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HMRC internal manual

Trusts, Settlements and Estates Manual

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Trust income and gains: beneficiaries: payment from trust capital - exceptions to normal rule - payment to supplement or augment income

The cases of Cunard’s Trustees v CIR (27TC722) and Trustees of the will of H K Brodie v CIR (17TC432) established that where there is a pre-existing income interest (whether in the form of an annuity or interest in possession) payments out of trust capital to supplement or augment income constitute income in the hands of the recipient.

Where the beneficiary has a pre-existing annual income entitlement, and the trustees can or have to supplement or augment the trust income out of capital:

  • if they can use capital in this way, i.e. it is discretionary, ITA/S494 will apply
  • if they have to use capital in this way, the annual payments treatment will apply.

Example:

  • Dilwar lives rent-free in trust property. The deed provides for income to be used to pay rates and other property expenses, while the rest of income is to be used for his benefit. If the income is insufficient, the trustees are empowered to use capital at discretion to keep the beneficiary at same level of comfort as in the past. Dilwar has a pre-existing income entitlement, so the payment from capital is treated as income in his hands. ITA/S494 applies to the capital payments.
  • Elena has an annuity of £10,000 a year. If the trust income is less than £10,000, the trustees have to make up the shortfall from trust capital. Elena has a pre-existing income entitlement, so the payment from capital is treated as income in her hands. The whole £10,000 is taxable as income and the annual payments treatment applies.