust: Some types of trusts, like bare trusts, of Interest in Possession Trusts (IIP's) might be taxed more favorably than others.
At MW Tax, we can assist with a range of services to help manage your trust more efficiently, and keep up to date with your tax obligations including:
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Dealing with all relevant trust registrations services..
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Analysing and optimising the use of trust management expenses.
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Preparing and submitting your trust return to HM Revenue and Customs and preparing forms R185.
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Calculating and advising on subsequent tax liabilities or refunds due.
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Calculating and advising on trust pools.
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Advising on the tax treatment of income and capital distributions.
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Where necessary, preparing and submitting self-assessment tax returns for the relevant beneficiaries and advising on any tax liabilities or repayments due.