Trustees and the 50% tax rate
The 50% rate of income tax, due from 6 April 2010, for those earning more than £150,000 in income has been widely reported. What has not gained as much coverage is that this also applies to discretionary trusts with annual income exceeding just £1,000. This means that if no action is taken, the trustees are liable to pay income tax of 50% (or 42.5% in the case of dividend income).
However (as is already the case with trust income currently liable to income tax at 40%), if the trustees pay this income out to beneficiaries, the beneficiaries may be able to claim back some or all of the income tax, depending on their own personal circumstances. This article looks at this and other ways that Trustees can mitigate the effect of the tax rise.
For example, if trustees of a discretionary trust receive dividend income of £30,000, this would give them a net fund to distribute to the beneficiaries of £10,508 without triggering a further tax liability. A beneficiary who is a higher rate taxpayer would receive the net amount, and would have no further tax liability, nor would he be able to claim a repayment. A beneficiary who was a basic rate taxpayer, or who had unused personal allowances, would be able to make a repayment claim of up to £3257. There would clearly be some time, and possibly some professional fees involved in making a repayment claim.
In order to avoid the time and cost involved in making repayment claims and the cashflow implications, the trustees could consider converting the discretionary trust into a life interest trust. There are several ways in which this could be done.
One way would be to give one or more of the beneficiaries the right to receive the income. Trustees could build in flexibility by allowing themselves the option to revoke the right to receive the income at some future date. The beneficiaries would then be taxed on the income, avoiding the need to make repayment claims, and avoiding paying the 50% rate of income tax (assuming that the beneficiary is not in the high earner tax bracket).
Another way of achieving a similar result would be to give one or more beneficiaries the right to the income for a fixed period. The benefit of this option is that it allows the trustees to review the income entitlement on a regular basis, taking into account any changes in circumstances and perhaps also avoiding the ‘trust babe’ mentality of children who come to rely on the trust fund rather than making their own way in life.
Ironically, the changes to the taxation of trusts in 2006 mean that both these options are available to trustees without risking Inheritance Tax charges which would previously have applied.
The message to trustees is to review their income distribution policy before the changes come into effect and to take professional advice about the tax benefits and consequences to back up their decisions.
Reviewed in 2015