Question
I am a new Trustee of a Nil Rate Discretionary and Acccumulation Trust of which the Settlor has only set up one trust. I wish to pay the interest income of this Trust to Beneficieries however I wish to retain sufficient of the income in the trust to deal with the tax liability.
Having calculated the 20% which is due on the first £1,000.00 and setting this aside with the 50% tax on the rest of the interest income,this produces a figure of the likely tax due. If then using the tax pool calculater I put in the total income and presumably this figure, includes the tax deducted at source, realised during the tax year and then insert the possible payment of the remaining income after tax I am left with a tax shortfall.
My question is, is this extra tax which has to be paid above the above calculated amount of tax due or is this shortfall included in the above tax figure. In the case of the former I can only pay the remaining income after further deduction of this amount of tax whereas in the latter case I can safely pay out all the remaining income in a particular tax year?Answer
For the benefit of other readers, a 'tax pool' is the name HMRC gives to the record of how much income tax a discretionary trust has paid versus the 50% tax assumed to have been paid by the trust (called a 'tax credit') on any income it distributes to beneficiaries (e.g. children/grandchildren).
Because non, basic and higher rate taxpaying beneficiaries can reclaim some or all of the 50% tax already (deemed to have been) deducted, the tax pool prevents more tax being reclaimed by a beneficiary than was actually paid by the trust (i.e. it stops the taxman from losing money).
When there's a tax pool shortfall, i.e. the trust has paid less tax than the 50% tax credits attached to beneficiary income payments, this is normally due to one or both of the following reasons:
1. As you've said, a discretionary trust must pay 20% tax on the first £1,000 of income it receives then 50% on the remainder, so this is the tax that enters the tax pool. However, because all income paid to beneficiaries is deemed to have been taxed at 50%, the tax pool may have up to 30% shortfall on the first £1,000 of income.
Example: the trust receives £3,000 of interest (I've assumed it's paid gross), which it pays to beneficiaries as £1,500 with an attached £1,500 tax credit (50% tax). The trust pays income tax of £1,200 on the £3,000 received (20% x £1,000 plus 50% x £2,000). However, because the £1,500 paid to beneficiaries is assumed to have had £1,500 (50% tax) deducted, a £300 tax pool shortfall must be paid by the trust.
2. When a discretionary trust receives dividends they're taxed at 42.5% of the gross dividend (divide the dividend received by 0.9), of which 10% is non-refundable, so only 32.5% enters the tax pool. And if this falls within the first £1,000 of income then the trust doesn't pay tax, so no tax enters the tax pool.
Example: the trust receives £3,000 of dividends (equal to £3,333 of gross dividend) which it pays to beneficiaries as £3,000 with an attached £1,500 tax credit (50% tax). The trust pays income tax of £758 on the £3,000 received (32.5% x £3,333, no tax on first £1,000 of gross dividend). However, because the £1,500 paid to beneficiaries is assumed to have had £1,500 (50% tax) deducted, a £742 tax pool shortfall that must be paid by the trust.
I know the calculations can get a bit messy, but I hope this makes sense. The key is to remember that the trust must have paid 50% tax (or the equivalent of, if dividends) on all income distributed to beneficiaries. So when the HMRC tax pool calculator shows a tax pool shortfall it must be paid in addition to the usual tax paid by the trust, or the income distribution to beneficiariesshould be reduced until the shortfall is wiped out if the trust doesn't want to pay extra tax.
As an aside, ensure you're offsetting all allowable expenses against trust income - you can deduct certain 'trust management' expenses incurred by trustees in carrying out their duties, most commonly the costs of accounting for the trust's income. Take a look at a useful HMRC guide here.
Also, beneficiaries should make sure they reclaim tax on the income received, where appropriate. They should receive a completed form R185 from the trustees every tax year detailing the income the trust has paid along with the tax credit. They can use these figures to apply for the appropriate tax refund via a self-assessment tax return or HMRC R40 claim form.
To work out their potential tax refund they simply need to calculate how much income tax they would personally pay on the income received (adding back the tax deducted by the trust to get a gross income for this purpose) then subtract from the tax already deducted by the trust (i.e. the tax credit). The balance is the amount reclaimable.
