From 6 April 2016, the change in how dividends are taxed can have a significant effect on trusts.
This can be an overall advantage for any discretionary trust which receives a significant sum in company dividends and then go on to distribute such income, or a disadvantage where company dividends are retained within the discretionary trust. There can also be a disadvantage compared to the taxation regime for “life interest” trusts, where beneficiaries may have the benefit of the £5,000 dividend allowance. In every case, the Trustees must do some “number crunching” before deciding what is best for the beneficiaries.
A Discretionary Trust is, broadly speaking, one in which assets are held for the potential benefit of a pool of beneficiaries, but controlled by trustees who may or may not be included amongst the potential beneficiaries. Although the trustees may decide each year that they will principally benefit one particular person, the key is that they have the discretion as to whether that person, or any other person from the pool, receives any benefit and, if so, they have the discretion as to how much that person receives. These trusts can be enormously useful, not just for tax savings but also for family protection and flexibility. However, in future the trustees need to be careful to consider the extra dividend tax payable.
Discretionary Trusts are now taxable at 38.1% on dividends and that tax attaches to the dividend income which the trustees pay out. However, the trustees must account for income tax at 45% on those income distributions and so may have to pay an additional 6.9% tax (previously a larger percentage) to make up the tax shortfall, and of course find that additional money. Furthermore, discretionary trust beneficiaries cannot claim the new £5,000 per year dividend tax free allowance. Discretionary Trustees therefore now need to add an extra tax planning item to the agenda of their regular meetings.
Discretionary Trustees might consider creating interests in possession (the right to receive the income). This could potentially allow the beneficiary to use the £5,000 tax free allowance and also avoid the additional tax on the trust. However, there are of course other factors to take into account, such as the effect on inheritance tax. Trustees should take detailed advice if they are in the position where the additional dividend tax will be significant.
For trust tax advice, please click here to email Eric Wardle, Head of our Trusts and Tax Team on call him on 01604 233110.