Consultation outcome

Income Tax: Low income trusts and estates

Updated 15 March 2023

Summary

Subject of this consultation

This consultation is about proposals to formalise and extend an existing arrangement that relieves from income tax those dealing with trusts and death estates with small amounts of income.

Scope of this consultation

This is a technical consultation on the way in which income tax is to be calculated for low-income trusts and estates and seeks views on the proposed design.

Who should read this

Trustees and personal representatives with experience of low-income trusts and estates; and their representative bodies.

Duration

The consultation will run for 12 weeks from 25 April 2022 to 18 July 2022.

Lead official

The lead official is Alan McGuinness of HM Revenue and Customs (HMRC).

How to respond or enquire about this consultation

Written responses can be made:

By post to:

Assets and Residence Team
HM Revenue and Customs
Area 3C/03
100 Parliament Street
London
SW1A 2BQ

By email to: asres.consult@hmrc.gov.uk

Additional ways to be involved

HM Revenue and Customs welcomes meetings with interested parties to discuss these proposals.

After the consultation

The government will analyse the consultation responses and publish a summary of responses later this year.

Getting to this stage

In 2016, following tax on bank and building society interest no longer being deducted at source, HM Revenue and Customs introduced an arrangement to ensure that new burdens did not arise on trusts and estates whose only income consists of small amounts of savings interest. This consultation stems from an undertaking to review the situation longer term.

Previous engagement

In 2021, HM Revenue and Customs obtained preliminary views about the arrangement and how to legislate it from members of its Capital Taxes Liaison Group.  

1. Executive summary

Summary

1.1. In 2016, following tax on bank and building society interest no longer being deducted at source, HM Revenue and Customs (HMRC) introduced an arrangement to ensure that new burdens did not arise on those managing trusts and estates whose only income consists of small amounts of savings interest.

1.2. This consultation contains proposals for legislating this arrangement in an expanded form.

1.3. Under the proposals, low-income trusts and estates with income from any source up to a ‘de minimis’ amount (to be decided following this consultation) will not be subject to income tax on that income.

1.4. For trusts and estates with income more than the de minimis amount, income tax will be due on the full amount of income rather than only applying to the income above the de minimis amount. This is in the interests of simplification for both customers and HMRC, as the rules required to take the alternative approach would be complicated and require additional administration for all involved.

1.5. Tax pools apply to discretionary trusts and keep track of income tax the trustees pay. When trustees make a discretionary payment of income it is treated by the beneficiary as if income tax has already been paid at the trust rate (currently 45%); and the trustees must have paid enough income tax (in the current or previous years) to cover this ‘tax credit’. Under these proposals, even where discretionary trusts would be covered by the de minimis rule, they will still have to pay tax when they pay income out to a beneficiary, to ensure that the tax credit remains funded.

1.6. This consultation seeks views on these proposals.

2. Introduction

Background to this consultation

2.1. Prior to 6 April 2016, banks and building societies deducted tax from interest they paid on deposits under an arrangement known as the Tax Deduction Scheme for Interest. This deduction arrangement ceased from 6 April 2016 and such interest is now paid without deduction of tax. This reflected the fact that following the introduction of the Personal Savings Allowance from the same date, around 95 per cent of savers were expected to be no longer liable for tax on this interest.

2.2. However, trustees of trusts and personal representatives (PRs) of death estates do not have tax allowances in the same way as individuals do. As a result, with the payment of interest gross of tax, even the trustees and PRs of the smallest trusts and estates became liable to file a self-assessment return when they hadn’t previously had to do so.

2.3. To prevent this, in 2016 HMRC introduced a narrowly targeted arrangement that removed trustees and PRs from Income Tax where the only source of income for the trust or estate is savings interest and the tax liability is below £100. This arrangement was intended to be a temporary arrangement pending a longer-term solution.

2.4. On 30 November 2021 the government announced that it would consult on formalising the arrangement, with its precise form and level being confirmed following consultation.

Why is the government consulting?

