Proposed new tax rates on dividends, due to come into force next week on 6 April will mean trustees of discretionary trusts may have to give some thought to how they hold investments, distribute to beneficiaries and account for the tax due.
Thousands of trusts exist in the UK and many hold investments in equities – either direct shareholdings or via mutual funds.
Currently, dividends paid on investments held within a trust come with a notional 10% tax credit leaving trustees with an effective tax rate of 30.56%.
From April, the non-reclaimable 10% dividend tax credit has been scrapped and, unlike individuals, trusts do not get the new tax free dividend allowance of £5,000 per annum. For trusts, dividends received within the £1,000 starting band will be taxed at 7.5%; and dividends in excess of this will be taxed at the increased rate of 38.1%. The combined result of these changes is that trustees will be 10.8% worse off on accumulated income.
Previously, when beneficiaries received distributions they have been able to recover the difference between the tax withheld and their marginal rate. Whilst beneficiaries receiving distributions will be in the same position as before in this regard, they will not be able to use their personal dividend allowance, as they will be receiving trust income and not dividend income. They will therefore lose out.
So what can be done?
Where there is a need to distribute income on a regular basis, a solution could be to create revocable life interests and mandate income directly to beneficiaries to allow direct receipt of dividends personally and use of personal dividend allowances.
Where income is not required regularly an alternative could be to use investment bonds. They have a number of advantages:
- they are a non-income producing asset;
- they allow annual 5% tax-deferred withdrawals;
- they have the ability to be assigned to a lower tax rate beneficiary;
- no ongoing tax liability or tax return until a chargeable event occurs; and
- if the settlor is still alive, any tax is at the settlor’s marginal rate not the trustees.
HMRC have confirmed that dividend income received by life company funds will continue to be exempt from tax.
Trustees do have a fundamental duty of care to act in the best interests of all beneficiaries. The Trustee Act 2000 introduced a number of new duties on trustees to obtain and consider proper advice when making or reviewing investments and that should also include any taxation changes.
PM+M Wealth Management Ltd is authorised and regulated by the Financial Conduct Authority.