Chapter 6: Trustees' first slice of trust rate income

Overview

1443.     This Chapter is based on sections 686D and 686E of ICTA.

Clause 491: Special rates not to apply to first slice of trustees' trust rate income

1444.     This clause provides for the first £1,000 of any trustees' unrelieved total income that would otherwise be chargeable at one of the special trust rates to be taxed instead at the rate or rates that normally apply to the income. It is based on section 686D of ICTA.

1445.     Subsections (3) and (4) set out the steps to be taken in identifying the first slice of income (if it exceeds £1,000) and in determining the rate of tax to apply to income within that slice.

1446.     The order is established by reference to the rules regarding ordering of income in clause 16. The effect is that, so far as possible, the first slice consists first of income for which the normal rate is the basic rate, then, of income for which the normal rate is the savings rate and finally, of income for which the normal rate is the dividend ordinary rate. The first slice is then taxed at the normal rates appropriate to the types of income of which it consists.

Clause 492: Cases where settlor has made more than one settlement

1447.     This clause reduces the band of income charged at normal rates if a settlor of that settlement has made other settlements. It is based on section 686E of ICTA.

1448.     The £1,000 band is divided by the total number of existing settlements made by the settlor, but not so as reduce the band below £200. If there is more than one settlor for the settlement in question then the lowest threshold arrived at by this calculation is used.

Chapter 7: Discretionary payments

Overview

1449.     This Chapter concerns the tax treatment of a payment made by trustees to a beneficiary in the exercise of a discretion. It is mainly concerned with the taxation of the trustees, but contains some provisions affecting the beneficiary.

1450.     The discretionary payment is treated as a net amount corresponding to a gross amount from which the trustees have deducted income tax at the trust rate.

1451.     That gross amount is chargeable to income tax on the beneficiary as an annual payment within Chapter 7 of Part 5 of ITTOIA, and the beneficiary is treated as having paid the income tax deducted. The deduction of income tax at source provisions that normally apply to annual payments are disapplied by clause 832(5)(d) and (e) of this Bill.

1452.     The trustees, who will be charged to tax on the income of the trust at either the dividend trust rate or the trust rate, with the total tax paid going into a "tax pool", have to account for the tax deemed to have been deducted only to the extent that there is insufficient tax in the tax pool.

Clause 493: Discretionary payments by trustees

1453.     This clause sets out what payments come within this Chapter. It is based on section 687(1) and (5) of ICTA.

1454.     Subsection (1) provides that an annual payment is within this Chapter if it is made by trustees in the exercise of a discretion (exercised by the trustees or any other person) and provided that condition A or B is met. And it is made explicit that the trustees must be UK resident. See Change 89 in Annex 1.

1455.     Condition A is that the payment is income of the beneficiary for either income tax or corporation tax purposes. "Beneficiary" is used instead of the phrase "person to whom [the payment] is made" in section 687(1)(a) of ICTA. The reference to corporation tax provides a link to section 687A of ICTA.

1456.     A discretionary payment from an employment-related settlement may be taxed on a beneficiary as employment income. Such a payment is excluded from this clause. But the income arising to the trustees out of which the payment is made is taxable at the special trust rates. In such circumstances there is effectively double taxation and the trustees may be able to claim a payment from HMRC. See ESC A68.

1457.     Condition B is that the payment is treated as income of a settlor under section 629 of ITTOIA.

Clause 494: Grossing up of discretionary payment and payment of income tax

1458.     This clause provides for the grossing up of discretionary payments and sets out the treatment of the tax deemed to have been deducted. It is based on section 687(2) of ICTA.

1459.     Subsections (1) and (2) provide for the amount of the actual payment to the beneficiary to be grossed up by reference to the trust rate for the year in which the discretionary payment is made.

1460.     The amount by which a payment is grossed up represents income tax. Subsections (3) and (4) provide that the beneficiary or the settlor (in a case where the discretionary payment is treated as income of the settlor), is treated as having paid the tax deemed to have been deducted.

Clause 495: Statement about deduction of income tax

1461.     This clause provides for the recipient of the discretionary payment to be able to obtain a statement from the trustees giving details of the payment and tax treated as deducted. It is based on section 352 of ICTA as it applies to payments under section 687 of ICTA.

1462.     In a case where the income is treated as that of the settlor, it is the settlor rather than the recipient who will need these details. Accordingly, this clause gives authority to the appropriate person to require a statement from the trustees. See Change 90 in Annex 1.

Clause 496: Income tax charged on trustees

1463.     This clause sets out the tax effect on the trustees of making a discretionary payment. It is based on section 687(2) of ICTA.

1464.     The source legislation provides for all the tax deemed to have been deducted to be assessed on the trustees, subject to set-off under section 687(3) of ICTA (the "tax pool"). But the charge under this clause is only on the amount of tax by which the amount treated as deducted exceeds the amount of the tax pool for that year. This is similar to the approach adopted in clause 424 (gift aid).

