Are Trusts Liable for Capital Gains Tax?

Frequently, trusts are established with the intention of mitigating a tax liability. More often than not this concerns inheritance tax (IHT) and planning; trusts can be an efficient method of separating oneself from assets and therefore reducing the potential IHT liability suffered by beneficiaries, and of ensuring that assets are dealt with in a suitable way on the death of the settlor (that is, the individual establishing the trust). There are numerous circumstances, however, in which trust will still be subject to some form of tax. This is particularly true of capital gains tax (CGT).

Capital Gains Tax

In general, CGT is payable by trustees on assets held in trust. The rate and manner of this payment will depend on the type and terms of the trust. There is, however, an exception to this; when the trust in question is a bare trust (the definition and details of which are given in an article elsewhere on this site), the trust itself will not be subject to any tax. Rather, the beneficiaries will be required to pay the tax on any capital gains or income derived from the trust. Frequently, however, these liabilities will be reduced or avoided through the use of the beneficiaries' annual allowances, particularly as bare trusts frequently have minors as beneficiaries.

Tax Rates

Generally, trustees will be required to fill out a tax return on which they must declare any income or capital gains derived form the trust. In interest in possession trusts, any rent, trading or savings income will be charged at a flat rate of 20%, while dividends will be subject to a 10% flat tax. In discretionary trusts the first £1,000 of income will be taxed in the same way, but after this dividends will have a 32.5% charge levied while any other income will be taxed at a rate of 40%. It should be noted that these rates are subject to change year on year.

Tax on Beneficiaries

Tax paid by beneficiaries will, again, depend on the nature of the trust. In the case of interest in possession trusts, as the beneficiary receives all of the income generated (less the trustees' costs) they are taxed at their normal rate. However, the beneficiary will be entitled to some relief as the assets have already been subject to tax while in the trust.

The tax treatment in discretionary trusts is different; in these cases, any income paid to the beneficiaries is considered to have already been taxed at a flat rate of 40%. As such, if the beneficiary is a basic rate taxpayer they will be entitled to a refund of some or all of the tax that has already been paid. In this way, the beneficiary is likely to have their income topped up by the Inland Revenue.

When considering establishing a trust for tax mitigation purposes it is always advisable to seek professional advice, as poor drafting of the relevant documents can reduce the effectiveness of the trust.