Cross Practice Insights Part 3: Tax Considerations for Trustees and Beneficiaries

When establishing a trust, it is important to remember that this is not a ‘tax free’ way of investing and/or distributing assets. Different types of trusts are taxed differently and trustees and beneficiaries must be aware of their obligations to pay taxes which are owing. In part three of our cross-practice insights series, we look into tax considerations for trustees and beneficiaries.

If trustees are responsible for paying tax then they must ensure that there are sufficient funds within the trust to meet payments. For beneficiaries of a trust, it is important to understand the type of trust they are the beneficiary of, and the type of distribution received, in order that they can take this into account when considering their own tax affairs.

If trustees and beneficiaries do not pay tax in a timely manner (or at all) then they could also be liable for interest and, potentially, penalties. It is therefore important that parties involved in a trust structure ensure that they are familiar with the necessary tax regimes and take advice if needed.

1. Disclosure duties to beneficiaries

Trustees have a number of obligations and responsibilities to the beneficiaries of the trust which includes a duty to disclose certain information, when requested.

In respect of tax, beneficiaries need to understand whether they receive income from a bare trust or an interest in possession trust. If the beneficiary asks, the trustees must confirm the source of income generated, how much income the beneficiary has benefited from and if tax has already been paid on the income; if so, how much tax has been paid. A beneficiary will also need to know whether the income is being paid to them gross or net in order that they can establish how to deal with their personal tax return.

Trustees can provide this information using an R185 form.

The tax position is different under accumulation and discretionary trusts and this is why it is important that a trustee provides information, when requested, to a beneficiary.

2. Trustee duties

Trustees are, amongst other things, responsible for reporting and paying tax on behalf of the trust. If there are two or more trustees, the trustees must nominate one as the ‘principal acting trustee’ to manage the trust’s tax affairs. 

It is important to note that all trustees are accountable for tax and may be charged tax and interest personally if the trust does not pay the correct amount of tax.

In the first instance, once a trust has been established, the trustees need to consider if the trust should be registered with HMRC. Most trusts need to be registered as it is likely that the trust will have some tax liability (for example from income received from properties, inheritance tax or stamp duty land tax on the sale of properties).

Trustees of non-UK resident trusts must consider registering with HMRC if the trust becomes liable for tax on UK income or assets (for example, UK properties).

HMRC has published guidance on how trustees should treat taxable income but it is important to note that HMRC guidance is just that, guidance, and specialist advice should be sought as early as possible.

3. What to do if tax was not paid when required

Trustees may not understand their duties to file tax returns, or even pay tax on behalf of the trust until years after the trust was established and the tax liabilities started to accrue. This can be for a number of reasons, for example the trustees did not know that they were trustees, they received incorrect advice to say that trusts are completely tax-exempt or, new trustees have been appointed and are now on notice that the old trustees breached their duties.

As soon as trustees know that there has been historic underpayment of tax, it is important that they take advice on making a disclosure to HMRC.

Whilst it may seem counterintuitive to notify HMRC of a liability that may have gone undetected for a number of years, it is usually best to approach HMRC first rather than waiting for HMRC to approach you. By making a voluntary disclosure, the trustee would be taking control of the narrative with HMRC and be more in control of timescales. Penalties are also often reduced if the disclosure is voluntary (and unprompted), or proactive, rather than in response to HMRC’s enquiries (i.e. prompted).

It is also important to consider the time limits that HMRC have to open an assessment, or for which tax may be due.

Ordinarily, HMRC can issue an assessment within 4 years of the end of the relevant tax period. If HMRC considers that the taxpayer, or trustees’ behaviour has been ‘careless’, they can assess up to 6 years from the relevant period. If the behaviour has been deliberate, HMRC can look back 20 years. The number of years for which a disclosure should be made needs to be carefully considered and advice should be taken in relation to the same.

4. If you’re already in a dispute, taxation of settlement monies

Issues of tax in contentious trust and estate disputes can sometimes be ‘deal breakers’ but are often overlooked until shortly before settlement discussions take place or even during settlement discussions.

Parties will need to consider tax which is due to be paid, or should have been paid. They will also need to consider whether any settlement payments are considered as capital or income in nature. Settlement payments which are treated as income from a trust would be taxable.

Regardless of whether settlement payments are to be treated as income or capital, concessions and/or reliefs may be applicable and it may be possible to offset those against any losses.

The key is for these issues to be considered early on in any settlement discussions.  Any potential tax liabilities can significantly impact the quantum of any settlement and claimants in particular, may want to factor in tax liabilities to any offers made or accepted in settlement discussions.

In conclusion

Given that the Office for Budget Responsibility forecast that inheritance tax liabilities are likely to raise £8.3 billion for the year 2024-25, and the total income and capital gains tax raised from trust and estates for the year ending 2023 was £1.58billion, it is likely that trusts and estates will continue to be a particular area of interest to HMRC in the coming years. As with all tax matters, if a taxpayer considers there has been an underpayment in tax, either in their personal capacity or in their role as a trustee, it is always best to seek advice and consider how best to approach HMRC.

Tax is not a straightforward issue and, although parties are not necessarily expected to understand its nuances, it is sensible to be aware or tax implications and take advice from suitably qualified professionals as to its application.

Further information

If you have any questions regarding this blog, please contact Laura Phillips TEP or Krishna Mahajan.

 

About the authors

Laura Phillips TEP, is a Legal Director in the Dispute Resolution team. Laura has particular expertise in Contentious Trust and Estate and Court of Protection Disputes.

Krishna is a Senior Associate in the Dispute Resolution team, who specialises Tax Disputes and Investigations