With effect from 6 April 2010 the Finance Act 2009 increased the trust rate to 50% from 40% and the dividend trust rate from 32.5% to 42.5%.
Which trusts are affected?
These rates apply to any trust where the trustees can accumulate the income. There is no gradual introduction of the rates. Personal income tax rates only increase to 50% if the individual’s income exceeds £150,000 but the standard rate band for trusts remains at £1,000.
By contrast, where beneficiaries have a right to receive income, the trustees pay tax at the basic rate and the beneficiary only pays more tax than that on the trust income if their taxable income including the trust income exceeds £37,400 for 2009/10 (i.e. if the beneficiary is a higher rate tax payer).
Repayment of tax
Where trustees of a trust where beneficiaries have no right to income choose to distribute income to a beneficiary who is liable to tax at less than the 50% rate, that beneficiary is entitled to a repayment of the difference between the 50% rate and the beneficiary’s personal rate.
Should trustees accumulate income?
Trusts that accumulate income will be penalised for saving for the future. From 6 April 2010, there is a powerful disincentive to accumulate income for the future benefit of beneficiaries. If the trust accumulates income then income tax has to be paid on the accumulated income at 50%.
Should trustees exercise discretion to pay out income?
If the trust distributes the income, then additional tax has to be paid by the trustees on the distribution unless there is a positive ‘tax pool’ to frank the distributions. If the trust has been running for some time without making income distributions then it is likely to have a positive ‘tax pool’, but this will quickly be used up if income distribution becomes the norm. The additional tax liability will then have to be paid from trust funds. Inevitably, there will be less available for distribution to the beneficiary.
Should trustees change their investment strategy?
Trustees may wish to re-think their investment strategy. If capital investments can be switched at a low or no CGT cost to be invested for capital growth rather than income this would provide the opportunity in future to make capital distributions at less than 6% IHT and possibly 18% CGT rather than 50% income tax. Post the Election rumour has it that non-business gains will be subject to a higher rate of CGT. So trustees will need to watch ‘jumping out of the frying pan into the fire’.
Should trustees change the trust?
If the trustees can exercise a power to give a beneficiary a right to receive income, trust income will effectively be taxed at the beneficiary’s rates. Such powers often allow trustees to grant revocable rights, which mean that they can retain control and flexibility over future income payments. However, trustees do need to balance short term advantages against the longer term needs of all the beneficiaries in each case. The legal and tax costs of switching coupled with the need to balance interests may militate against precipitate action.
All information contained in this Briefing Note is of a general informational nature and is intended to be helpful. It does not represent legal advice. Whilst reasonable endeavours are taken to ensure that information is accurate and up-to-date as at the date of publication, STEP and its contributing authors do not accept liability or responsibility for any loss or damage occasioned to any person acting or refraining from acting on any information contained in this Briefing Note. Specialist legal or other professional advice should be sought before entering (or refraining from entering) into any specific transaction. This Briefing Note is not intended to be directional in nature but informative.