Trusts are often used in tax and estate planning where provision is to be made for children. The most flexible trust type is a discretionary trust but the price for that flexibility is a higher tax rate on income generated by trust assets during the trust period and received by the trustees. This higher rate of 45% (38.1% for dividends) is often cited as a deterrent for people seeking to settle their assets on trust.
Whilst this high rate appears at first glance as a deterrent, this is not the end of the story. Where children are intended to be the primary beneficiaries, they are often able to reclaim this tax. Take for example a discretionary trust that is, at the moment, focusing its income on meeting school fees for two minor children, who have no other income. This trust is generating income after expenses of £20,000 from its rental property portfolio. The net income after tax would then be £11,000, which on exercise of the trustees’ discretion could be distributed equally to those two children. This £5,500 may not meet as much of the school fees as the trustees would like. However, it is worth remembering that discretionary income is paid net of a 45% tax credit. The payment to each child of £5,500 is in fact a gross payment of £10,000 with tax amounting to £4,500 deducted. As each child has no other income, the gross payment of £10,000 is below their personal allowance (£11,850 for 2018/19) and the tax is available to be reclaimed. This could then be used in further settlement of school fees or added to their personal savings account.
As adults are typically more likely to be using their personal allowance against income from other sources, such as a salary, the tax available to be reclaimed may be lower, but for a basic rate taxpayer the rate payable is just 20%, whereas the trust income is 45% and so the difference of 25% is refundable. Even a higher rate taxpayer can benefit from the 5% difference.
A life interest trust will pay tax at the basic rates and so historically, there was little to be done for many beneficiaries, especially where the income was from dividends and so no tax was physically paid. Following the changes to the dividend tax regime, unless income is mandated directly to the beneficiary, tax is paid by the trustees on dividends. However, the beneficiary has a £2,000 allowance (£5,000 for 16/17 and 17/18) within which there is no tax payable on dividends, in addition to their personal allowance. There are also savings allowances available, dependant on income level, but that’s for another article!
Each year, the trustees should provide an R185 certificate to the beneficiary, setting out the income distributed from the trust, which will enable a repayment claim to be prepared (or a Tax Return, if required). A repayment claim (R40) can be submitted up to 4 years after the end of the relevant tax year and so, until 6 April 2019, a claim can be made for the tax years 2014/15 to date. For a minor child, the repayment claim will need to be made by their parent or guardian. If you would like any further information in relation to income tax and trusts or you would like us to make a backdated reclaim on behalf of a child, please get in touch.
This article is from the summer 2018 issue of Private Lives, our newsletter covering the key legal and tax issues that individuals face. To download the latest issue, please visit the newsletter section of our website. Law covered as at July 2018.
To keep up-to-date with the latest news, legal updates and seminar information, please register and select the areas that are of interest to you.
The content of this article is for general information only. It is not, and should not be taken as, legal advice. If you require any further information in relation to this article please contact the author in the first instance. Law covered as at July 2018.