Taxation and trust registration for discretionary trust

poseidon1

Presumeably, on @DRS1's suggestion in your previous thread, you expressed the Deed of Appointment terminating the trust as being irrevocable.

I have come to realise from my past interactions with you that detail and careful reading of legal documents is not your strong point.

However if you had paid the slightest bit of attention to Aviva's explanatory notes to the Deed of Appointment you would have seen the following:

'' This deed provides for a revocable appointment only. If you wish to make an irrevocable

appointment delete the word ‘revocable’, add the word ‘irrevocable’ and initial the

amendment. An irrevocable appointment can’t be changed.''

If that means little to you I can confirm that in trust law, purporting to revoke an irrevocable appointment is unlawful.

Therefore when lawyers draft Appointments they do so after proper consideration of all the implications ( including tax outcomes) before committing to action.

Life companies in general and Aviva in particular, strongly reccomend untutored laymen like yourself to seek legal and tax advice when dealing with their standardised trust documents, precisely to try and avoid your kind of ill considered changes or appointments out of a trust. MSE forums do not constitute such advice.

itwasntme001

Actually I came here to say the same thing poseidon1 - the deed is actually revocable, and as you say, it can therefore be altered (the recovable term was never crossed out).

Given this, please let me know how to proceed next with making the changes to the distribution as mentioned earlier in the thread. As you say I am an untutored dummy so need all the help I can get!

Thank you for your godly wisdom and expertise so far and in advance of you hopefully helping me further with my quesiton.

PS: your username checks out - Greek god mythology always fascinated me when I learnt it in school :)

poseidon1

I indicated that it you wanted to deal with the policy income separate from the capital it should not have been part of the Appointment deed in the first place.

You may by pure happenstance/carelessness failed to make the deed irrevocable, but you did in fact actually distribute capital and income as you intended, by virtue of that Appointment. As a result you now possess 50% of the trust income and capital and the bare trust is now sitting on the other 50%.

You have completed what your deed set out to do ( ie termination of the trust), outstanding tax compliance at policy trust level is all that remains as indicated in my post on 22nd.

This is a useful object lesson for others of the considerable complexities of discretionary trusts and their administrative quirks, which by and large means professional advice is always advised.

DRS1

I confess I am not entirely clear why you want to revise the Deed of Appointment to redirect the income to someone who pays income tax instead of shoving it all at the child who presumably does not.

Is it that you don't want to be seen to be taking money back out of the bare trust?

I was wondering if a loan would be the answer? You lend the child an amount equal to the 45% tax the policy trust is meant to have paid HMRC the child pays that to the policy trust trustees and they pay HMRC. Then the child reclaims the tax from HMRC and when that arrives it is used to repay the loan.

One issue may be how the repayment arrives - is it bank transfer or a cheque. Even if it is a cheque there would need to be a bank account. I think that account should be separate from the bare trust account - if only because if you took the repayment from that bare trust account you'd be doing what you are trying to avoid. So maybe it should be an account which was clearly set up by a parent for their child.

You would want the loan documented especially the repayment terms and any interest payable. Or maybe you just say it is interest free repayable on demand. Such loans used to be popular but I have no idea if they have tax consequences now.

But all of this may be irrelevant. I don't know if the policy trustees could actually provide the beneficiaries with a tax deduction certificate now given that they never deducted the tax in the first place. Dare I mention professional advice?

itwasntme001

DRS1 - I want to direct the income fully to the bare trust where no income tax will be payable. So the remaining small amount to be paid would mean an end result of there being 55% of the trust income in the bare trust.

DRS1

https://forums.moneysavingexpert.com/discussion/comment/82010595#Comment_82010595

Ah sorry I got it the wrong way round.

Being ignorant why would only 55% of the income end up in the bare trust? Are you thinking you would not try to reclaim any tax from HMRC? But surely sending the interest to the child is so you can reclaim more tax? I am confused.

In case it helps here is a note from Aberdeen on discretionary trusts which has a section on income tax.

Discretionary trusts

itwasntme001

https://forums.moneysavingexpert.com/discussion/comment/82010639#Comment_82010639

Trustees need to withold the tax due (a statuatory law), so only pay the net amount to beneficiaries. So for income it is witholding 45% of it. This is paid to HMRC. The beneficiary gets a tax credit form R185 which can be used to get a tax refund upto 45% minus marginal tax rate.

itwasntme001

The Aviva life insurance discretionary trust appears to be a settlor-interested one because the potential beneficiary list include settlor's spouse. The settlor has not passed away (claim payout was for terminal illness).

I understand that this means:

• the income is taxed on the settlor at their marginal income tax rate
• the trustees still need to pay the 45% trust tax on the income
• the actual beneficiary receiving the income, who is not the settlor or settlor's spouse, receives the gross income amount and there is no tax liability (or is it at their marginal income tax rate?)
• the trustees should send form R185 to the settlor for the tax credit so the settlor can claim for [45% - personal marginal tax rate] on the income. This amount needs to be passed onto the trustees.

Is the above correct?

