Comprehensive Guide to Reporting and Paying Tax on UK Trust Income

Let’s say you're the trustee of a family trust set up by a relative to help fund their grandchildren’s education. Each year, the trust earns income from investments and property, and it’s your responsibility to ensure the funds are distributed correctly and taxes are handled properly.

However, the UK tax rules for trusts can be complicated, and failing to comply could lead to costly penalties and legal issues. Sounds daunting, right?

Don’t worry - this guide will break everything down for you. We’ll walk you through the steps to report and pay taxes on trust income for the 2024/25 tax year, offering clear examples and straightforward explanations. By the end, you’ll feel confident and ready to manage your trust without stress, or unexpected costs. Let’s get started and ensure you’re on the right track!

Understanding Trusts in the UK

A trust is a legal arrangement where a settlor (the person who creates the trust) transfers assets to a trustee, who holds and manages them for the benefit of the beneficiaries. Trusts are governed by trust law and can hold various assets, including cash, property, shares, and land. They are commonly established for purposes such as:

• Safeguarding family wealth
• Supporting minors or individuals with disabilities
• Managing tax liabilities

The UK recognises several types of trusts, each with distinct features and tax implications. Below, we outline the most common types and explain their key differences.

1. Bare Trusts:

• A simple arrangement where the beneficiary has immediate and absolute ownership of the trust assets and any generated income from the moment the trust is created.

• The beneficiary is directly responsible for paying taxes on this income and any capital gains.

• The trustee manages the assets on behalf of the beneficiary but does not handle complex tax matters. While trustees may settle income tax on behalf of the beneficiary, the beneficiary remains responsible for it. Trustees are not responsible for capital gains or life insurance policy gains.

• Example: A grandparent establishes a bare trust for a grandchild's education. The grandchild owns the funds and any earned income and is liable for the associated taxes, even if the trustee manages the payments.

• Key Feature: The beneficiary's rights to the assets and income are immediate and unconditional.

2. Interest in Possession Trusts:

• The beneficiary (life tenant) has the right to receive income from the trust's assets for their lifetime or until a specified event (e.g., marriage, reaching a certain age).

• The trustee manages the assets, and the life tenant is entitled to the income (e.g., rental income, dividends). The trust's capital typically passes to other beneficiaries after the life tenant's interest ends.

• The life tenant is liable for tax on the income generated by the trust. Although trustees may pay the tax on their behalf, the life tenant remains responsible. Capital gains tax is generally not the life tenant's responsibility unless capital is later distributed to them.

• Example: A grandparent sets up an IIP trust for their child, who receives the income for life, with the capital passing to the grandchildren upon the child's death.

3. Discretionary Trusts:

• The trustee has full control over how income and capital are distributed among the beneficiaries, based on the trust deed's terms. Beneficiaries do not have an automatic right to income or capital.

• The trustee considers the beneficiaries' needs and circumstances when making distributions. This structure is suitable for situations where future beneficiary needs are uncertain (e.g., providing for children with varying financial needs).

• Discretionary trusts are subject to higher income tax rates on trust income, which the trustees are responsible for paying. Beneficiaries may also be liable for tax on distributions they receive, but they can receive a credit for any tax already paid by the trust. Trustees are responsible for managing any capital gains tax on distributions made from the trust.

• Example: A parent establishes a discretionary trust for their children, allowing the trustee to distribute income or capital based on each child’s financial needs, such as education or healthcare.

Tax Registration for Trusts

Most UK express trusts must register with HM Revenue and Customs (HMRC) via the trust registration service (TRS). This obligation arises from the UK's Money Laundering Regulations, which aim to increase transparency around the ownership of assets held in trusts. Registration is required even if the trust has no immediate tax liability.

Key Registration Requirements:

Who Must Register: All UK express trusts must register, unless they are specifically exempt.

• An "express trust" is generally one that was deliberately created, usually in writing (e.g., a will trust, a lifetime trust).

• Exemptions include certain types of trusts, such as charitable trusts and some pension schemes.

Unique Taxpayer Reference (UTR): Trustees must register the trust and obtain a UTR before submitting any tax returns.

If the trust has taxable income or gains, it is required to submit a Trust and Estate Tax Return (SA900) annually.

Important deadlines:

• New trusts created on or after 1 September 2022 must register within 90 days of their creation.

