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HMRC internal manual

Trusts, Settlements and Estates Manual

HM Revenue & Customs
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Settlements legislation: treatment of income in hands of beneficiary

In many cases where the provisions of ITTOIA/Part 5, Chapter 5 have the effect of treating income as that of the settlor, the trustees will have a duty or power to pay such income to beneficiaries.

Bare trusts and IIP trusts

The income of such trusts belongs to the beneficiary as it arises. Where the settlements legislation applies to income belonging to a non-settlor life tenant, the income is treated as that of the settlor and the settlor alone so there is no charge on the actual beneficiary.

Accumulation/discretionary trusts

Settlor-interested trusts

Payments to beneficiary other than the settlor

Where you tax the settlor on the income arising to the trust, for years up to and including 2005-06 treat the beneficiary’s income as nil. Although a discretionary payment to the beneficiary strictly constitutes a new source of income in their hands (TSEM3756), we treat the measure of the beneficiary’s income as nil, to avoid taxing the same income twice.

For 2006-07 onwards the law provides that discretionary payments to the beneficiary are treated as though the beneficiary had paid tax at the higher rate (see TSEM3757). The amount of the actual payment (it is not grossed up) should be shown in the beneficiary’s return and it 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.

Payments to the settlor

Where you tax the settlor on the income arising to the trust, discretionary payments out of the trust to the settlor are not further taxable. For years up to and including 2005-06 the phrase in ITTOIA/S687(1) ‘but would not be his income if it were not made to him’ means ITTOIA/S687 does not apply to payments that fall to be treated as the income of the settlor under ITTOIA/S624. For 2006-07 onwards discretionary payments made by the trustees to the settlor are taken out of charge by ITTOIA/S685A(5).

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Trusts for minor child of settlor

The income of the trustees is not chargeable on the settlor until a discretionary payment is made out of that income - see TSEM4512. That discretionary payment is not taxable on the minor child.