If so, the tax credit that is returned to the trustees, is that back in the discretionary trust and thus the trust remains open, or is it closed once all distributions sent to beneficiaries?

poseidon1

Just to be absolutely clear on one important detail, before talking about the tax implications of settlor interested trusts

Under section E of the policy trust document your father was required to tick any of the categories of reserved settlor benefits, he did not wish to retain outside the trust. Confirm he did tick the terminal illness box-

https://static.aviva.io/content/dam/document-library/adviser/individualprotection/al53003c.pdf

Assuming he did so, then as a settlor interested trust, the mechanics of how the tax compliance is dealt with is covered by section 2.3 of HMRC's guidance attached and copied in its entirety below

https://www.gov.uk/government/publications/trusts-and-settlements-income-treated-as-the-settlors-hs270-self-assessment-helpsheet/hs270-trusts-and-settlements-income-treated-as-the-settlors-2026

'' 2.3. Tax paid by the trustees and your tax liability

Where trustees have already been taxed on the income, you get credit for that tax and can set it against your liability, as settlor, on the trust income. If you’ve not been given a form R185 (Settlor), you may need to speak to the trustees to find out the amount of any tax they’ve been charged. The rates of tax applied will differ according to the type of trust and nature of the income — use boxes 7 to 12 on the Trusts etc pages according to the rate of tax charged on the trustees to make sure you get the correct amount of credit.

The trustees are required to fund your Income Tax liability because you’re charged to tax on income that may not belong to you; it’s treated as yours solely for Income Tax. Where the tax paid by the trustees exceeds your own liability, that excess belongs to them.

For accumulation or discretionary trusts, the trust rate of 45% means that, in most cases, unless you are liable at the additional rate, the tax paid by trustees will exceed the tax due from you. Where this happens you’re required to return the excess tax to the trustees.

If required, HMRC will provide a certificate with the details of the repayment due to you on the trust income treated as yours to help you work out how much you owe the trustees. You can ask your own HMRC office or the office dealing with the affairs of the trust for such a certificate.

Where the tax paid by the trustees is insufficient to cover your tax liability on the settlement income, you can claim a refund of any additional tax that you have to pay from the trustees. If required, HMRC will provide a certificate with the details of the tax due from you on the trust income treated as yours for you to show the trustees how much they owe you. You can ask your own HMRC office or the office dealing with the affairs of the trust for such a certificate ''

The upshot of the above is:

1. Trustees report and pay the 45% tax as I previously advised.
2. Trustees supply the settlor with an R185 Settlor tax certificate
3. Settlor reports the trust income on his own tax return via SA107, and is taxed on the gross interest but with credit for 45% paid by the trust.
4. If settlor's marginal rate of tax is less than 45% resulting in a personal tax repayment, he is required to refund this back to trust.

As for your final question, you purported to ( unwisely) terminate the trust with no thought of the need to provide for trust income tax payable.

Accordingly, to handle this matter to HMRC' s satisfaction, you and the bare trust will have to disgorge your 50% shares of cash necessary to settle the intial 45% tax payable. Therefore both you and the bare trust are out of pocket to this extent. You then await your father to submit his personal tax return and eventually obtain a tax refund if his marginal rate results in a partial refund of the tax paid by the trust. That refund ( if any) is then returned to you and the bare trust in equal shares.

That is then the end of the matter with the trust beneficiaries bearing a net income tax charge on the trust income, depending on your father's marginal rate but with no process by which any of that tax (paid by him) can be recovered by a zero tax status beneficiary. By the same token you as a tax paying beneficiary have no further liability on that income since only your father will have received an R185 for this income source.

If you or your father have zero experience of handling self-assessment you might wish to engage a professional to deal with the trust tax return and your father's return to ensure HMRC's compliance (if nothing else) is done properly.

itwasntme001

Yes all the boxes were ticked including the terminal illness box. We are both well versed in filing tax returns.

Have some follow up questions from your reply:

• just to be clear the refund (if any) back to the trust/trustees from the settlor is the excess 45% tax refund after offsetting against the settlor's income (from the trust) tax liability? E.g. if the settlor pays 20% income tax on the trust income, then 45-20 = 25% is returned back to the trust/trustees? So in effect the settlor is not disadvantaged (or advantaged) in anyway from this from a tax perspective.
• the income the settlor has to pay tax on is treated as interest, and not merely income, so ability to use personal savings allowance?
• if the settlor were to pass away at anytime from now, then nothing changes in any of this except for the fact that the tax return is filed by the executors if need be?
• does the income have to be attributable on a 50-50 basis to both beneficiaries, as you mention about the disgorging of enough cash to make up the 45% tax, 50% from each of the beneficiaries. Or can all the income be given to one of the beneficiaries, and make sure the 45% is disgorged from that beneficiary's account? I understand there is no benefit in managing income distributions to take advantage of tax efficiency of the bare trust account, given it is a settlor-interested trust, but just asking for completeness.
• Given the time line in tax payments and tax refunds. i.e. SA900 form to pay the 45% trust tax, R185 settlor form issued, settlor to do SA/SA107 next year for 26/27 and resultant tax refund and distribution of excess to beneficiaries via the trust/trustees, when does the trust officially close as per on TRS registration, and officially close from a legal perspective? After the SA900 return is done (presumably can be done soon) or after the refund is paid back to beneficiaries, or some other time?

TIA.