Trusts and Estates

[trustqueries]

Ref Discretionary Trust

I am a trustee of a discretionary will trust and following a mix up with the Inland Revenue HMRC have now asked that going forwards (from tax year ending 5 April 2011) I have to tick boxes 8.12 and 8.16 on the Trust tax returns.

The error in terms of the way in which the trust has been previously treated for tax came to light earlier this year following the death of my mother who set the trust up over 20 years ago following the death of her uncle. HMRC do not consider it worthwhile to amend previous returns which is a relief to myself and my brothers.

This is fine but I am now confused as regards how much income I can pay away without incurring additional tax. Previously all income (net of tax at 10%) was paid away to my mother.

For the year ending 5 April 2011 the trust received a total of £3,150.00 (gross) in dividend income. Tax pools seem somewhat complicated and I am wondering how much by way of discretionary payments I can make (to non tax payers) without incurring an additional liability. Is it :

The full gross amount - £3150.00
The amount less the 10% tax deducted - £2,835.00
The amount less tax at 42.5% - £1811.25
The amount less tax at 42.5% on £2150 and tax at 10% on £1000 - £2,136.25

I think it is £2,136.25 and if so:

What please are the figures that should be placed under box 1 (net payments from non settlor-interested......) in form R185 and how much can the non tax paying recipient claim back?

Many thanks for your help

[maths]

It would seem that in past the trust was settlor interested but it no longer is following the death of the settlor.

Assuming this to be so the trust, as a discretionary trust, is subject to 50% on its income or 42.5% on dividend income. The first £1,000 of income is subject to tax at 10% if dividend income or 20% otherwise.

The income tax liability of the trustees falls into a tax pool.

On a distribution to a beneficiary the trustees have to find 50% of the distribution as a tax payment; part of this payment is deemed to come out of the tax pool. However, with dividend income a shortfall arises which is problematic.

If trustees receive £3,150.00 (gross) dividend income then £1,000 taxed at 10% (£100) and £2,150 taxed at 42.5% (£914).

Total tax liability £1,015 less tax credit of £315 giving net liability of £700.

Cash available to trustees £2,835 (net div) less £700 giving £2,135.

However, if £2,135 is paid out then trustees need to find tax of £2,135but they only have £700 in the tax pool; hence, shortfall of £1,435.

Thus, the maximum cash which can be paid out is £1,418 (which is the net sum put on the R185).

Tax then due from trustees £1,418 of which £700 from tax pool and £718 (from the balance of £2,135 less £1,418).

I have assumed that there is no more cash in the tax pool (than set out above).

In short, dividend income of discretionary trusts when paid out create adverse cash flows.

The beneficiary gets £1,418 with attaching tax credit of £1,418 (ie gross £2,836). He is subject at his rate of income tax (let's assume 20%) giving £567 and thus claims back £1,418 less £567 ie £851.

[trustqueries]

Hi Maths

Many thanks for your full and comprehensive response which is much appreciated

Rgds