Part 2 of 4
This is the Finance Act 2017 version of this article. It is relevant for candidates sitting the Advanced Taxation – United Kingdom (ATX-UK) (P6) exam in the period 1 June 2018 to 31 March 2019. Candidates sitting ATX-UK (P6) after 31 March 2019 should refer to the Finance Act 2018 version of this article (to be published on the ACCA website in 2019).
From the September 2018 session, a new naming convention is being introduced for all of the exams in the ACCA Qualification, so from that session, the name of the exam will be Advanced Taxation – United Kingdom (ATX-UK). June 2018 is the first session of a new exam year for tax, when the exam name continues to be P6 Advanced Taxation (UK). Since this name change takes place during the validity of this article, ATX-UK (P6) has been used throughout.
In the first part of this article we looked at the reasons why it may be beneficial to use a trust.
In the remainder of this article we shall briefly review the different types of trust and then turn to the tax implications of using trusts in some detail.
A trust is created when a settlor transfers the legal ownership of property to the trustees who hold the property for the benefit of the beneficiaries.
Where a beneficiary is entitled under the trust deed to the income from the property or to use the property, the trust is an ‘interest in possession trust’ and the beneficiary is known as the ‘life tenant’. The person who receives the trust property on the death of the life tenant is known as the ‘remainderman’ and their interest is known as a ‘reversionary interest’.
This form of trust may be used in a will where there is a surviving spouse and children. The surviving spouse (life tenant) is entitled to the income generated by the assets but does not have access to the assets themselves. The children (remaindermen) will receive the assets on the death of the surviving spouse. Under this arrangement, if, for example, the spouse remarries, the capital is protected and will eventually be transferred to the children.
Where the trustees have discretion as to the accumulation and distribution of trust income and assets such that a particular beneficiary only has the possibility (as opposed to a legal right) of receiving a benefit under the trust, the trust is known as a ‘discretionary trust’.
This form of trust enables a settlor to make general provision for the future needs of the beneficiaries in a flexible manner. The trustees will decide how to meet the precise needs of the beneficiaries as and when they arise in the future.
Property can be transferred into trust by a settlor whilst they are alive or via their will. In addition, following an individual’s death, a trust can be created via a deed of variation.
Overview
When thinking about trusts and tax it is helpful to regard the trust, or the body of trustees, as a separate taxable person. Once this point is recognised it becomes reasonably clear that, for example, the trustees will pay income tax on the income generated by the trust assets. Beneficiaries receiving income from a trust are then entitled to a tax credit in respect of the tax paid by the trustees. (Note that the calculation of the income tax liability of trustees is not examinable.)
The transfer of assets to a trust, just like any other transfer of assets, brings to mind capital gains tax (CGT) and inheritance tax (IHT). Both taxes must, of course, be considered again where property passes out of the trust from the trustees to a beneficiary. In both situations it is important to apply the basic rules of the two taxes – the fact that the question concerns trusts should not be allowed to cloud the issue. (Note that the calculation of CGT and IHT payable by the trustees on the transfer of assets to a beneficiary is not examinable.)
Chargeable gains made by the trustees whilst they are managing the trust assets will give rise to CGT. Trustees may also have to pay IHT in respect of the property held within the trust. IHT will be paid every 10 years at a maximum of 6% of the value of the assets within the trust. (Again, note that the calculation of these tax liabilities of the trustees is not examinable.)
Income tax
Income tax is paid by the trustees of the trust on the income generated by the trust assets. The calculation of the income tax liability of the trustees is not examinable.
The beneficiary of an income in possession trust receives income from the trust net of a tax credit of 7.5% in respect of dividend income and 20% in respect of all other income. The gross income is included in the beneficiary’s income tax computation as either other income, savings income or dividend income, depending on the nature of the underlying income. A credit is available for the income tax already suffered.
The beneficiary of a discretionary trust receives income from the trust net of a tax credit of 45%. The gross income is included in the beneficiary’s income tax computation as non-savings income and a credit is available for the income tax already suffered.
Inheritance tax
As far as IHT is concerned, it is important to recognise that value is transferred when a trust is created and when the property passes from the trust to the beneficiary. There may also be a charge, known as a 10-year charge or a principal charge, whilst the property is within the trust.
The inheritance tax implications of transferring assets to a trust and of property passing absolutely from a trust to a beneficiary are summarised in Table 1 below.
Table 1: Inheritance tax and trusts
Download larger version of Table 1
It can be seen from the table that:
Note that Table 1 refers to a trust with an immediate post-death interest. This is a particular type of interest in possession trust, and is treated differently from all other trusts in that the trust property is treated as belonging to the life tenant for the purposes of inheritance tax. Such a trust can only be created on the death of the settlor.
You need to be clear as to what is meant by setting up a trust and the names of the various parties to the arrangements. You must then learn the IHT implications of the transfer of assets to and from trustees.
Written by a member of the ATX-UK (P6) examining team
The comments in this article do not amount to advice on a particular matter and should not be taken as such. No reliance should be placed on the content of this article as the basis of any decision. The authors and ACCA expressly disclaim all liability to any person in respect of any indirect, incidental, consequential or other damages relating to the use of this article.