20 MINS

MINI CPD COURSE

TAXATION OF TRUST INCOME
 Mini CPD Course

THIS COURSE EXPLAINS THE UK INCOME TAX

TREATMENT OF BARE TRUSTS, INTEREST IN
POSSESSION TRUSTS AND DISCRETIONARY TRUSTS.

LEARNING OBJECTIVES
To understand the tax treatment of:
• bare trusts and interest in possession trusts under UK rules
• discretionary trusts, including tax pools, under UK rules
• the above types of trusts where they fall under the
settlor-interested trust or vulnerable beneficiary rules.

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TAXATION OF TRUST INCOME

BARE TRUSTS
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INTEREST IN POSSESSION TRUSTS

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DISCRETIONARY TRUSTS
TAX POOL

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SETTLOR-INTERESTED TRUSTS
VULNERABLE BENEFICIARIES
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QUESTIONS
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ANSWERS TO QUESTIONS

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 Mini CPD Course

TAXATION OF TRUST INCOME

Trusts often contain income-generating assets such as property, securities and deposits. These will be taxed according to
the rules for the particular type of trust.
For income tax purposes there are three main types of trust: bare, interest in possession and discretionary. In addition,
settlor-interested trusts have their own rules, as do some trusts for vulnerable beneficiaries (the term used in the
legislation): bereaved minors and disabled people.
Investment bonds are non-income producing assets, even though chargeable event gains are subject to income tax.
Special tax treatment applies to investment bonds held in trust, so they are not covered in this course.

BARE TRUSTS

A bare trust is the simplest form of trust. The assets subject to the terms of the trust are held for the benefit of the named
beneficiary. There are no conditions or age requirements hence they are sometimes referred to as ‘nominee
arrangements.’ For these reasons, a bare trust is generally ignored for tax purposes: the beneficiary is taxed as the owner
of the asset and, therefore, the recipient of the income that arises.
Any income that arises on the trust assets is paid to the trustees and is taxed on the beneficiary at their marginal rate of tax.

EXAMPLE
Keeley, age 16, was left £50,000 in her grandfather’s will. Her parents – the executors and trustees – administer
the trust that resulted from this legacy. The fund is invested in OEICs, which are to be transferred to Keeley at
age 18. In 2018-19, the trustees use trust income to pay towards school fees. The trust income is assessed on
Keeley, but there is no tax to pay as she has no other income and this amount falls within her personal allowance.

An exception to these rules is the parental settlement provisions. These anti-avoidance rules state that if an outright gift is
made from parents to a minor child and the annual income that arises on that is £100 or more, the income will be taxed
as though it was the parents’.

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 Mini CPD Course

INTEREST IN POSSESSION TRUSTS

Where a trust entitles the beneficiary to receive income, this will usually be taxed under interest in possession rules. This
can be a life tenancy created via a will or a trust set up during lifetime. Most lifetime interest in possession trusts set up
since 21st March 2006 are taxed in the same way as discretionary trusts for inheritance tax purposes. But if a beneficiary
has the current right to the trust income, it’s still an interest in possession trust for income tax purposes.
If the income is paid directly to the beneficiary, they are taxed at their marginal rates on the income received. In this case,
or where the trust income has all been taxed at source, the trustees don’t need to complete a tax return. Instead the
beneficiary includes the income they have received in their own assessment as trust non-savings income, trust savings
income or trust dividend income, which will take into account their personal allowance, personal savings allowance and
dividend allowance.
If the income is not paid directly to the beneficiary (or they don’t declare it), the trustees are subject to basic rate tax.
They do not benefit from a personal allowance, personal savings allowance or dividend allowance so these cannot reduce
the liability. When the post-tax income is later distributed to the beneficiary, it is paid with a credit for the tax paid by the
trustees (detailed on an R185 form).
The beneficiary’s marginal rate income tax liability is calculated using the gross income figure from which the tax credit is
deducted. The beneficiary will either be entitled to a tax reclaim or they will have further tax to pay, which is normally
settled through self-assessment.

EXAMPLE
Sonya, age 24, is the beneficiary of an interest in possession trust set up by her grandmother during her lifetime.
The fund is invested in OEIC fixed interest funds. In 2018/19, the total income of £2,500 was paid directly
to Sonya.
The trustees have no income tax to pay and do not need to submit a tax return in respect of the income.
Sonya is taxed at her own marginal rate on the trust savings income received. Any part of the income that falls
within her personal allowance, £5,000 0% band or her personal savings allowance will not suffer tax.

