Trusts & Tax: What you need to know

Setting up a trust can be useful way of safeguarding your assets and providing for loved ones, however it is important to consider how trusts are taxed, and how this many affect you or your beneficiaries financially. In this article, we provide an overview of the main types of tax that affect trusts in Northern Ireland.

Taxation of Trusts

With any trust the principal taxes to be concerned about are inheritance tax, capital gains tax and income tax. There are also others which may apply (Stamp Duty Land Tax, for example). The key taxes are relevant on the creation of the trust; during the administration period itself, and; on the termination of the trust.

Inheritance Tax

Most new lifetime trusts will be relevant property trusts and fall into the ‘Relevant Property Regime’. This means that gifts into such trusts are ‘Chargeable Lifetime Transfers’ under the Inheritance Tax Act 1984 (IHTA 1984) and will be subject to a charge to inheritance tax on creation (at a ‘lifetime rate’ of 20% over the available ‘nil rate band’ – currently £325,000).

Every ten years an ‘anniversary charge’ applies (currently at a maximum rate of 6%) and a proportionate charge may arise on payments out of the settlement between anniversaries (an ‘exit charge’).

The death of the settlor within seven years would result in an additional 20% charge to bring the total liability up to the death rate of 40%.

Trusts arising on death are not subject to an entry charge as any inheritance tax liability would arise on the testator’s estate, but the trust would thereafter fall into the Relevant Property Regime. There are special rules for Bereaved Minors’ Trusts and 18 to 25 trusts.

In the case of a Bereaved Minors’ Trust, the trust assets are exempted from the Relevant Property Regime during the minority of the beneficiary and no further inheritance tax will be payable when they take an absolute entitlement at eighteen.

In the case of an 18 to 25 trust, whilst the beneficiary is between those ages a creeping charge to inheritance tax will apply at a rate of 6% per annum, with the result that a beneficiary taking an entitlement at 25 would suffer a maximum inheritance tax charge of 4.2% over and above the available nil rate band. If the vesting age is expressed as being any greater than 25 then the trust would fall within the Relevant Property Regime from the testator’s date of death and be subjected to the normal anniversary and charges until the assets vest.

If an IPDI (Immediate Post Death Interest) ends before the life tenant’s death (for example by the life tenant giving up their interest or by the trustees exercising overriding powers in order to terminate it) then this would be treated as a gift by them at that time. If the trust continues, falling into the Relevant Property Regime, then this will be a chargeable lifetime transfer and the 20% lifetime rate would apply along with ongoing anniversary and exit charges thereafter.

If the IPDI terminates on death then it is added to the free estate of the life tenant for inheritance tax purposes and subjected to a 40% inheritance tax charge along with the free estate on a pro-rata basis. If the assets remain in trust other than on a Bereaved Minors’ Trust/18-25 trust (for the life tenant’s children) or a disabled person’s trust, then it will again become a relevant property trust but there will be no 20% charge.

Capital Gains Tax (CGT)

For all taxable trusts a CGT rate of 20% will apply to disposals of chargeable assets (28% of the case of residential property). These represent the higher rates of CGT. Only 50% of the individual annual exempt amount is available – currently £3,000.00 for 2023/24 – and this must be shared between all trusts created by the same settlor. Where a trust has a ‘vulnerable beneficiary’ (such as in the case of a disabled persons trust), an election can be made for CGT transparency so that any gains are assessed on that beneficiary.

When trust assets vest absolutely in a beneficiary as against the trustees, whether because the beneficiary reaches a specified vesting age, the trustees make an appointment in their favour or the trust is being wound up, this will also trigger CGT and a tax liability will arise on all accumulated gains within the fund or portion of the fund concerned. However, ‘Holdover Relief’ may be available under Section 260 TCGA 1992 to defer the gains so that the beneficiary takes the assets at their base cost with the gains attached. This would be the case on an appointment out of a relevant property trust, or on the vesting of a bereaved minor’s trust or an 18 to 25 Trust.

For IPDI trusts there is a capital gains tax uplift on the death of the life tenant since the trust assets are aggregated with their free estate for Inheritance Tax purposes.

Income tax

For IPDI trusts any income would be returned by trustees at the basic rate and a statement of income provided to the life tenant who must then include that information in their own tax return and pay tax at their own marginal rate.

For trusts without an interest in possession, income is returned by the trustees and the tax paid at the higher rates of tax. This creates what is known as a ‘tax pool’. Any income distributed to beneficiaries of a discretionary trust comes with a tax credit attached from the tax pool which can then in the main be reclaimed by lower rate or non-taxpayers. Again, where there is a vulnerable beneficiary then an election can be made for income tax transparency in the same way as for CGT.

If you would like to find out more about Trusts, the taxation of trusts, or any of the issues raised in this article, please contact Michael Graham.

Find out more about Cleaver Fulton Rankin’s Private Client services here.

This article has been produced for general information purposes and further advice should be sought from a professional advisor.