Trust income and gains: beneficiaries: individual beneficiary receives discretionary income payment from a resident trust: settlor-interested trust
The treatment of a discretionary payment in the hands of the beneficiary of a settlor-interested trust or settlement, where the settlor is chargeable on the underlying income arising to the trustees under ITTOIA/S624, depends on:
- whether that beneficiary is also the settlor and
- the period in which the payment is made.
Beneficiary is not the settlor - periods up to 5 April 2006
The measure of payment in the hands of the beneficiary is treated as nil. Although a discretionary payment to the beneficiary strictly constitutes a new source of income in his or her hands this treatment ensures that the income is not taxed twice.
Beneficiary is not the settlor - periods from 6 April 2006
ITTOIA/S685A provides that where an annual payment is made at the discretion of the trustees out of income that is charged to tax on the settlor, the treatment in the following paragraph applies. It will be a matter of fact whether the income out of which the payment is made is charged on the settlor. For example, a payment made out of income shortly after a trust becomes non-settlor-interested could still be income that is charged on the settlor, and so S685A will apply. Conversely, a payment made out of income shortly after a trust becomes settlor-interested could be from income that is not charged on the settlor, and so S685A will not apply.
Where a discretionary payment is made out of income charged on the settlor, the beneficiary is treated as though he or she has paid tax at the higher rate on the actual amount of the payment under ITTOIA/S685A. The payment is not grossed up and is included in the calculation of that person’s total income. The tax credit ensures the beneficiary has no further liability in respect of the payment but it is ring-fenced so that no part of it can be repaid or set against liability arising from any other income of the beneficiary. ITTOIA/S685A as enacted by FA 2006 did not alter the statutory ordering rules under which income from a trust is charged before savings and/or dividend income. The result was that a beneficiary of a settlor-interested trust who also had savings and/or dividend income could find the non-trust income was being pushed into higher rates so that more tax was due overall. FA2008/S67 amended ITTOIA/S685A (with effect from 6 April 2006) so that income from a settlor-interested trust is treated as one of the highest slices of income. Although this ensures that other income is not pushed into higher rates income from a settlor-interested trust remains part of the beneficiary’s total income and may therefore affect tax reliefs and benefits which are means tested (for example Age allowance, Student loan repayments).
Where only part of the income arising to the trustees is chargeable on the settlor, the beneficiary is treated as having paid income tax at the higher rate only on a proportion of the discretionary payment corresponding to the proportion of income chargeable on the settlor to the total income of the trustees.
Beneficiary is also the settlor - periods up to 5 April 2006
Where the settlor is chargeable on the income arising to the trustees discretionary payments made to the settlor as a beneficiary of the trust or settlement are not further taxable. The wording in ICTA88/S687(1) ‘but would not be his income if it were not made to him’ means S687 does not apply to payments that fall to be treated as the income of the settlor under ITTOIA/S624.
Beneficiary is also the settlor - periods from 6 April 2006
Discretionary payments made by the trustees to the settlor are taken out of charge by ITTOIA/S685A(5).