I am a new Trustee of a Nil Rate Discretionary and Acccumulation Trust of which the Settlor has only set up one trust. I wish to pay the interest income of this Trust to Beneficieries however I wish to retain sufficient of the income in the trust to deal with the tax liability.
Having calculated the 20% which is due on the first £1,000.00 and setting this aside with the 50% tax on the rest of the interest income,this produces a figure of the likely tax due. If then using the tax pool calculater I put in the total income and presumably this figure, includes the tax deducted at source, realised during the tax year and then insert the possible payment of the remaining income after tax I am left with a tax shortfall.
My question is, is this extra tax which has to be paid above the above calculated amount of tax due or is this shortfall included in the above tax figure. In the case of the former I can only pay the remaining income after further deduction of this amount of tax whereas in the latter case I can safely pay out all the remaining income in a particular tax year?Answer
For the benefit of other readers, a 'tax pool' is the name HMRC gives to the record of how much income tax a discretionary trust has paid versus the 50% tax assumed to have been paid by the trust (called a 'tax credit') on any income it distributes to beneficiaries (e.g. children/grandchildren).
Because non, basic and higher rate taxpaying beneficiaries can reclaim some or all of the 50% tax already (deemed to have been) deducted, the tax pool prevents more tax being reclaimed by a beneficiary than was actually paid by the trust (i.e. it stops the taxman from losing money).
When there's a tax pool shortfall, i.e. the trust has paid less tax than the 50% tax credits attached to beneficiary income payments, this is normally due to one or both of the following reasons:
1. As you've said, a discretionary trust must pay 20% tax on the first £1,000 of income it receives then 50% on the remainder, so this is the tax that enters the tax pool. However, because all income paid to beneficiaries is deemed to have been taxed at 50%, the tax pool may have up to 30% shortfall on the first £1,000 of income.
Example: the trust receives £3,000 of interest (I've assumed it's paid gross), which it pays to beneficiaries as £1,500 with an attached £1,500 tax credit (50% tax). The trust pays income tax of £1,200 on the £3,000 received (20% x £1,000 plus 50% x £2,000). However, because the £1,500 paid to beneficiaries is assumed to have had £1,500 (50% tax) deducted, a £300 tax pool shortfall must be paid by the trust.
2. When a discretionary trust receives dividends they're taxed at 42.5% of the gross dividend (divide the dividend received by 0.9), of which 10% is non-refundable, so only 32.5% enters the tax pool. And if this falls within the first £1,000 of income then the trust doesn't pay tax, so no tax enters the tax pool.
Example: the trust receives £3,000 of dividends (equal to £3,333 of gross dividend) which it pays to beneficiaries as £3,000 with an attached £1,500 tax credit (50% tax). The trust pays income tax of £758 on the £3,000 received (32.5% x £3,333, no tax on first £1,000 of gross dividend). However, because the £1,500 paid to beneficiaries is assumed to have had £1,500 (50% tax) deducted, a £742 tax pool shortfall that must be paid by the trust.
I know the calculations can get a bit messy, but I hope this makes sense. The key is to remember that the trust must have paid 50% tax (or the equivalent of, if dividends) on all income distributed to beneficiaries. So when the HMRC tax pool calculator shows a tax pool shortfall it must be paid in addition to the usual tax paid by the trust, or the income distribution to beneficiariesshould be reduced until the shortfall is wiped out if the trust doesn't want to pay extra tax.
As an aside, ensure you're offsetting all allowable expenses against trust income - you can deduct certain 'trust management' expenses incurred by trustees in carrying out their duties, most commonly the costs of accounting for the trust's income. Take a look at a useful HMRC guide here.
Also, beneficiaries should make sure they reclaim tax on the income received, where appropriate. They should receive a completed form R185 from the trustees every tax year detailing the income the trust has paid along with the tax credit. They can use these figures to apply for the appropriate tax refund via a self-assessment tax return or HMRC R40 claim form.
To work out their potential tax refund they simply need to calculate how much income tax they would personally pay on the income received (adding back the tax deducted by the trust to get a gross income for this purpose) then subtract from the tax already deducted by the trust (i.e. the tax credit). The balance is the amount reclaimable.
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