Title: Bare Trust. Beneficiary is entitled to the income and entitled to the capital at age 18.

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1 Prudential Trusts & Trustee Taxation Part 6 Learning objectives: - Taxation of Trustees - Income Tax - Capital Gains Tax - Inheritance Tax Title: Taxation of Trustees Voice over: I now want to consider the Taxation of Trustees. Title: Bare Trust. Beneficiary is entitled to the income and entitled to the capital at age 18. Voice over: Well the simplest form of trust is a Bare Trust and in a Bare Trust, the beneficiary is entitled to the income and entitled to the capital at age 18. So the tax treatment is very simple. The income is treated as the beneficiary s income and he or she puts it on his or her own self-assessment return. Title: Interest in Possession Trust. Trustees calculate their income in the same way as individuals would. There are no personal allowances or reliefs and Beneficiaries show the amount received in self-assessment returns. Voice over: If we go to a slightly more complex structure, the Interest in Possession Trust, well the Trustees calculate their income in the same way as individuals would. There are no personal allowances or relief s available to Trustees and the person entitled to the income is the Beneficiary and the Beneficiary shows amounts received, in other words the trustees income, in his or her own self-assessment return and gets credit for any tax deducted or suffered. Title: Discretionary Trust. Trustees pay income tax on income at 45%, 38.1% if it is dividend income and have a basic rate band of 1,000 taxed at 20% (dividends 7.5%). Voice over: And the most complex structure is that of a Discretionary Trust. The Trustees of a Discretionary Trust, pay income tax on income at 45%. 38.1% if it is dividend income and the trustees have a basic rate band of 1,000 which is taxed at 20% percent. And that was introduced to simplify the tax administration of small Trusts. Title: When trustees make an income payment to a beneficiary he/she is treated as receiving income on which tax at 45% has been paid. Voice over: When the trustees make an income payment to a beneficiary, he or she is treated as receiving income on which tax at 45% has been paid. So the amount received is grossed up and included as part of the beneficiary s income for the year of receipt. Trustees of course have to deduct tax at 45% in making an income payment. Title: Trustees need to have paid sufficient tax to cover the tax deducted or treated as deducted. Also, tax paid in earlier years can be used to Äòcover payments to beneficiaries in later years using the Tax Pool mechanism.

2 Voice over: And the Trustees need to have paid sufficient tax to cover the tax deducted or treated as deducted. And tax paid in an earlier year, can be used to Äòcover payments to beneficiaries in later years. And this is achieved through the mechanism of a tax pool. Title: Tax Pool mechanism: Trustees collecting the income are taxed if they retain the income.if they pay out to Beneficiaries then tax is collected from Beneficiaries. Voice over: The idea is that the Trustees collect the income, if they retain the income they suffer tax, If it s paid out to Beneficiaries then the tax is collected from the Beneficiaries so there s no double taxation. Title: Preventing the use of Trusts to avoid paying Income Tax. If the Settlor (or spouse or unmarried minor children) retains an interest in a Trust, then the income of the Trust is regarded as the Settlor s income. Voice over: Now as I mentioned, Trusts have been used with the intention of avoiding Income Tax and there are lots of rules which are aimed at preventing this and the most well known rule is that if the Settlor, the person who sets a trust up, retains an interest in a Trust or his spouse retains an interest in the Trust or his unmarried minor children retain an interest in the Trust, then the income of the Trust is regarded as the Settlor s income. And that is quite a sensible rule and one which has application in many different circumstances. Title: Trustees and Capital Gains Tax (CGT). Trustees are subject to CGT. The main events triggering CGT liabilities which could impact trustees are: - Creation of a trust - Actual disposals by trustees Voice over: So let s look at Trustees and Capital Gains Tax. Trustees as a body are subject to Capital Gains Tax and the main events triggering Capital Gains Tax liabilities which could impact trustees are: The creation of a trust, unless of course it was established with exempt assets or on death, and actual disposals by Trustees. Sales of assets transfers to Beneficiaries. So perhaps the Trustees own shares in BP and sell them at a profit. That is a Capital Gain arising to the Trustees. Title: Profit from shares is a capital gain arising to the Trustees. Trustees pay two rates of CGT: - 28% for gains on residential property and Äòcarried interest - 20% on all other assets Voice over: And currently Trustees pay two rates of Capital Gains Tax. 28% for gains on residential property and what s known as Äòcarried interest. And 20% on all other assets. Title: There are no Settlor interested anti avoidance rules applied to CGT. Trustees have an annual CGT exemption as half that available to an individual ( 5,550 for ). Voice over: There are no Settlor interested anti avoidance rules applied to Capital Gains Tax and of course Trustees have an annual Capital Gains Tax exemption which has always been set at half that available to an individual. So the annual exemption available to Trustees is half that available to an individual. In other words 5,550 for And there are anti avoidance rules designed to stop exploitation of the annual exemption by use of multiple Trusts.

