Characterisation of trust distributions
Characterisation of trust distributions

The following Private Client guidance note provides comprehensive and up to date legal information covering:

  • Characterisation of trust distributions
  • Fixed interest trusts (life interest trusts)
  • Source of income—life interest trusts
  • Discretionary trusts
  • Source of income—discretionary trusts
  • Taxation of distributions
  • Dividend income
  • Application of ESC B18 before 6 April 2016

The tax treatment of a distribution from a trust in the hands of the recipient is determined in the first instance by whether the distribution is income or capital.

Fixed interest trusts (life interest trusts)

Under a fixed interest trust, one or more of the beneficiaries is entitled to the income of the trust for a specified time. If the trust is a life interest trust, for example, the beneficiary or life tenant has the absolute right to the underlying income of the trust; this right is known as an interest in possession. By contrast, under a discretionary trust the trustees have the power to make a distribution of income to the beneficiaries.

These distinctions are important because they determine the source of the income. The source of the income is important because it determines the tax character of the trust distribution. In the case of a fixed interest trust, the source of the income are the income producing assets themselves. By contrast, in a discretionary trust the trust itself is the source of the income.

Source of income—life interest trusts

A landmark case in establishing the source of trust income is Archer-Shee v Baker. The case gave rise to what is known as the Archer-Shee or Baker principle.

For trusts governed by English law, a beneficiary who has a