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Sam
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I am setting up a discretionary trust in accordance with my

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I am setting up a discretionary trust in accordance with my late brother's will. We will be paying out annually to one beneficiary £6000 from capital and £2000 from net income after paying just under £2000 tax (trustee rate 45%). I understand the beneficiary will be able to claim back some of this tax as he is a basic rate taxpayer but will he be taxed on the £6000 as this will be paid from capital in the Trust to be set up.
Submitted: 2 years ago.
Category: Tax
Expert:  Sam replied 2 years ago.
Hi
Thanks for your question, I am Sam and I am one of the UK tax experts here on Just Answer.
You are correct that the beneficiary can claim back the trust income in excess of the 20% rate band, and you will need to provide the beneficiary with form R185 each year detailing the payment made and the tax deducted (tax credit)
As £2000 will be income and £6000 capital (and you can provide satisfactory evidence that the £6000 comes from the capital and there is no pre existing amount set) then its just the income paid out that is subject to tax.
HMRcs stance on this
"Income of Trust Beneficiary - Discretionary payment from trust capital [3757]
A discretionary payment made out of trust capital is usually not regarded as the income of the beneficiary. This view was supported in the case of Stevenson v Wishart and Others (59 TC 740).
Exceptionally, payments out of capital are treated as the income of the beneficiary where the beneficiary has pre existing annual income entitlement
• of a fixed amount or
• of a certain defined level as in Cunard’s Trustees v CIR (27 TC 122)
• and the trustees can or are required to top up the trust income to that amount or level out of capital."
But it would appear that unless the position is watertight then HMRC do try and argue this position and insist its subject to tax. So there must not be a pre existing position that sets the annual entitlement -
See link here from the trust manual
http://www.hmrc.gov.uk/manuals/tsemmanual/TSEM3785.htm
So you can see that if this to be a pre existing position of annual payments to be made, then the capital is subject to tax also.
I am shocked that HMRC would see this as a hypothetical situation, you (from my viewpoint) are merely trying to establish the correct tax position for each of the payment made.
Let me know if you need any further clarification
Thanks
Sam
Sam and other Tax Specialists are ready to help you
Customer: replied 2 years ago.

Hi Sam,

Thanks for your speedy response which was more detailed than expected.

In a letter of wishes to his will my brother stated income was to be paid annually to the beneficiary but the deceased privately expressed to me that he expected that to be £8000 as interest rates were higher then. As the beneficiary was contemplating a legal challenge to the will I agreed a discretionary payment which I believe my brother would have approved of £8000 plus any tax rebate per annum to avoid this legal action which he has reluctantly approved. He now asks that I set up a formal agreement to cover this improved payment but I have explained this could result in the capital payment also being taxed as it would not then be at the trustees discretion. Do you agree?

Many thanks

Frank

Expert:  Sam replied 2 years ago.
Hi Frank
Thanks for your response, and I am glad that you find the Just Answer service more detailed than your expectations might lead you to expect!
Then as the beneficiary has an expectation of £8000 a year plus rebate , then I would advise that the whole lot is liable to trust tax (45%) of which you will provide an R185 detailing the annual payment with 45% tax credit - and I would advise you provide copies of the links I have provided you with to substantiate the requirement by the trust to treat this whole amount as a taxable position, as you are correct that its not at your discretion but as an expectation from the beneficiary.
Let me know if you have any further questions, but if you would be willing, in the meantime to rate/accept the answer, it would be appreciated, as this ensures that Just Answer credit me for my time.
Thanks
Sam
Customer: replied 2 years ago.

Hi Sam,

Thanks. Had hoped the full sum would not be taxable but imagine there is nothing I can do to change this.

Have sent excellent rating.

Frank

Expert:  Sam replied 2 years ago.
Hi Frank
Thank you so much, and you are right the tax position is not one that is up to you to choose, its a matter of law - but at least you have the HMRC guidance to support that fact - should this be challenged by the beneficiary.
Thanks and have a great evening
Sam
Customer: replied 2 years ago.

Hi Sam,

Sorry to trouble you further. At present no annual payment has formally been agreed with the beneficiary just proposed by me to ward off litigation not appreciating the payments could be taxed differently. I believe the beneficiary would be prepared to accept income payments (taxed @45%) and additional payments (would these always have to be of differing amounts?) at the trustees discretion if it led to less tax being paid by the Trust. If so would the form R185 need to be issued to the beneficiary for just the income amounts or will the additional discretionary payments need to be included on it?

Finally if the discretionary Trust is set up and later because of high tax implications (HMRC exceptionally taxing as income not part capital) the trustees decide to close it by making the whole trust fund (expected to be £300,000) available to the beneficiary which my brother did not want (but neither would he wish to be paying tax on capital already taxed when he was alive) would the Trust or beneficiary be liable to tax on £300,000?

Many thanks for your continued help.

Frank

Expert:  Sam replied 2 years ago.
Hi Frank
Thanks for your response
But its what the beneficiary expects based on what you advise the capital payments will always be subject to tax. Even if you differ the amounts - you know that the additional payments are not due to anything other than his demands and expectations rather than how the trust should run - where usually only income is distributed (although it can be accumulated within the trust)
I am afraid you cannot alter what is fact without putting yourself as not operating the trust and its distributions accurately and legally.
The discretionary element elates to the income NOT the capital.
And without having access to the full will and the size of the estate - we on Just Answer could not advise further on tax implications should the trust then be closed. But assuming its just capital remaining and there are no further IHT issues, this should not create any issues, but you would need to speak with the solicitor who handled your late brothers estate, or seek advise from one, as our expertise lies with taxation within the operation of the trust rather than opening and closing!
Thanks
Sam
Customer: replied 2 years ago.

Hi Sam


 


Thank you and I understand that without access to all the trust information your reply cannot be expected to fully answer my concerns. I will need to take further advice of my solicitor.


 


Best wishes


Frank


 


Frank

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