2.5. Since the arrangement’s introduction, two main criticisms have been made:

• as the HMRC arrangement only applies to savings interest income, trusts and estates with low levels of dividend income, for example, are required to make tax returns (paying tax on both the interest income and the other income
• the current HMRC arrangement requires a person to calculate their tax liability before they can decide whether the arrangement applies to them

2.6. Given these criticisms, and that HMRC arrangements are intended to be only temporary pending a long-term solution, the government is considering legislating the arrangement in a broader form, removing low-income trusts and estates from income tax generally. The government is keen to ensure that this is done in a way that works smoothly with the existing taxation framework.

2.7. This consultation seeks views on the proposals described in the next chapter.

3. The proposed changes

3.1. This chapter describes the proposed changes and how they will work. To aid discussion and comment, draft clauses for the proposed legislative changes are provided at Annex B.

Overview of the proposed changes

3.2. At present, a person’s liability to income tax for a tax year is determined by applying the following ‘steps’ as set out in section 23 of the Income Tax Act 2007.

Step 1

Identify the amounts of income on which the person is charged to income tax for the tax year.

The sum of those amounts is ‘total income’.

Each of those amounts is a ‘component’ of total income.

Step 2

Deduct from the components the amount of any specified relief to which the person is entitled for the tax year (e.g. trade loss relief against general income).

The sum of the amounts of the components left after this step is ‘net income’.

Step 3

Deduct from the amounts of the components left after step 2 any specified allowances to which the person is entitled for the tax year. This step only applies to individuals.

Step 4

Calculate tax at each applicable rate on the amounts of the components left after step 3.

Step 5

Add together the amounts of tax calculated at step 4.

Step 6

Deduct from the amount of tax calculated at step 5 any specified tax reductions to which the person is entitled for the tax year (e.g. double taxation relief and income tax relief for trusts with a vulnerable beneficiary).

Step 7

Add to the amount of tax left after step 6 any amounts of tax for which the person is liable for the tax year under certain specified provisions (e.g. discretionary trust tax pool adjustments).

The result is the person’s liability to income tax for the tax year.

3.3. The proposal is to introduce into the above income tax liability calculation a ‘de minimis’ amount for trustees and PRs.

3.4. This will provide that the amount of net income at the end of Step 2 of the calculation is taken as being £0 when the person’s net income at the end of that Step is within a prescribed de minimis amount. In this way, trusts and estates with income within the de minimis amount would not be subject to income tax on that income. Trusts and estates with income more than that amount would be subject to income tax on the full amount of income.

3.5. The precise level of the de minimis amount is to be decided. As the existing HMRC arrangement applies where tax does not exceed £100, the draft clauses provided at Annex B use an illustrative amount of £500. This equates to £100 of tax relief at a 20% tax rate.

3.6. The proposal has no effect on Step 7 of the income tax liability calculation, with any income tax charged on trustees on discretionary trust tax pool adjustments, for example, remaining payable irrespective of the amount of net income at the end of step 2.

Why is a normal allowance not being proposed?

3.7. The key aim of the proposals is to reduce administrative burdens for low-income trusts and estates whilst avoiding unnecessary complications elsewhere.

3.8. Reforming how income tax applies to trust and estate income requires consideration of not only how tax applies to the trustees and PRs but also how it applies to the beneficiaries of that income or, in the case of some trusts, the settlor.

3.9. In broad terms, there are circumstances where the trust or estate income is, or is treated as, the income of a person or persons other than the trustees or the PRs; with any income tax borne by the trustees or the PRs being available as a tax credit against the tax due by those other persons in a similar way to how a withholding tax operates (see paragraph 3.12 onwards, below). A regime where all trusts and estates benefit from an allowance, with only the amount of income above the allowance being taxed, is likely to give rise to issues connected with this general principle, including:

• whether ordering rules are required: income can be subject to tax at different rates depending on, for example, whether it is used against administration expenses. With an allowance, rules may be necessary to determine whether tax relief is given first to income otherwise chargeable at higher rates or to income chargeable at lower rates.
• how to determine the amount of tax credit available to a person: whilst this may be reasonably straightforward where all the trust or estate income is designated to a single person, it becomes increasingly complex where there is more than one beneficiary, especially if the income consists of a mix of relieved and taxed income (the taxed income possibly also being taxed at various rates depending on its nature).

