Article written by Marc Brinklow, Trust Manager
The Chancellor has brought in a number of changes for trusts and estates with the aim of simplifying the reporting and taxing of small amounts of income to HMRC.
In this article Marc Brinklow, Manager in the Trust Department, explains what the key changes are, when they came into effect, the implications involved and the main tax impacts.
What are the changes?
1.) Low-income exemption – trusts and estates with annual income from any source up to £500 will not be subject to tax on that income.
Where a settlor has a number of existing trusts, the £500 limit will be proportionately reduced for accumulation and maintenance and discretionary trusts, to a minimum £100.
2.) Standard rate band removal – the government will abolish the default basic rate and dividend ordinary rate of tax that applies to the first £1,000 of discretionary trust income (currently, 20% tax on non-dividend income and 8.75% on dividend income). Where a settlor has created more than one trust, the £1,000 band is proportionally reduced to a minimum of £200.
This means that all income will be subject to the Rate Applicable to Trusts (“RAT”) for Income Tax purposes, which is currently 45% on non-dividend income and 39.35% on dividend income for discretionary trusts.
3.) Beneficiaries of UK estates will no longer pay tax on income distributions of up to £500.
4.) Technical amendments will be made to ensure that for beneficiaries of estates that their tax credits and savings allowance continue to operate correctly.
When do the changes come into effect?
The changes relating to the low-income exemption, the removal of the standard rate band and beneficiaries of UK estates who receive income distributions of up to £500 will take effect from 6 April 2024.
The technical amendments referred to above came into effect from 6 April 2023.
What are the implications of the changes?
1.) Despite the introduction of the low-income exemption, any trust or estate with income of more than £500, will be taxed on the full amount of income received, not just the amount above the threshold.
2.) Trust reporting requirements – currently, there is an obligation for a trust or estate to submit a self-assessment tax return and pay tax on any level of income received on an annual basis. However, from 6 April 2024, providing the income is below the £500 exemption limit, there will be no filing requirement or tax liability due.
3.) Tax pools on discretionary trusts – when trustees make a discretionary income distribution, it is treated by the beneficiary as though Income Tax has already been paid at the trust tax rate, currently 45%. The trustees must therefore have paid enough Income Tax in the current and prior years to cover this tax credit.
So, although the trustees will not have to report income under £500, any distributions made to a beneficiary will still involve the trustees in computing the amount of tax payable on the income distributed to ensure that the 45% tax credit remains funded.
4.) Offshore trusts – currently, non-UK trustees are treated as having paid Income Tax at the basic rate (currently at 8.75%) on receipt of UK dividends. Therefore, if discretionary offshore trusts receive UK dividends as their only source of income and this falls within the standard rate band, there is no tax liability or UK reporting requirement.
However, when the standard rate band is abolished, the discretionary offshore trusts may well have a reporting requirement and a tax liability on receipt of UK dividends if the basic rate tax credit is less than the RAT (currently at 39.35%).
What are the tax effects on the beneficiaries of trusts and estates?
1.) Beneficiaries of trusts – with the introduction of the low-income exemption, there will no longer be a tax credit attached to the income of beneficiaries of interest in possession trusts or settlor interested trusts, providing the trust income is below the £500 limit. As a result, any non-tax paying beneficiaries will no longer have to submit a tax repayment claim for any tax suffered on the trust income as they will receive this gross. If the beneficiary is a UK taxpayer, they will no longer receive a tax credit due to no tax having been paid by the trustees.
In the case of a basic rate taxpayer, this will mean that they now have to file a self-assessment tax return, whereas currently, they might not need to if their basic rate tax liability is covered by the tax deducted by the trustees.
The same point is relevant to higher rate taxpayers, although there is more chance that they are already submitting tax returns. The beneficiaries will just need to remember to report the small amounts of trust income.
2.) Beneficiaries of UK estates – when income is distributed to a beneficiary during the administration period of an estate, the beneficiary will include the gross income on their personal tax return and the personal representatives of the estate will then issue a form R185 showing the amount of estate income paid to the beneficiary and the amount of tax paid on that income.
Under the tax rule changes, the beneficiaries of UK estates will not pay tax on income distributed to them within the £500 limit, as mentioned above.
If you would like to discuss specific circumstances, please get in touch.