Characterisation of trust distributions for tax purposes

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

  • Characterisation of trust distributions for tax purposes
  • Fixed interest trusts (life interest trusts)
  • Source of income—life interest trusts
  • Discretionary trusts
  • Source of income—discretionary trusts
  • Taxation of distributions
  • Dividend income
  • Distributions to minor children of settlor
  • Non-resident settlor

Characterisation of trust distributions for tax purposes

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.

FORTHCOMING CHANGE: On 27 October 2021, the government announced at Autumn Budget 2021 that the dividend ordinary rate will increase from 7.5% to 8.75%, the dividend upper rate will increase from 32.5% to 33.75% and the dividend additional rate and the dividend trust rate will both increase from 38.1% to 39.35%. These rate increases are contained in clause 4 of Finance Bill 2022 and once enacted will take effect from tax year 2022–23. See: Autumn Budget 2021—Private Client analysis—Dividend rates and Tax—Finance Bill 2022 tracker.

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

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