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Income tax: low income trusts and estates consultation

30 June, 2022Gerry Brown
books

HM Revenue & Customs (HMRC) has recently issued a consultation paper on income tax and low-income trusts. The proposals would formalise and extend an existing arrangement that affects many trustees. Gerry Brown unpicks and explains what’s in the proposals and highlights what you need to know as a paraplanner.

With effect from 6 April 2016 banks and building societies stopped deducting tax from interest payments. This meant many trustees found that they were receiving small amounts of untaxed interest and consequently had to complete income tax self assessments.

To reduce this administrative burden, HMRC introduced a temporary arrangement that removed trustees from income tax where:

  • the only source of income is savings interest, and
  • the tax liability is below £100.

The government now wishes to formalise and expand this arrangement.

What the government is proposing on low-income trusts

You can see the full consultation on the Gov.uk website, where the government also states its case. “The key aim of the proposals is to reduce administrative burdens for low-income trusts and estates whilst avoiding unnecessary complications elsewhere.”

At the moment, beneficiaries of bare trusts simply return the income arising on the trust fund in their self assessment. And there’s no proposal to change this.

Trustees of ‘interest in possession’ trusts currently pay tax on the income they receive and then distribute that income to the beneficiary entitled to it. The trustees deduct tax from the payment and if the beneficiary is a non-taxpayer they can reclaim the tax deducted.

That may sound fair but it’s obviously time consuming. It would be better for the trustees to mandate the trust income to the beneficiary. The income – such as interest or dividends – is then paid directly to that beneficiary, who then includes it in their self assessment. But unfortunately this simple approach is not adopted as often as it should be.

Trustees of ‘discretionary’ trusts pay tax on their income but are not obliged to distribute that income. They have discretion as to whether that income is accumulated or paid out.

If they distribute the income, they deduct tax at 45% and the recipient beneficiary can get a credit for that tax in their income tax self assessment. Again this can be time consuming.

HMRC suggests that the £100 limit currently temporarily in place be increased to £500.

Tax revenue on low-income trusts

The government’s tax take won’t fall as a result of any changes. If the trustees don’t have to deduct tax, the beneficiary won’t be entitled to a tax credit.  The proposed changes are tax neutral.

In cases where the income does give rise to a tax liability for the beneficiary, this proposal won’t affect that liability. However, it may reduce the amount of tax credit available and therefore increase the amount of tax the beneficiary must pay.

Trustees of ‘interest in possession’ trusts could be compelled to mandate income to the beneficiary. This would significantly reduce administrative costs.

The aim of the consultation is to reduce administrative costs. It might be worthwhile, therefore, to raise the income limit, perhaps to £1,000. Or you might wonder whether there should be any limit if there’s no tax loss to the government.

The proposals relate only to income tax. There’s no suggestion that a similar approach might be adopted for capital gains tax or inheritance tax.

You have until 18 July 2022 to respond to the Income tax: low income trusts and estates consultation. Why not have your say?

Gerry Brown is a Consultant at QB Partners. He began his professional career as an inspector of taxes and later qualified as a chartered accountant. He’s worked at a number of financial services companies providing technical support and contributes to our Diploma in Paraplanning (DipPP).

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