Beneficiaries of bare trusts and interest in possession trusts must declare any income on his or her personal tax return. Although trustees of these trusts can pay income tax on behalf of a beneficiary, it is the beneficiary who is chargeable to the tax.
Trustees of discretionary trusts are responsible for declaring both the income arising from the trust fund and payment of the tax due. The rate of tax payable depends on the individual financial circumstances of the trust. When trustees of discretionary trusts make payments of income to a beneficiary, the beneficiary treats the payment as if income tax has already been paid at the higher trust rate applying to the trust. The beneficiary receives a tax credit. This means that the beneficiary could claim some or all of the tax back depending on his or her personal tax status.
A tax pool is a record kept by the trustees which shows the difference between the total amount of income tax paid by the trustees for that current tax year (plus income tax carried over in the tax pool from earlier years) and the total value of tax credits attached to income payments to beneficiaries for that year.
When the trustees pay tax at the trust rate applying at the time, the tax pool increases by the amount of tax paid. However, when trustees pay income to beneficiaries the amount in the tax pool is reduced by the value of the tax credit attached to each payment. The tax credit may exceed the amount of tax actually paid by the trustees.
Consequently, shortfalls can arise where the amount of tax credits on payments to beneficiaries exceeds the amount of tax actually paid by the trustees as recorded in the tax pool for that particular tax year. In such cases the trustees are personally liable and must pay the shortfall back into the tax pool. This can easily happen if the income tax affairs of the trust are not closely monitored.
It is, therefore, very important that trustees of discretionary trusts seek professional advice to ensure that they comply with the strict tax rules applying to the treatment of income arising in discretionary trusts to avoid being held personally liable.
For anything further, one of our specialists would be delighted to meet you either in our office or in your own home to talk through your requirements and answer any questions. Please contact us at any time.