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There are some important changes to the taxation of trusts on the horizon. This blog summarises these changes and how they may affect trustees.
Capital gains tax
The capital gains tax (CGT) annual exempt amount available to trustees is reducing from 6 April 2023. The annual exempt amount (AEA) is the amount of capital gains that trustees can realise during a tax year that are exempt from capital gains tax.
In 2022-23, the CGT AEA available to trusts is £6,150. From 6 April 2023, this is reducing to £3,000 and then further reducing to £1,500 from 6 April 2024.
Trustees also need to be aware that where a settlor has established multiple settlements (generally, most trusts apart from bare trusts), the trust annual exempt amount is apportioned across each settlement, subject to a de minimis limit of 1/5 of the AEA per settlement where 5 or more settlements have been created (and are in existence during the relevant tax year).
For example, if a settlor has created 4 settlements, the AEA of £3,000 in 2023-24 would be apportioned at £750 per settlement. It is not possible to transfer any ‘unused’ AEA from one settlement to another. In 2024-25, the apportioned AEA per settlement would fall to £375 in this example.
For jointly settled trusts, it is the settlor who has established the higher number of trusts that determines how the AEA is apportioned for that trust.
Any taxable capital gains that exceed the trust’s AEA are assessed for CGT at 20% or 28% if the gain arises from the disposal of residential property or carried interest.
Reviewing investment portfolios
Trustees may wish to review investment portfolios in light of the reductions to annual exempt amounts to ensure that unexpected capital gains (and therefore CGT liabilities) are not triggered, especially, for example, portfolios which may be regularly rebalanced, sometimes automatically, to maintain a target asset allocation in the portfolio.
With the reduction to the CGT AEA, capital losses can be increasingly important.
Any losses incurred during the same tax year as capital gains must be fully offset against the capital gains until the capital gains are reduced to £0. Any remaining losses can then be carried forward indefinitely to set against capital gains arising in future tax years.
Investment bonds may offer a tax-efficient and administratively simple solution to trustees, where investment bonds are an appropriate investment.
The following features of investment bonds may be attractive:
Non-income producing assets
Investment bonds are non-income producing assets – a liability to income tax will only arise if a ‘chargeable event’ is triggered. Investment bonds are also not, generally, subject to capital gains tax.
A chargeable event is triggered on an investment bond on:
- The death of the life assured which triggers payment of the death benefit
- If the bond (or bond segments) are assigned for financial consideration (for money or money’s worth)
- The maturity of the bond if it is written to a specific date
- Taking withdrawals that exceed the bond’s cumulative 5% p.a. withdrawal allowance (an ‘excess chargeable event’)
- The full and final surrender of the bond or segments within the bond.
The 5% withdrawal allowance
Investment bonds allow up to 5% of the amount invested to be withdrawn each year without incurring an immediate tax liability. Any part of this 5% allowance that is not used during a particular year can be carried forward to future years. The total available 5% allowances cannot exceed the amount invested in the bond.
At the end of each policy year, all withdrawals taken during that policy year are tested against the bond’s cumulative 5% withdrawal allowances and, as discussed above, if withdrawals taken exceed the cumulative 5% withdrawal allowances, an excess chargeable event is triggered. The excess over the cumulative 5% allowances is subject to income tax in the tax year in which the chargeable event is triggered.
When the bond (or segments within it) is finally surrendered, all withdrawals taken and excess chargeable event gains arising during the lifetime of the bond (or surrendered segments) are taken into account to determine the final chargeable event gain subject to income tax
Taxation of dividends inside bonds
Dividends received within the life funds held in a UK bond are not subject to tax within the fund (unlike other income arising to the fund) as the profits from which the dividend derived have already been subject to corporation tax in the hands of the dividend paying company. However, when a chargeable event gain arises on a UK investment bond, the policyholder receives a 20% income tax credit on the whole gain to reflect the tax paid within the life funds. This tax treatment makes investment bonds a tax-efficient vehicle within which to accrue dividends.
Taxation of chargeable event gains
Chargeable event gains realised by the trustees of a bare trust are generally assessed against the absolute beneficiary(ies) of the trust. One exception applies where a parent has established a bare trust for a minor, unmarried child and income arising to the trust exceeds £100 p.a. per beneficiary per parent who established the trust. In such a case, the parent(s) are assessed for income tax on the chargeable event gain arising from the investment bond. This rule is often referred to as the parental settlement rule.
Discretionary and other trusts
For discretionary and other trusts, the settlor(s) is generally assessed for income tax on chargeable event gains if the settlor(s) is alive and UK resident during the tax year in which the chargeable event gain arises. The settlor can benefit from top-slicing relief on the chargeable event gain.
If the settlor(s) is either non-UK resident or had died in a previous tax year, UK resident trustees are assessed on chargeable event gains at the rate applicable to trusts (45% for income in excess of the trust’s standard rate tax band (see below)) less the 20% income tax credit if the chargeable event gains arose within a UK investment bond.
Assignment of investment bonds
As an alternative to trustees realising a chargeable event gain, for example on surrender of an invest bond or segments within the bond, the trustees can assign the bond (or segments within it ) to a beneficiary(ies). If the beneficiary(ies) subsequently encashes the bond or bond segments, the beneficiary is then assessed to income tax on the chargeable event gain.
Assignment of bond segments allows the trustees to choose who is assessed for income tax on chargeable event gains and can often result in significantly lower, or no, tax liabilities arising if the encashing beneficiary is a basic rate income tax payer or non-taxpayer.
The standard rate income tax band
Trusts currently are taxed at the basic rate of income tax (20% on savings or non-savings income and 8.75% on dividend income) on income that falls into the trust’s standard rate tax band. The standard rate tax band is £1,000, but, as with the capital gains tax annual exempt amount, the standard rate band is apportioned across all settlements created by the settlor subject to a de minimis limit of £200 per trust. Any income in excess of the trust’s standard rate band is taxed at the rate applicable to trusts (45% for savings and non-savings income and 39.35% for dividends).
It should also be remembered that trusts do not receive a personal savings allowance or dividend allowance.
Trusts whose only income is savings interest
A trust whose only income is savings interest does not need to declare this interest to HMRC provided the interest does not exceed £100 p.a.
Proposed changes to the taxation of trusts from 2024-25
The 15 March 2023 Budget set out proposals to remove the £1,000 standard rate income tax band from 6 April 2024.
A trust that accrues income that does not exceed £500 p.a. from 2024-25 will have this income written down to £0 for tax purposes. Again, this £500 limit is apportioned across all trusts created by the settlor, subject to a de minimis limit of £100 p.a. per trust.
If the trust’s income exceeds £500 p.a. from 2024-25, all income is assessable for income tax.
How else can Trustee Support Services help me?
We can provide a range of services to trustees and their advisers, including reports on particular aspects of a trust, including taxation, and drafting deeds and other documents, for example to add and/ or remove trustees to a trust or to remove a beneficiary etc. Please feel free to contact us to discuss your requirements – if we are not able to help you, we might just know someone else who can!
This is a summary of the taxation of trusts and does not cover all circumstances. It is based on Trustee Support Services’ understanding of taxation, legislation and HMRC practice as at 26 March 2023, all of which can change without notice.
Trustees and/ or their advisers should not rely on the contents of this blog when taking, or refraining from taking, actions that could affect the tax treatment of a trust. We accept no responsibility for any such actions which may, or may not, be taken.