3 Title: Trustees can apply for entrepreneurs relief and principal private residence relief. Voice over: In certain situations, Trustees can also qualify for entrepreneurs relief and trustees can qualify for principal private residence relief if, under the terms of the Trust, a beneficiary occupies a dwelling owned by the Trustees. Title: In the context of anti avoidance transfers between Settlor and Trustees and between the Trustees and Beneficiaries are treated as taking place at Äòopen market value Voice over: And in the context of anti avoidance, it s important to remember that transfers between a Settlor and Trustees, and between the Trustees and Beneficiaries, are treated as taking place at open market value. Title: Hold-over relief is available to Trustees and availability can be used to pass assets from one generation to the next without triggering a CGT charge. Voice over: And of course hold-over relief is also available to Trustees in specified situations and the availability of that relief can be used to pass assets from one generation to the next without triggering a Capital Gains Tax charge. Title: IHT. Trusts are very useful in IHT planning, but it s not particularly because of the tax characteristics of Trusts. Voice over: So now turning to Trustees and Inheritance Tax and there is a common understanding that Trusts are very useful in Inheritance Tax planning and that s true but it s not particularly because of the tax characteristics of Trusts. Title: Bare Trusts. The Beneficiary becomes entitled to the Trust at 18 so owners of the assets, subject to attaining the age of majority. Voice over: If we look at Bare Trusts then again, as I ve mentioned before, these are the simplest form of Trust they aren t really Trusts at all but the Trust fund is in the beneficiary s estate The Beneficiary becomes entitled to the Trust fund at 18. So in effect they are already owners of the assets subject to attaining the age of majority. Title: Interest in Possession Trusts and Discretionary Trusts Voice over: Interest in Possession Trusts and Discretionary Trusts have their own special Inheritance Tax regime. And if you put yourself in the position of someone working in HMRC policy division or in the Treasury, faced with designing and developing an inheritance tax system, what would you do in relation to Trusts? Well you re certainly not going to allow a gaping loophole in the UK Inheritance Tax code. Title: They have their own IHT code knows the Relevant Property Regime. Every 10 years there are two tax charges on the value of the Trust fund and when assets leave the Trust Voice over: And for that reason Interest in Possession Trusts and Discretionary Trusts have their own Inheritance Tax code. And this is known as the Relevant Property Regime. So there are two tax charges every 10 years on the value of the Trust fund and when assets leave the Trust. And the following examples show how

4 these tax charges are calculated. And I do appreciate that the examples are quite complex. Title: The maximum tax rate oh the 10th anniversary is 6% and the maximum rate on a transfer to a Beneficiary is also 6%. Voice over: The maximum tax rate on the 10th anniversary is 6% and the maximum tax rate on a transfer to a Beneficiary is also 6% and the calculations show how the effective rates of tax are worked out and the impact on various transfers and on the value of Trust assets. So I hope you ll take time to consider these worked examples and appreciate how the tax code works. [what follows all appears as text on screen] There are two potential IHT charges: 1. Periodic charge (every 10 years) 2. Exit Charge (on assets leaving the Trust) 1. Periodic charge (every 10 years) Clare set up a trust on 1 July 2004 (with no previous chargeable transfers) Before 30 June 2014 the Trustees made advances to Beneficiaries amounting to 130,000 On 30 June the Trust fund was valued at 230,000 The periodic charge on 1 July is calculated as follows: Cumulative total 130,000 Deemed transfer 230,000 Value 360,000 NRB (325,000) Taxable 35,000 20% 7,000 Actual rate (7,000/230,000x100) 3.04% Effective rate (3.04x30%) 0.912% Tax due (230,000x0.912%) 2, Exit Charge (on assets leaving the Trust) The PQR trust was established on 1 February The initial trust fund was 253,000. The Settlor s cumulative total in the previous seven years was 201,000. The Trustees distributed 400,000 on 20 January Hypothetical transfer 253,000 Settlor s cumulative total 201,000 (454,000) Nil-rate band 325,000 Taxable 129,000 20% 25,800 Effective rate 25,8000/253,000x3/10= 3.059% There have been complete 27 quarters to the exit

5 Appropriate fraction of effective rate is: 27/40x3.059%= 2.065% Tax charge 40,000x2.065%= 826 This is paid by the beneficiary Title: You have now completed this CPD learning. Visit our Testing Centre to test your learning and get your CPD certificate.