Taking on the role of a trustee carries a duty to act in the best interests of all parties to the trust and to ensure that the trust is properly managed. One of the trustee’s key responsibilities is dealing with the trust’s taxes.
Clarissa Landcastle, trusts and estates administration specialist at Hugh James, explains the tax implications for the three categories of trusts which all trustees must comply with to avoid costly penalties.
Types of trust
For tax purposes, trusts fall within three categories – bare trusts, interest in possession trusts (IIP), and relevant property trusts. Although the specific category may not always be explicitly stated in the trust deed, understanding the type is crucial for tax management.
- Bare trust: In a bare trust, the beneficiary or beneficiaries have the right to all of the trust’s income and capital.
- Interest in possession trust (IIP): In an IIP, a beneficiary has the right to the income generated by the trust.
- Relevant property trust: These allow trustees discretion over how to handle the trust’s income.
Tax reporting
For bare trusts, the trust assets belong to the beneficiary, and taxes are calculated at the beneficiary’s tax rates. The beneficiary is responsible for all tax reporting.
IIP trusts and relevant property trusts both have tax reporting obligations. The most common taxes applicable are income tax, capital gains tax and inheritance tax. Specific rules apply to trusts for vulnerable people and parental trusts, but the following are the general guidelines.
Income tax
If the trust’s annual income is under £500, no income tax is due. If income exceeds £500, the applicable rates are:
- IIP trusts – 8.75% on dividend income and 20% on other income.
- Relevant property trusts – 39.35% on dividend income and 45% on all other types of income.
For IIP trusts, if all income is paid directly to the beneficiary and does not pass to them via the trustees, the beneficiary is responsible for declaring that income themselves. The trustees do not need to include that in the trust’s tax return.
All other income, for both IIP and relevant property trusts, is reportable by the trustees by 31 January following the end of the tax year.
If the trust’s income tax liability in a tax year exceeds £1,000 then HMRC will expect the trust to make payments on account of the following year’s income tax. These payments are due on 31 January and 31 July.
Capital gains tax
Trusts often include assets like shares and property that attract capital gains tax (CGT) when sold or transferred.
Trusts have an annual CGT exemption of £1,500. The current tax rates are:
- Residential property: 24%
- Other chargeable assets: 20%
Capital gains returns for residential property must be submitted to HMRC within 60 days of the completion date, through its online reporting system.
All other types of capital gain are included on the trust’s self-assessment return for the year in which the gain arose, and must be submitted by 31 January of the following year.
Inheritance tax
The inheritance tax treatment of IIP trusts differs depending on whether or not the trust is considered a qualifying interest in possession trust (QIIP).
Qualifying interest in possession trust (QIIP): Typically created on a person’s death, giving a beneficiary the right to benefit from the income of the trust for their lifetime.
A QIIP does not have any inheritance tax reporting requirements during the beneficiary’s lifetime. On the beneficiary’s death the value of the trust aggregates with their estate and is taxed at 40%.
Other IIP and relevant property trusts: These trusts are subject to a different inheritance tax regime. Trustees must review the trust’s inheritance tax position on each 10 year anniversary of the trust (periodic charge reports) and at any point when assets are transferred out of the trust to a beneficiary (exit charge reports).
On each 10 year anniversary of the trust, the trustees must consider whether a report to HMRC is required. If the value of the trust exceeds 80% of the nil rate band sum in force at the time of the anniversary, a report must be filed.
The tax calculations can be complex, depending on the circumstances of the trust, but broadly the rate of tax applicable at a periodic charge is 6% of the trust value.
Trustees should obtain valuations of the trust assets as at the anniversary date.
Exit charge reports
When any assets are paid (appointed) out of the trust, whether any tax is payable on the exit of the assets from the trust will depend on the most recent 10 year anniversary periodic charge calculation.
The inheritance tax report must be filed, and any tax liability paid, by the end of the sixth month following the month in which the anniversary or the exit took place.
Penalties
HMRC can impose penalties for late or non-submission of tax returns, late payments or providing incorrect information. The trustee is liable for these penalties, making accurate and timely tax reporting essential.
How we can help
Trustees must be diligent in understanding and fulfilling their tax obligations to manage the trust effectively and avoid penalties. Seeking professional advice can help ensure compliance with all relevant tax laws and regulations.
Our team at Hugh James can review the trust to advise on the applicable tax reporting requirements, confirm the deadlines for reporting so that the trustee can ensure these are not missed and so protect themselves from liability to penalties, assist with the administration of the trust and the preparation of tax returns, and identify any complex tax issues.