Clause 497: Calculation of trustees' tax pool

1465.     This clause sets out the calculation of the trustees' tax pool available for a tax year, in order to determine whether a charge on the trustees arises under clause 496. It is based on section 687(3) of ICTA.

1466.     To make the comparison in clause 496, the amount of the tax pool available for a tax year is the amount at the end of the tax year (including tax going into the pool in that year) before reduction in respect of amounts of tax deemed to have been deducted from payments in the tax year. It follows that the amount of the pool available for the previous year has to be adjusted at Step 1 for the amount of tax deemed to have been deducted in the previous year in order to arrive at the correct brought forward figure. See also the transitional provision in Part 10 of Schedule 2.

1467.     Subsections (2) and (3) ensure that tax only goes into the pool if it is tax paid at a time when the trustees were UK resident. This is a corollary to trustees having to account for tax only on discretionary payments made while UK resident, See Change 89 in Annex 1 and the commentary on clause 493. It is also provided that the opening pool is nil if the settlement is established during the year.

Clause 498: Types of income tax for the purposes of section 497

1468.     This clause sets out the types of income the tax on which goes into the tax pool. It is based on section 687(3) and (3A) of ICTA.

1469.     The clause streamlines many of the references to other provisions made by section 687(3) of ICTA. For example, following the amendments made by ITTOIA, section 687(3)(a2) and (aa) of ICTA are unnecessary because the sections mentioned there are within Chapter 3 of Part 4 of ITTOIA and so are already covered by section 687(3)(a1) of ICTA.

1470.     Following its substitution by FA 2006, section 686A of ICTA brings together the charges on items that were previously charged at the trust rate under various separate provisions. This means that there may have been overlap between paragraph (bc) and other paragraphs of section 687(3) of ICTA and uncertainty about the amount of tax to go into the pool. That uncertainty is removed by this clause.

Chapter 8: Trustees' expenses and beneficiary's income

Overview

1471.     This Chapter is concerned with how trustees' expenses affect the income of a beneficiary. It has no application to discretionary payments by trustees, but relates to circumstances in which a beneficiary (and no-one else) is entitled to the whole of or a share in the income of a settlement. Such a beneficiary is often described as having an interest in possession.

1472.     Much of this Chapter is new, as there is very little statutory guidance about how trustees' expenses affect the measure of a beneficiary's income. The principles set out in this Chapter are mainly derived from trust and tax law, but are well understood and have been the subject of guidance issued by HMRC. See Change 91 in Annex 1.

Clause 499: Application of Chapter

1473.     This clause sets out the circumstances in which the Chapter applies. It is new.

1474.     The key factor is that there is a beneficiary who is entitled to some or all of the income of the trust before it is distributed.

Clause 500: Restrictions on use of trustees' expenses to reduce the beneficiary's income

1475.     This clause sets out restrictions which apply in arriving at the amount of the trustees' expenses which are to be taken into account in measuring a beneficiary's income. It is new.

1476.     Subsection (1) provides that expenses may be taken into account if they are incurred in the current tax year or an earlier tax year and are chargeable to a beneficiary's income in accordance with the following subsections. The critical issue is not in which year the expense is incurred, but in which year the beneficiary's income is reduced by reference to the expense. See Change 91 in Annex 1.

1477.     Subsections (2) and (3) provide that the expenses must either be chargeable to income under a term of the settlement (subject to any overriding law) or, if the deed contains no such term, they must be chargeable to income under trust law (subject to any overriding term of the settlement). See Change 91 in Annex 1.

1478.     Subsection (4) makes it explicit that expenses cannot be used to reduce the beneficiary's income if they have been or will be taken into account in calculating the trustees' liability to income tax for any tax year.

Clause 501: Non-UK resident beneficiaries

1479.     This clause performs a similar function to clause 487 (which applies to expenses taken into account in taxing trustees in receipt of accumulated or discretionary income) in providing that a proportion of expenses is to be disregarded if part of the beneficiary's income is untaxed income. It is based on section 689A of ICTA.

Clause 502: Meaning of "untaxed income" in section 501

1480.     This clause defines "untaxed income" for the purposes of clause 501. It is based on section 698A(1) and (5) of ICTA.

1481.     The definition is the same as that in clause 487(4) and (5) with beneficiary substituted for trustees.

Clause 503: How beneficiary's income is reduced

1482.     This clause explains how trustees' expenses are taken into account in measuring a beneficiary's income. It is based on section 689B of ICTA.

1483.     Trustees are liable at the normal rates on the income of the trust. The beneficiary receives income net of tax and expenses, but is entitled to the gross income after expenses. So to calculate the true measure of the beneficiary's income, the net income of each type is calculated, expenses are allowed against that income and what is left is grossed up at the normal rate for that type of income.

