Quilter 11 Interest in possession (IIP) trusts Income tax (i.e., the beneficiary is entitled to income arising inside the trust) Trust income is taxed on the trustees at basic rate (20% on interest and 7.5% for dividends). The trustees must then distribute the income to the beneficiary. When the beneficiary receives the income, they are also taxable. However, they receive a tax credit equivalent to the tax paid by the trustees. This is then used to offset their own personal liability to income tax. Unlike income from discretionary trusts, income from an IIP trust does not lose its ‘identity’. The beneficiary of an IIP trust is treated as having received interest and dividends rather than just ‘trust income’. This means they can use their dividend allowance, personal savings allowance and 0% starting rate band to reduce their liability to income tax. Where the income falls within these or their personal allowance, the beneficiary can reclaim the tax paid by the trustees. Where the income exceeds these allowances/bands, the income will be taxable at the beneficiary’s marginal rate: However, the beneficiary will use the tax credit from the trustees to reduce that liability. For example: A beneficiary receives interest with 20% deducted by the trustees. A basic rate tax payer will have no further liability. A higher rate tax payer will pay an extra 20% and an additional rate tax payer will pay 25%. The trustees could choose to mandate the income payments directly to the beneficiary. This way, they do not need to submit a trustee tax return unless they have other liabilities (such as capital gains tax). The beneficiary will receive the income gross and will need to pay the applicable rate of tax. Capital gains tax (CGT) After allowing for the trustees’ annual CGT exemption, any gain is taxed at 20% (28% for property gains). If the trust capital passes absolutely to named beneficiaries following the death of an interest in possession beneficiary (provided that beneficiary had a qualifying interest in possession ), no liability to CGT arises and the new beneficiaries will receive the assets at a revised base cost (i.e., the value at date of death of the previous IIP trust beneficiary). This will be based on the market value of the assets at the time. If an IIP trust beneficiary dies and their interest continues on to a new beneficiary under the trust provisions, this revised value basis, as above, will also apply. However, if the interest of a beneficiary ceases during their lifetime and other beneficiaries become absolutely entitled to the trust funds, the change of entitlement is considered to be a ‘disposal’ for CGT purposes, with any tax liability belonging to the trustees. A relief known as Hold-over Relief may apply to capital gains tax. This relief does not remove the tax but enables it to be deferred and passed on to the new beneficiary subject to certain conditions being met. Please speak to your legal or financial adviser for further information. Basic rate tax payers : 20 % (interest) 8.75 % (dividends) Higher rate tax payers: 40 % (interest) 33.75 % (dividends) Additional rate tax payers: 45 % (interest) 39.35 % (dividends) The beneficiary of an IIP trust is treated as having received interest and dividends rather than just ‘trust income’.