Dividends on a Discretionary Trust

5erge

My in laws created a disc trust containing shares with their grandchildren as the beneficiaries.  We have been using their tax free status to claim back the tax paid on the dividend income but simply reinvested income to buy more shares.

We no longer want to invest in more shares because we are trying to reduce the overall trust amount.  If we decide to take the taxed dividends out of the trust and transfer it to my kids would we be in any breach?  The money would essentially be sent back to their grand parents account then transferred to each child, however would the 3k gift limit be applicable here even though the tax has already been paid on the dividend?

I will seek professional advice but just wanted some pointers.

Cheers

D

xylophone

My in laws created a disc trust containing shares with their grandchildren as the beneficiaries.  We have been using their tax free status to claim back the tax paid on the dividend income but simply reinvested income to buy more shares.

Are you sure you had this right?

https://www.gov.uk/trusts-taxes/trusts-and-income-tax

I'd suggest that  you consult an expert, probably a tax accountant specialising in Trusts.

5erge

Thank you for the reply.  Yes, my children are not tax payers.  They are the beneficiaries.  We pay tax on the trust income and claim back the tax on their behalf.  You claim using an R40 and R185.

I will seek further prof advice though as I always want to be 100%.

spider42

Taking your last point first, the whole of the amount that the grandparents put into the trust will have been a chargeable lifetime transfer (CLT). If this exceeds the remainder of their nil rate band (£325,000 less any previous CLTs, less £3k limits etc), then IHT is payable at 20% when the trust is set up (not on death). Further IHT may also be due if they die within 7 years. So the gifts already made by the grandparents will, I suspect, be well in excess of the annual £3k gift limit.

Depending on the the value of the trust, there may be an IHT exit charge if capital (not income) is distributed to beneficiaries. IHT isn't an issue of only income is being distrusted from the trust.

Has the trust been registered on the trust register? Has it been registered with HMRC for Self Assessment?

Trusts generally pay tax on dividends at the highest dividend tax rate (currently 39.35%). Although the first £1,000 may be taxed at 8.75%, but the £1,000 limit gets divided by the number of trusts the settlors have set up. Trusts don't get a divided allowance.

When payments are made by the trustees to the grandchildren, this comes with a deemed 45% tax deduction. So if the trustees pay them £55, this is treated as gross income of £100, from which £45 tax has been deducted. But if the trustees haven't paid sufficient tax to cover the deemed tax deduction, then they need to top up the tax pool to cover it.

So if the trust received £1,000 in dividends, the tax liability would initially be £87.50. But if £550 was then distributed to the grandchildren, then it needs £450 in the tax pool. But there is only £87.50, so the trustees need to pay a further £362.50 over to HMRC to top it up to £450.

The grandchildren can then claim the £450 back by completing an R40 (assuming they are still non-taxpayers after receiving the trust income), so they are left with the full £1,000 (£550 from the trust, plus £450 tax refund). But it is rather a convoluted process to get there!

Some of your question doesn't appear to make sense. If the trustees have reinvested all of the dividend income to buy more shares within the trust, then the income can't have also been distributed to the grandchildren, and so no tax refund would arise to the grandchildren.

You ask about taking out the "taxed dividends", but you must have already done this if the grandchildren have claimed the tax back on them. They can only make a refund claim on income that has been distributed to them.

And if the income has been invested into buying more shares, there is also a risk that the income has been 'accumulated' and become capital, thereby preventing it being distributed as an income distribution to beneficiaries in the future.

The money can't (I assume) be transferred back to the grandparents, as this will almost certainly have been precluded in the trust deeds. If the settlors can benefit from a trust, then it would be a settlor interested trust. That would essentially mean that all of the trust's income would be treated as taxable income of the grandparents.