In the first of a two-part article, Peter Rayney looks at the taxation of dividends received by discretionary trusts.
With many trustees starting to deal with ‘their’ trust tax returns for 2016/17, this is perhaps an opportune time to examine the impact of the new dividend tax regime on discretionary trusts.
The tax legislation (in ITA 2007, s 479) requires that income received by discretionary trusts be taxed at the special trust rates, or in the case of dividend income, the dividend trust rate. This is subject to the overriding rule relating to settlor-interested trusts, which requires the trust income to be taxed on the settlor.
The special ‘discretionary trust’ tax charges arise on income that is either accumulated or payable to the beneficiaries at the trustees’ discretion (ITA 2007, s 480). This is different from an interest in possession trust where a life-tenant beneficiary has an absolute right to the income.
There are broadly two main aspects to discretionary trust tax. First, there is the tax charge arising on the trust income. Second, in some cases, an additional tax charge may arise when the trust distributes income to a beneficiary (where the trust has paid insufficient tax to ‘frank’ the 45% tax credit that attaches to the income distribution). This aspect will be covered in the second part of the article.
Since 2016/17, discretionary trusts have been taxed as follows:
- the first £1,000 of taxable income (known as the standard rate band (SRB)) is taxed at the basic rates – with dividend income taxed at 7.5% and all other trust income taxed at 20% (ITA 2007, s 491). The order of priority for income attracting the SRB is: non-savings income, savings income, and finally dividends. The £1,000 SRB may be divided by the number of trusts set up by the same settlor, subject to a minimum of £200 per trust;
- subject to the above, all trust income is taxed at 45%, with a special 38.1% rate applying to dividend income. The trustees cannot claim the benefit of the personal savings allowance or the £5,000 dividend ‘nil-rate’ band; and
- trust management expenses that are properly chargeable against income can be deducted in computing the tax payable at the higher rates (but not the 7.5% or 20% basic tax rate elements) (ITA 2007, s 484). Trust expenses are set against dividend income before other income (ITA 2007, s 486).
A worked example showing the tax liability calculation for a discretionary trust is shown below.
Example: Discretionary trust income tax computation - 2016/17
The trustees of The Folk Family 2008 Discretionary Settlement received the following income during the year ended 5 April 2017:
Dividend from 20% holding in Dylan Ltd £15,000
Net rental income (after deducting property expenses) £24,700
Bank interest (paid gross) £2,900
The trust incurred administrative expenses (charged against ‘income’) of £897. The net income is accumulated within the trust.
The trust’s tax liability for 2016/17 would be calculated as follows:
(Rental income) £24,700 + (Bank interest) £2,900 = £27,600 £
First £1,000 x 20% 200
Balance £26,600 x 45% 11,970
Dividend income - £15,000 less grossed-up trust management expenses (TMEs) of £970 (i.e. £897 deemed to be paid out of taxed dividend income – therefore £897 x 100/92.5) = £14,030
Net dividend income £14,030 x 38.1% 5,345
Adjustment for TMEs not deductible at the basic rate
£970 x 7.5% 73
Total tax liability 17,588
Practical Tip:
Trust management expenses must be grossed-up at the appropriate tax rate to ensure like is compared with like in the trust tax computation.