3.10. In contrast, a regime that uses a de minimis amount avoids new complications arising for those trusts and estates with income above the set amount.

3.11. It is acknowledged though that a de minimis amount creates a ‘cliff-edge’ effect for trusts and estates near its ceiling. This would suggest that the appropriate amount should be relatively small.

Question 1: Bearing in mind that the proposals aim to reduce burdens on trustees and personal representatives of low-income trusts and estates, do you have comments on the proposal to legislate a de minimis system?

How are beneficiaries and settlors affected?

3.12. There are several circumstances when trust or estate income is taxed on a beneficiary or a settlor as well as the trustees or PRs, with the beneficiary or settlor obtaining a tax credit for the tax paid by the trustees or PRs on that income. Broadly, this occurs when:

• a beneficiary of an estate is entitled to income produced from the estate assets from the date of death
• income arises from trust property in which the settlor has an interest
• a beneficiary of an ‘interest in possession’ trust is entitled to the trust income

3.13. There are also circumstances when distributed trust or estate income is taxed on the beneficiary or settlor as a separate and distinct source of income, with the beneficiary or settlor obtaining a tax credit for the tax paid by the trustees or PRs when the underlying income arose. Broadly, this occurs when:

• a beneficiary of an estate obtains income treated as arising from an interest in the whole or part of the residue of the estate
• a beneficiary of a trust receives a discretionary payment of income

3.14. The effect of the proposals in this consultation on beneficiaries and settlors will remain in line with the effects of the HMRC concession and varies depending on the person’s tax position.

3.15. In many cases the availability of personal allowances will provide reductions in administrative burdens for this group as well as for the trustees or PRs.

Example 1

An ‘interest in possession’ trust receives dividend income only, totalling £480.

Ordinarily, the trustees would be liable to income tax at the dividend ordinary rate. From 6 April 2022 the rate is to be 8.75%, the tax payable being £42. Assuming there are no management expenses chargeable to income, the £438 balance would be distributed to the income beneficiary.

The income beneficiary has used only £1,000 of their £2,000 tax free dividend allowance. As the person has unused allowances covering the trust dividend income, they may make a claim to HMRC for the £42 paid by the trustees.

Under the proposal, assuming a de minimis amount of £500, the trustees would not be liable to income tax; the full £480 of income would be distributed; and the beneficiary would have no tax to pay or claim in respect of that income because of available allowances. The tax outcomes would be the same as now but with reduced administrative burdens for both the trustees and the beneficiary.

3.16. Where the income does give rise to an income tax liability on the beneficiary or settlor, the proposal will not affect that liability but may reduce the amount of tax credit available and therefore the amount they must pay HMRC by the normal payment date for the tax year.

3.17. The proposals will have no impact on persons in receipt of discretionary payments from trusts. Payments will continue to be received with a 45% tax credit, as set out in section 9 and section 494 of the Income Tax Act 2007.

3.18. In relation to UK estate income, current rules assume that the PR is liable to pay tax on that income. The grossing up provisions at section 663 of the Income Tax (Trading and Other Income) Act 2005 apply by reference to the rate of tax normally applicable to the income in question. Exceptions where income is treated as being borne at 0% are provided for at section 663(5). As such, residuary beneficiaries of estates may claim a tax credit even where no tax is payable by the PR. The government is considering what amendments may be appropriate in this regard.

Question 2: Do you have comments on how a de minimis system may impact on beneficiaries and settlors of trusts or estates?

Discretionary trusts – Tax pool adjustments and disaggregation

Tax pool adjustments

3.19. Tax pools apply to discretionary trusts and keep track of income tax the trustees pay.

3.20. When trustees make a discretionary payment of income it is treated by the beneficiary as if income tax has already been paid at the trust rate (currently 45%), as set out in section 9 and section 494 of the Income Tax Act 2007; and the trustees must have paid enough income tax (in the current or previous tax years) to cover this ‘tax credit’. If the tax credit cannot be covered by the amount of tax recorded in the tax pool, the trustees must pay the difference.

