Part 2 of 3
This is the Finance Act 2023 version of this article. It is relevant for candidates sitting the ATX-UK exam in the period 1 June 2024 to 31 March 2025. Candidates sitting ATX-UK after 31 March 2025 should refer to the Finance Act 2024 version of this article (to be published on the ACCA website in 2025).
In the first part of this article we looked at the reasons why it may be beneficial to use a trust and the different types of trust.
In this part we shall review the income tax, capital gains tax and inheritance tax implications of using trusts.
Overview
When thinking about trusts and tax it can be 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 8.75% 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
Transfer into trust |
While the property is in the trust |
Property passes absolutely to a beneficiary |
In settlor’s lifetime: On death: |
10-year charge |
• trustees pay a maximum of 6% (known as an exit charge) |
Trusts are subject to the 10-year principal charge and an exit charge when the property passes to the beneficiary. It should be noted that these charges are at a maximum of 6% (30% of the lifetime tax rate of 20%) This tax rate may or may not be significant in the context of the planning that is taking place.
Capital gains tax
As far as CGT is concerned it should be remembered that there is no CGT on death. Where the transfer to or from the trust has not arisen on death, it is necessary to consider whether the assets are chargeable or exempt. If they are chargeable, and a gain has arisen, the availability of reliefs, particularly gift holdover relief, should also be considered.
The CGT implications of transferring assets to a trust, and of property passing absolutely from a trust to a beneficiary, are summarised in Table 2 below.
Table 2 – Capital gains tax and trusts
Transfer into trust |
Property passes absolutely |
In settlor’s lifetime: On death: |
• compute gain by reference to market value |
It should be noted that, due to the availability of gift holdover relief, no CGT need be paid on the transfer of any assets to a trust.
Think of the trust, or the body of trustees, as a separate taxable person. You must then learn the income tax implications of receiving income from a trust and the IHT and CGT implications of the transfer of assets to and from trustees.
Written by a member of the ATX-UK 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.