Taxation of Trusts

A trust needs to be actively managed for as long as it exists. In particular, the Trustees will have to make sure that they account to HMRC for any tax due by the trust. There can be Inheritance Tax or Capital Gains Tax consequences to setting up a trust so it is important that specialist advice is obtained at the outset.

Depending on the nature of the Trust Fund, the Trustees may have to prepare annual accounts and lodge a Trust Return to HMRC every year. Trustees are now obliged to register the Trust through HMRC’s Trust Registration Service.

Income Tax

Any income generated by the trust will be subject to income tax at the rate of 37.5% for dividends and 45% for other income at current rates. Under current rules, it will be possible to mitigate this by streaming out the income to the various beneficiaries and taking advantage of their own tax rates and individual personal allowance rather than the trust rates and low annual allowances.

Capital Gains Tax (CGT)

A trust is also subject to CGT on any assets realised during the course of the administration. The current rates for this are 28% or 20% on any gains. The termination of the trust will potentially give rise to a charge to CGT when the assets are transferred to the beneficiaries. However, under current rules, it will be possible to mitigate this, by applying for holdover relief. This “holds over” the gain on the investments transferred to the beneficiaries giving them a lower acquisition cost. The advantage is that they can realise the investments over a longer period taking advantage of their potentially lower marginal rate of CGT (18% or 10% at current rates).

Inheritance Tax (IHT)

A lifetime trust is a relevant property trust for IHT purposes. These trusts are subject to an entry charge on setting up, a periodic charge every 10 years and an exit charge upon assets leaving the trust. The amount of IHT payable depends on the value of the Trust Fund and is calculated with reference to the available nil rate band.

The lifetime IHT rate is 20%. The 10-year charge is a fairly complex calculation dependent on a number of factors but in broad terms, as the rules stand, the effective rate is 6%. This is, in fact, a maximum figure as there are a large number of figures to take into account and would only apply on the amount in excess of the nil-rate band then prevailing.

Although the IHT position is somewhat complex, it is possible to manage it. The major advantage of the trust is that it is possible to get a large capital sum into a trust without an initial IHT impact and the potential for minimising future impact of IHT. This trust then has the flexibility to make funds available to the family as and when required without forming part of their respective estates.

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