3.21. Under the proposal, trustees with income within the de minimis amount will not incur income tax and therefore have tax years in which no tax is added to the tax pool. To ensure that the tax credits are funded, trustees will continue to have to pay the difference between the tax pool amount and the tax credit irrespective of the amount of income that arises in the year (see paragraph 3.6 above). These ‘top up’ payments may be higher than is currently the case because of the reduced earlier additions to the tax pool. However, overall, the tax pool and ‘top up’ payments would not exceed what is currently paid.

Example 2

In year 1, the trust income is £350. Assuming a £500 de minimis amount, the trustees would not be liable to tax on the income and no tax would enter the tax pool.

In year 2, the trust income is £400. Again, the trustees would not be liable to tax on the income and no tax would enter the tax pool.

In year 2, a discretionary payment of £110 is also made to a beneficiary. For the beneficiary, it is treated as being made with an accompanying £90 tax credit (£200 at 45%: the grossed up amount for the discretionary payment = £110 x (100/(100-45)) = £200). As no tax has entered the tax pool, the trustees would be liable to pay £90 in this tax year in order to fund the beneficiary’s tax credit.

Without the proposal, the trustees would be liable to tax on the income as it arises in year 1 for £70 (£350 x 20%) and year 2 for £80 (£400 x 20%). As £150 would have entered the tax pool the beneficiary’s £90 tax credit would be fully funded and no further amount would be payable by the trustees.

Disaggregation

3.22. Trustees of accumulation and discretionary trusts are currently charged tax at lower rates of tax in respect of the first £1,000 slice of trust rate income compared to income above the £1,000 slice, as set out in section 491 of the Income Tax Act 2007. Anti-disaggregation rules exist to deter income generating assets being split between several trusts for the purposes of obtaining the lower rate of tax on a higher level of income than would otherwise be the case. They provide that where more than one trust made by a settlor exists during a tax year then the £1,000 slice is reduced to the greater of £200 or the amount calculated by dividing £1,000 by the number of trusts, as set out in section 492 of the Income Tax Act 2007. There are no proposals to change these rules.

3.23. To deter similar activity for the purpose of accessing several de minimis amounts, the de minimis amount for accumulation and discretionary trusts will also be modified. Where the first £1,000 slice is reduced to an amount less than the normal de minimis amount, it is proposed that the de minimis amount will be that lower amount. This will ensure that tax remains payable once the lower rate slice has been exceeded.

Assume there are four trusts made by the settlor that are in existence during the tax year. The maximum amount of trust rate income that is taxed at the lower rates therefore becomes £250 (£1,000 divided by 4).

If a given trust has trust rate income during the tax year, then the available de minimis amount is reduced to £250 to match this first slice amount.

It will have nil income tax to pay in respect of that income if its income is below £250. If its income exceeds £250 then a tax liability would arise on all the income for that trust in the normal way. That is, trust rate income within the reduced first slice band (i.e. up to £250) will be charged at the lower rates; and income in excess of that amount will be charged at trust rates.

The de minimis amount for trusts that do not have trust rate income during the tax year would be unaffected.

Question 3: Do you have comments on the proposals for discretionary trust tax pool adjustments and interactions with the disaggregation rules?

4. Assessment of impacts

4.1. This chapter provides a provisional assessment of impacts for introducing the proposals outlined in chapter 3 with a de minimis amount set at £500. A guide to impact assessments can be found in Annex C of the Autumn Budget 2021: Overview of tax legislation and rates. An Exchequer Impact assessment will be published when the de minimis amount is announced.