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 Mini CPD Course
DISCRETIONARY TRUSTS
Trustees of a fully discretionary trust for income tax
purposes can decide when to distribute income to
beneficiaries. Remember that a wide range of ‘relevant
property’ trusts are taxed as discretionary trusts for IHT
purposes – even though some of these have interest in
possession beneficiaries with a right to the trust income.
Unlike bare and interest in possession trusts this means
no beneficiary can be assessed on the income that arises
on the trust’s investments until the trustees pay it to
them. For this reason, the trustees are assessed on the
income in the year of receipt. When trust income is later
distributed to the beneficiaries, they are assessed with
credit given for the original tax paid by the trustees.
The trustees get a standard rate band of £1,000,
although this is split if the settlor created more than
one trust (but not below £200). For this purpose, the
amount of standard rate band depends on the number of
trusts created by the same settlor that are still in
existence in the tax year in question. Income falling
within the standard rate band is taxed at the basic rates
(7.5% for dividends and 20% for non-dividend income).
Above the standard rate band the trustees are charged to
income tax at the top rates (38.1% for dividends and
45% for non-dividend income). No personal allowance,
personal savings allowance or dividend allowance is
available to them.
Because the income tax the trustees pay is often more
than the tax that will ultimately be paid by the
beneficiaries, distributions of income from the trust will
be paid with a tax credit detailed on the R185 form.
Beneficiaries are then assessed at their marginal rate of
tax and overpaid tax is refunded, however the income
they receive loses its original nature and becomes trust
income. Because of this, neither the personal savings
allowance nor dividend allowance can be offset against
it. Furthermore the lower tax rate applying to dividends
is lost and replaced with 45%.
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TAX POOL
To enable the trustees to balance the tax paid on
accumulating income against the tax credit that must be
attached to distributed income they must use a tax pool.
This is an administrative system that allows the trustees
to calculate how much tax they have paid (or been
credited with paying) on income received so that when
they distribute income with a 45% tax credit they will
know whether they have accumulated enough tax to
cover the credit. If they have paid enough the tax pool
will be in surplus; if they haven’t they must pay the
shortfall to HM Revenue & Customs.
EXAMPLE
A discretionary trust receives £5,000 interest in 2018-
19. The trustees income tax liability is:
Total trust income £5,000
Standard rate band
(£200)
(£1,000 x 20%)
Trustee rate
(£1,800)
(£4,000 x 45%)
Total tax paid: (£2,000)
Net trust income £3,000
The trustees decide to distribute all of this income to the
beneficiary in 2018-19. The net distribution of £3,000
will be 55% of the total payment, which means the tax
credit must be:
• £3,000 x 45%/55% = £2,454.
• The trustees have only paid tax of £2,000 so far.
They must, therefore, make up the shortfall of £454.
• The beneficiary will receive total trust income of
£5,454, of which £2,454 is a 45% tax credit.
Alternatively, the trustees could distribute £2,444 net
income. The grossed up amount would be £4,444
carrying a 45% tax credit of £2,000. If so, the trustees
don’t have to make any additional payments of tax to
HMRC out trust capital – which would be required if they
had an insufficient tax pool.
 Mini CPD Course

SETTLOR-INTERESTED TRUSTS

If the settlor or their spouse can benefit from the trust, it will be ‘settlor-interested’. In such cases the trust income will
be treated as that of the settlor. However, in the case of discretionary trusts, the trustees are still liable at the trust rates.
Where the trustees have paid tax at the trust rates, the settlor receives a tax credit and can utilise their personal savings
allowance and dividend allowance. If the settlor obtains a repayment of tax, they have to repay the difference back to
the trustees.

VULNERABLE BENEFICIARIES

Some trusts where no beneficiary has an interest in possession can qualify for vulnerable beneficiary treatment. There are
two categories – trusts for individuals aged under 18 who have lost one or both parents, and some trusts for disabled
people. The trust provisions have to meet criteria as specified in the legislation. The trustees and the beneficiary have to
make an election for this treatment. The overall effect is that trust income is taxed at the beneficiary’s rates.

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QUESTIONS

1. In 2018-19, a beneficiary of an interest in possession trust receives £1,000 of savings income directly from
the trust. Their only other income is £14,000 salary. What tax do they have to pay on the trust income?

i) £200
ii) £75
iii) £0
iv) A £200 refund

2. A discretionary trust tax pool shows tax paid of £400. The trustees wish to distribute £550 net to one of the
beneficiaries. How much tax do the trustees have to pay to HMRC assuming no other income this tax year?

i) £150
ii) £50
iii) £0
iv) £450

3. A bare trust is established with £100,000 for the settlor’s daughter, age 8. Who will be assessed on the
income that arises?

i) The settlor
ii) Both parents
iii) The daughter
iv) The trustees

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 ANSWERS TO QUESTIONS

1.
iii

2.
ii

3.
i

Scottish Widows Limited. Registered in England and Wales No. 3196171. Registered office in the United Kingdom at 25 Gresham Street, London EC2V 7HN.
Authorised by the Prudential Regulation Authority and regulated by the Financial Conduct Authority and the Prudential Regulation Authority. Financial Services Register number 181655.

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