A guide to investment for trustees 12 Inheritance tax (IHT) – trusts established before 22 March 2006 or created within a will The ‘trust’ capital from which an IIP beneficiary has the right to income is treated as being owned by him or her and forms a part of their estate for IHT purposes, even if no income is arising and where there is no entitlement to capital. Inheritance tax (IHT) – trusts established on or after 22 March 2006 The ‘trust’ capital from which an IIP beneficiary has the right to income is no longer treated as being owned by him or her following the Finance Act 2006 so it does not form part of their estate for IHT purposes. The trust is now subject to the same IHT regime as a discretionary trust. Entry , exit and periodic IHT charges can apply, but depending on the amounts involved the tax due may be zero. No part of the trust fund is treated as belonging to a beneficiary for IHT purposes. The initial payment by the settlor into the trust is a chargeable lifetime transfer (unless otherwise exempt) so there could be an immediate IHT liability at half the current IHT rates, even on a lifetime transfer. Discretionary trusts Trustees of discretionary trusts are charged income tax at the special trust rates, after deduction of trust expenses. Trustees may usually be able to choose to distribute savings or dividend income, or to re-invest into the trust. Dividends are taxed differently to other forms of income. The first £1,000 of taxable income, which would otherwise be chargeable at the rate applicable to trusts (RAT), is instead chargeable at the basic rate (20%) or dividend ordinary rate (8.75%), depending on the nature of the income. This part of income is known as the standard-rate band. Where income exceeds this amount, additional tax will be due. For a discretionary trust, the RAT for income, other than dividends, is 45%. The dividend trust rate is 39.35%. Taxation of savings income in excess of the standard-rate band, in the hands of the trustees Savings income is paid gross. The trustees are liable for 45% tax. The tax would be paid via the trustees’ self-assessment returns. Taxation of dividend income in excess of the standard-rate band, in the hands of the trustees Dividends will be received gross. The dividend trust rate is 39.35%. Taxation of dividend income distributed to, or for the benefit of, a beneficiary The tax paid by the trustees forms part of a ‘tax pool’. The beneficiary is treated as having received income from the trust net of 45% tax. The source of the income (e.g., whether it was derived from interest or dividends) is irrelevant. The beneficiary may reclaim some tax depending on their marginal rate of income. This is funded by the tax pool. The trustees may have to add money to the tax pool where the beneficiary’s reclaim exceeds the tax already paid by the trustees. Savings and dividend income re-invested then distributed If income is accumulated, the net distribution (after deduction of the trustee rate of tax) will roll up within the trust. This will then become additional capital of the trust which, whether retained or distributed to beneficiaries as capital at a later date, will not be subject to income tax, but may be subject to inheritance tax charges (i.e., exit or periodic charges). Capital gains tax (CGT) After allowing for the trustees’ annual CGT exemption, any gain is taxed at 20% (28% for property gains).