Summary of impacts

Impacts	Comment
Economic impact	This measure is not expected to have any significant economic impacts.
Impact on individuals, households and families	This measure is expected to have an impact on an estimated 28,000 individuals overall. It is expected to simplify the administration of tax in the majority of cases by avoiding the need for people to claim refunds; but some people are expected to have to return and pay the tax due, where previously that would have been done by the trustees. This measure is not expected to impact on family formation, stability or breakdown.
Equalities impacts	It is not anticipated that this measure will impact on groups sharing protected characteristics.
Impact on businesses and Civil Society Organisations	This measure is expected to have a significant impact on an estimated 53,000 businesses acting as professional trustees, personal representatives or in an advisory capacity. One-off costs will include familiarisation with the change and could also include upskilling staff and updating software or purchasing of new software. There are not expected to be any continuing costs. The measure is expected overall to improve businesses’ customer experience, with ongoing savings, in the long term as businesses may no longer have to file returns as professional trustees, personal representatives or on behalf of clients. This measure is not expected to impact civil society organisations.
Impact on HMRC or other public sector delivery organisations	This measure will require changes to trust and estate returns, income tax calculations and guidance.
Other impacts	No other impacts have been identified.

5. Summary of consultation questions

Question 1: Bearing in mind that the proposals aim to reduce burdens on trustees and personal representatives of low-income trusts and estates, do you have comments on the proposal to legislate a de minimis system?

Question 2: Do you have comments on how a de minimis system may impact on beneficiaries and settlors of trusts or estates?

Question 3: Do you have comments on the proposals for discretionary trust tax pool adjustments and interactions with the disaggregation rules?

6. The consultation process

This consultation is being conducted in line with the Tax Consultation Framework. There are 5 stages to tax policy development:

Stage 1: Setting out objectives and identifying options.

Stage 2: Determining the best option and developing a framework for implementation including detailed policy design.

Stage 3: Drafting legislation to effect the proposed change.

Stage 4: Implementing and monitoring the change.

Stage 5: Reviewing and evaluating the change.

This consultation is taking place during stage 2 of the process. The purpose of the consultation is to seek views on the detailed policy design and a framework for implementation of a specific proposal, rather than to seek views on alternative proposals.

Draft legislation is being exposed to aid discussion and comment. Revised draft legislation will be published later in the process in order to confirm, as far as possible, that it will achieve the intended policy effect with no unintended effects.

How to respond

A summary of the questions in this consultation is included at chapter 5.

Responses should be sent by 18 July 2022, by email to asres.consult@hmrc.gov.uk or by post to:

Assets and Residence Team
HM Revenue and Customs
Area 3C/03
100 Parliament Street
London
SW1A 2BQ

Telephone enquiries can be made to Alan McGuinness on 03000 585256

Paper copies of this document or copies in Welsh and alternative formats (large print, audio and Braille) may be obtained free of charge from the above address. All responses will be acknowledged, but it will not be possible to give substantive replies to individual representations.

When responding please say if you are a business, individual or representative body. In the case of representative bodies please provide information on the number and nature of people you represent.

Confidentiality

HMRC is committed to protecting the privacy and security of your personal information. This privacy notice describes how we collect and use personal information about you in accordance with data protection law, including the UK General Data Protection Regulation (UK GDPR) and the Data Protection Act (DPA) 2018.

Information provided in response to this consultation, including personal information, may be published or disclosed in accordance with the access to information regimes. These are primarily the Freedom of Information Act 2000 (FOIA), the Data Protection Act 2018, UK General Data Protection Regulation (UK GDPR) and the Environmental Information Regulations 2004.

If you want the information that you provide to be treated as confidential, please be aware that, under the FOIA, there is a statutory Code of Practice with which public authorities must comply and which deals with, amongst other things, obligations of confidence. In view of this it would be helpful if you could explain to us why you regard the information you have provided as confidential. If we receive a request for disclosure of the information we will take full account of your explanation, but we cannot give an assurance that confidentiality can be maintained in all circumstances. An automatic confidentiality disclaimer generated by your IT system will not, of itself, be regarded as binding on HM Revenue and Customs.

Consultation Privacy Notice

This notice sets out how we will use your personal data, and your rights. It is made under Articles 13 and/or 14 of the UK General Data Protection Regulation.

Your data

We will process the following personal data: Name

Purpose

The purpose(s) for which we are processing your personal data is to record responses to a public consultation: Income Tax: Low income trusts and estates

Legal basis of processing

The legal basis for processing your personal data is that the processing is necessary for the exercise of a function of a government department.

