ACCA ATX ^UK Syllabus A1. Income tax - Income tax position of trusts - Notes ^{3 / 3}

Definition of a trust

A trust is an arrangement whereby:

1. Property is transferred by a settlor

2. To the trustees

3. To be held for the benefit of one or more specified beneficiaries

4. On specified terms in the trust deed

5. Therefore:

   Settlor --> Property passes into a trust -->  Trustees are given the legal title to the property

What is interest in possession?

IIP can be the legal right to receive income generated by the trust assets and/or use the trust asset or live in a property owned by a trust.

Types of trusts

1. Discretionary trusts

2. Interest in possession trusts

Discretionary trusts

• No interest in possession exists

• The beneficiaries have no legal right to benefit from the income or capital of the trust

• The trustees decide how the trust assets are invested and managed

• Any distribution of income or capital out of the trust is at the complete discretion of the trustees

Interest in possession trust

• Interest in possession exists

• The beneficiary is known as the life tenant

• The life tenant has a legal right to benefit from the income of the trust

• The trustees will distribute the life tenant’s full entitlement every year

Income tax position of trust beneficiaries

The trust is a separate legal entity for income tax purposes. 

The body of trustees is a separate taxable person. 

The trustees are subject to income tax on the income arising in respect of trust assets each tax year and they distribute income to the beneficiaries. 

(You will not have to calculate IT payable by trustees).

The taxation of trust income

• The trustees account for income tax on the receipt of income by the trust each tax year under self assessment.

• Trustees are taxed at different rates depending on the type of trust.

• Trustees distribute income to the beneficiaries according to the terms of the trust.

Interest in possession trusts

• The life tenant of an IIP trust must be distributed his full entitlement to income each tax year.

• The life tenant is assessed in the tax year of entitlement (not receipt).

• The income of an IIP trust is received by the beneficiary net of 20% tax.

Discretionary trusts

How are the beneficiaries taxed?

They are taxed on the gross trust income in their personal income tax computations and they can deduct from their income tax liability, any tax deducted at source.

• The beneficiary of a discretionary trust only received income at the discretion of the trustees.

• Any income distributed from a discretionary trust is assessed on the beneficiary in the tax year of receipt.

• Discretionary trust income is always deemed to be received by the beneficiary net of 45% tax.

Illustration

John receives £10,000 income from a beneficiary trust.

He is an additional rate taxpayer (45%).

How much income tax will John have to pay on this trust income?

• Solution

  Income tax computation

  £10,000 * 100/55 = £18,182

  I.T. liability £18,182*45%  = £8,181
  Less Tax credit (45%) (£8,181)
  I.T. payable £Nil

Illustration

Jake has put a house and some cash into an I.I.P. trust.

His wife is the beneficiary. She is a higher rate taxpayer.

She lives in the house and the cash has been invested in shares which generate dividends of £5,000/year. 

What amount of income tax is payable by his wife on the dividends?

• Solution

  As she is the life tenant, she will be taxed on the dividend fully each year. 

  Income tax computation
  Dividend £5,000

  Tax
  £500 * 0% = 0 (Dividend NRB)
  £4,500 * 33.75% = 1,519