Settlor Interested Trusts

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23/02/1900

Interpretations from HMRC

The December 2009 issue of the HMRC Inheritance Tax and Trusts Newsletter contains some useful interpretations of HMRC’s view on the income tax treatment of settlor-interested trusts. What follows consists, in the main, of the text of the HMRC Newsletter. The bits in italics have been added by us for clarity/information.

Settlor-interested trusts - Income Tax

For income tax purposes, a settlor-interested trust is one under which the settlor or settlor’s spouse is a beneficiary.

With settlor-interested trusts, the settlor is liable for all Income Tax due on income received by the trustees, even income that is not paid out to the settlor. However, the trustees are required to pay the tax, as the recipients of the income.

The Income Tax rate applied depends on how the trust has been set up. If it operates as an accumulation or discretionary trust, the rate for that type of trust will apply ie. standard rate tax (effectively basic rate tax) on the first £1,000 of trust income and, currently, 32.5% on dividend income and 40% on all other income. If it operates as an interest in possession trust, the rate for that type of trust applies. In this case, the trustees are liable for basic rate tax with the beneficiaries entitled to income normally liable to tax at the higher rate (if appropriate) – however, with a settlor-interested trust a liability on the beneficiaries will not arise because it will fall on the settlor.

Although the settlor is liable for all the tax due on income from such trusts (or the settlor – interested element of a partly settlor-interested trust), the trustee must complete a Trust & Estate Tax Return and pay tax on all of the income arising from the trust. Trustees should provide the settlor with a statement of the income they have received showing the rates of tax charged on it, bearing in mind that the income might be taxed in part at basic rate as well as the special trust rates. There is currently no HMRC form for doing this and R185 (Trust Income) is not appropriate for this purpose. HMRC are developing a new form to address this need which should be available in time for the 2009-10 return.

The settlor must then enter on their personal tax return, details of the Income Tax the trustees have paid on their behalf. They do this using form SA107 Trusts etc - the trusts supplementary pages of the main SA100 Tax Return form.

With the rates of income tax for discretionary trusts increasing to 42.5% (dividends) and 50% (other income) from 6 April 2010, it will frequently be the case that the tax paid by the trustees will be greater than the tax liability of the settlor and so a tax reclaim will be appropriate.

Settlor-interested trusts – Capital Gains
Capital Gains Tax is a tax payable on ‘gains’ (profits) made from the sale or transfer of assets such as shares, property or possessions.

For the tax year 2007-08 and earlier, settlors pay Capital Gains Tax on any chargeable gains made by the trustees of settlor-interested trusts.

The definition of settlor-interested trusts for CGT purposes is slightly different from that for income tax in that the settlor, settlor’s spouse or minor child (who is unmarried and not in a civil partnership) must be a beneficiary. These gains are added to the settlor’s personal gains.

Because of the introduction, in 2008/09, of one rate of CGT of 18% for all taxpayers, for the tax year 2008-09 and beyond, the settlor-interested trust rules no longer apply for CGT purposes to trusts. Trustees now pay Capital Gains Tax on any chargeable gains they make above an amount called the ‘annual exempt amount’ which in most instances is usually half that allowed for an individual.

This document is strictly for general consideration only. Consequently Capital Ideas cannot accept any responsibility for any loss occasioned as a result of any action taken or refrained from as a result of the information contained in it. Each case must be considered on its own facts after full discussion with the client's professional advisers

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