• Trustees must update the TRS within 90 days of any changes to beneficial ownership or other relevant details.

Example: If a parent sets up a trust for their children, and it generates income, the trust must register with HMRC, even if no tax is due immediately.

How Much Tax to Pay on Trust Income UK

The rules for taxing trust income vary depending on the type of trust and the amount of income. Some trusts benefit from a £500 tax-free allowance, while others do not. Trustees cannot claim the dividend allowance.

The tax rates on trust income for the 2024/25 tax year are:

1. Interest in Possession Trusts:

• All other income: 20%
• Dividend-type income: 8.75%

2. Discretionary Trusts:

• All other income: 45%
• Dividend-type income: 39.35%

3. The £500 Trust Income Allowance

Some trusts are eligible for a £500 tax-free allowance. If a trust's total income exceeds £500, all of its income is taxed, not just the excess.

• For discretionary trusts, if the settlor has created more than one trust, the £500 allowance is divided between them, with a minimum allowance of £100 per trust. This can create complex calculations, and trustees should refer to HMRC guidance or seek professional advice.

• Bare trusts are generally not eligible for the £500 allowance.

4. Capital Gains Tax (CGT)

Trusts are liable for CGT on gains from asset disposals exceeding an annual exempt amount of £1,500 (£3,000 if there is a vulnerable beneficiary). The CGT rates for the 2024/25 tax year are:

Non-residential property gains:

• Taxed at 20% until 29 October 2024.
• Taxed at 24% from 30 October 2024 onwards

Residential property gains: Taxed at a flat rate of 24%

Reporting Trust Income

Trustees must file a Trust and Estate Tax Return (SA900) each year to report the trust's income and gains. The deadlines for filing are as follows:

Paper filing: 31 October following the end of the tax year (e.g., for the 2024-25 tax year, the deadline is 31 October 2025).

Online filing: 31 January following the end of the tax year (e.g., for the 2024-25 tax year, the deadline is 31 January 2026).

If these deadlines aren’t met, the trust could face penalties. Once the tax return is filed, HMRC will inform the trustees about any unpaid taxes by 31 January. Trustees can then make payments through bank transfer, direct debit, or cheque.

Responsibilities Towards Beneficiaries

Trustees must provide beneficiaries with a statement (using form R185 [trust]) detailing the trust's income and the taxes paid. This statement enables beneficiaries to understand their share of the income and the taxes already settled, which is essential for their own tax reporting. For instance, if a trust distributes £1,000 to three beneficiaries after tax, each should receive an R185 form showing their portion and the tax paid on it.

Considerations of Inheritance Tax

Trustees are responsible for reporting Inheritance Tax (IHT) in specific situations. IHT reporting is necessary when assets are transferred into or out of a trust, and some trusts are subject to a ten-year periodic charge.

For discretionary trusts, if the trust's value increases by its tenth anniversary, trustees must use HMRC form IHT100 (and potentially form IHT100a to IHT100g) to determine and report any IHT liability.

Understanding and managing IHT is crucial for trustees to ensure the long-term sustainability of the trust and protect the beneficiaries' interests. Given the complexities of IHT, seeking professional tax advice is strongly recommended.

Final Words

By following the steps outlined in this guide, you can avoid common pitfalls while reporting and paying tax on UK trust income. However, if you’re ever unsure or need professional assistance, it’s always a good idea to consult with tax experts who specialise in trust taxation.

At Taxd, we can help simplify your tax responsibilities and ensure that everything is handled smoothly. If you want to get started or need expert guidance, don’t hesitate to reach out to us.

FAQs

1. Which types of income are taxable for trusts in the UK?

Trusts can generate taxable income from various sources, including rent, savings, and dividends, depending on the trust's assets.

2. How should trustees report trust income to HMRC?

Trustees must file the Trust and Estate Tax Return (SA900) every year. Paper returns are due by 31 October, and online returns are due by 31 January.

3. What happens if I don’t register my trust with HMRC?

Failure to register a trust with HMRC can lead to penalties, loss of tax reliefs, and potential legal issues. Trusts should be registered as soon as they become liable for tax.

4. What is the treatment of inheritance tax with respect to trusts?

IHT may be payable when assets are transferred into a trust, and some trusts face charges every ten years or when assets are distributed. Trustees must report these transactions using form IHT100.