18 Mar 2015

Readers’ Forum: Settlor’s interest

BKL in the press, Publications

BKL tax adviser Terry Jordan offers advice in Taxation magazine’s Readers’ Forum.

This concerns the tax liability of a trust established by the settlor for the benefit of his children from which he is excluded from benefiting or it is not “settlor-interested”.  However, payments to unmarried minor children would be taxed on the settlor.

 

Is a trust settlor interested, and how should income be declared and taxed?

A director/shareholder of a trading company has transferred his shares into a discretionary trust that was set up for the benefit of his three minor children. A dividend has been paid into the trust, but no distributions have been made out of it.

Our dilemma is how we should deal with the tax reporting requirement. It appears that the trust is “settlor interested” by virtue of the minor children composing the class of beneficiaries, even though the settlor is specifically excluded from benefiting.

As far as we can ascertain, the trust should submit a tax return in the usual way and pay tax on the dividend at the 37.5% rate applicable to trusts.

However, it seems that the settlor should also make a return of the dividend income on his own tax return, but will have a lower tax liability on that income based on the 32.5% rate. This is because his taxable income, including the trust’s dividend income, would be comfortably less than £150,000.

We presume that the income tax liability on the dividend income should be limited to the tax circumstances of the settlor, such that the 32.5% rate should apply. However, we would welcome advice on the correct mechanisms for both reporting the income and making the correct income tax payment.

Query 18,548 – Confused

 

Reply from Terry ‘Lacuna’ Jordan, BKL

Confused’s client has transferred shares in a trading company into a discretionary trust established for the benefit of his three minor children. As with a recent query (18,436) capital gains tax holdover relief would not have been available on the client’s disposal in view of the provisions of TCGA 1992, s 169B and s 169F.

The trust is “settlor-interested” for capital gains tax purposes but, on the premise that the client’s wife as well as the settlor himself is specifically excluded from benefit, it is not settlor-interested for income tax purposes.

As Confused has established, the trustees are liable at the dividend trust rate. A further issue is that the notional tax credit on a dividend does not go into a discretionary or accumulation trust’s tax pool.

Only if the income is paid to or for the benefit of the settlor’s unmarried minor child is it taxed as the settlor’s income under ITTOIA 2005, s 629.

The trustees might consider appointing interests in possession (that could be revocable) in favour of the children, which nowadays would have no inheritance tax effect.

That would remove the trustees’ liability at the trust rate and the settlor would then be liable on the dividend income as it arose (because it would belong as of right to the children) until the children respectively attained age 18 or married under that age. In drafting such appointments, care would be needed to exclude the operation of Trustee Act 1925, s 31 that would otherwise permit accumulation of income to age 18.

 

The article is also available on the Taxation website.