Recipients

Your personal data will be shared by us with HM Treasury.

Retention

Your personal data will be kept by us for 6 years and will then be deleted.

Your rights

You have the right to request information about how your personal data are processed, and to request a copy of that personal data.

You have the right to request that any inaccuracies in your personal data are rectified without delay.

You have the right to request that any incomplete personal data are completed, including by means of a supplementary statement.

You have the right to request that your personal data are erased if there is no longer a justification for them to be processed.

You have the right in certain circumstances (for example, where accuracy is contested) to request that the processing of your personal data is restricted.

Complaints

If you consider that your personal data has been misused or mishandled, you may make a complaint to the Information Commissioner, who is an independent regulator. The Information Commissioner can be contacted at:

Information Commissioner's Office
Wycliffe House
Water Lane
Wilmslow
Cheshire
SK9 5AF

0303 123 1113 casework@ico.org.uk

Any complaint to the Information Commissioner is without prejudice to your right to seek redress through the courts.

Contact details

The data controller for your personal data is HM Revenue and Customs. The contact details for the data controller are:

HMRC
100 Parliament Street
Westminster
London
SW1A 2BQ

The contact details for HMRC’s Data Protection Officer are:

The Data Protection Officer
HM Revenue and Customs
14 Westfield Avenue
Stratford
London
E20 1HZ

advice.dpa@hmrc.gov.uk

Consultation principles

This call for evidence is being run in accordance with the government’s Consultation Principles.

The Consultation Principles are available on the Cabinet Office website.

If you have any comments or complaints about the consultation process, please contact the Consultation Coordinator.

Please do not send responses to the consultation to this link.

Annex A: Relevant (current) Government legislation

The main provisions relevant to this consultation are as follows:

Income Tax (Trading and other Income) Act 2005:

• Part 5 (miscellaneous income)
  • Chapter 5 (settlements: amounts treated as income of settlor or family)
  • Chapter 6 (beneficiaries’ income from estates in administration)

Income Tax Act 2007:

• Part 2 (basic provisions)
  • Chapter 2 (rates at which income tax is charged)
• Part 9 (special rules about settlements and trustees)
  • Chapter 3 (special rates for trustees’ income)
  • Chapter 4 (trustees’ expenses and special rates for trustees)
  • Chapter 6 (trustees’ first slice of trust rate income)

Corporation Tax Act 2009

• Part 10 (miscellaneous income)
  • Chapter 3 (beneficiaries’ income from estates in administration)

UK legislation can be found at www.legislation.gov.uk.

Annex B: Draft clauses

The following draft clauses are provided to aid comment and discussion. The amounts mentioned at new section 24B(3) and (4) are illustrative only; the final amount being subject to decision:

Calculation of net income for low income trusts and estates:

(1) Chapter 3 of Part 2 of ITA 2007 (calculation of income tax liability) is amended as follows.

(2) In section 23 (the calculation of income tax liability), at the end of Step 2 insert –

‘See also section 24B which provides that a taxpayer’s net income is taken to be £0 in certain cases.’

(3) After section 24A insert –

‘24B Calculation of net income at Step 2 for low income trusts and estates

(1) Subsection (2) applies in relation to a taxpayer if –

(a) they are the personal representative of a deceased person and, ignoring this section, their net income at the end of Step 2 of the calculation in section 23 would be equal to or less than the de minimis estates amount, or

(b) they are the trustee of a settlement and, ignoring this section, their net income at the end of that Step would be equal to or less than the de minimis trusts amount.

(2) The taxpayer’s net income at the end of Step 2 of the calculation in section 23 is taken to be £0.

(3) The de minimis estates amount is £500.

(4) The de minimis trusts amount is –

(a) in a case where section 492 (cases where settlor has made more than one settlement) modifies the application of section 491 (special rates not to apply to first slice of trustees’ trust rate income) and section 492(2) produces an amount less than £500, that lesser amount, or

(b) in any other case, £500.’

(4) The amendments made by this section have effect in relation to the tax year [ ] and subsequent tax years.