1484.     Subsections (1) and (2) provide that, when trustees' expenses are taken into account, they reduce different types of income of the beneficiary in a particular order.

1485.     Subsection (5) sets out the calculation in step form. See Change 91 in Annex 1 and the overview commentary on this Chapter.

Chapter 9: Unauthorised unit trusts

Overview

1486.     This Chapter provides rules about unauthorised unit trusts (UUTs).

1487.     There are related clauses about UUTs in Chapter 13 of Part 14. Those clauses provide for the trustees to be treated as making deemed payments representing the gross amount of the income they receive. They also provide for the trustees to be treated as deducting income tax from those payments at the basic rate, and for the collection of that income tax.

Clause 504: Treatment of income of unauthorised unit trust

1488.     This clause sets out the basis of the taxation of the trustees of a UUT. It is based on section 469(1), (2) to (2B) and (9) of ICTA.

1489.     The taxable income of the trustees of a UUT is treated as that of the trustees rather than the unit holders (subsection (2)).

1490.     All income of the trustees is to be charged at the basic rate (subsection (3)). The special trust rates do not apply (see subsection (4)(a) and clause 481(1)(b)).

1491.     Accordingly, certain sums that would ordinarily be treated as carrying a tax credit, or where the recipient is treated as having paid income tax, are not so treated if received by UUT trustees (subsection (4)(b) to (d)).

1492.     Subsection (5) provides that annual payments to unit holders do not come within the special discretionary payments regime in clause 494. The general provision for trustees to provide statements of tax deducted, in section 352 of ICTA, is rewritten in clause 495. But the provisions concerning such statements by UUT trustees are in clause 908 in Chapter 19 of Part 14, where they more naturally belong. So clause 495 is also excluded by subsection (5).

Clause 505: Relief for trustees of unauthorised unit trust

1493.     This clause gives relief to the trustees of a UUT for the payments to unit holders treated as made under Chapter 13 of Part 14. It is based on sections 348(1) and 835(6) of ICTA.

1494.     The relief is given by deduction in calculating net income. This is in line with the approach adopted generally to rewriting the provisions about charges on income. See Change 81 in Annex 1 and the overview commentary on Chapter 4 of Part 8.

1495.     The relief is limited by reference to two factors:

• the case law enacted in clause 450 (see the commentary on that clause and Change 82 in Annex 1); and

• the trustees' modified net income for the tax year.

Clause 506: Special rules for trustees affected by section 733 of ICTA

1496.     This clause is based on section 733(2) of ICTA.

1497.     Sections 731 to 735 of ICTA are anti-avoidance provisions. They are concerned with cases where:

• a person ("the first buyer") buys securities and subsequently sells them to someone else; in such a way that

• the first buyer becomes entitled to receive any interest payable on them.

1498.     Section 733(2) of ICTA addresses the case where:

• interest is payable to the UUT trustees as the first buyer;

• that interest, or some part of it, would be exempt, but is not so, because section 733(1) of ICTA cancels the exemption; and

• the trustees of the UUT are treated as making one or more deemed payments in the same tax year as that in which the interest arises.

1499.     The source legislation provides that an annual payment is to be treated as "paid out of profits or gains not brought into charge". It follows that, even though the exemption is cancelled by section 733(1) of ICTA, leaving interest in charge to income tax, the payment must not be treated as paid out of that interest.

1500.     This is rewritten so that relief is only given if, and to the extent that, the trustees have "non-affected income" equal to the payment treated as made. Non-affected income is defined as modified net income less affected income. On modified net income, see the commentary on clauses 448 and 958.

1501.     Because this is a rule relating to a very specific type of income, it is necessary to apply it before applying clause 505(7).

Chapter 10: Heritage maintenance settlements

Overview

1502.     A heritage maintenance settlement (an HMS) is a settlement that holds property ("heritage maintenance property") solely for the maintenance of, or for making provision of public access to, "qualifying property" designated under section 31 of IHTA. And the heritage maintenance property itself must be the subject of a direction under paragraph 1 of Schedule 4 to that Act.

1503.     The provisions of this Chapter grant income tax benefits to complement inheritance tax benefits granted under IHTA provisions. So many of the definitions in clause 507 cross-refer to IHTA provisions.

1504.     "Qualifying property" is defined in paragraph 3(2) of Schedule 4 to IHTA, and includes:

• land of outstanding scenic, historic or scientific interest;

• buildings of such outstanding historical or architectural interest that special steps should be taken to preserve them, and land essential to protect the character and amenities of such buildings; and

• objects historically associated with such buildings.

1505.     An HMS does not usually own the qualifying property itself. Its role is to hold the heritage maintenance property that has been settled for the purpose of maintaining the qualifying property and providing access to it. The IHTA rules specify that the heritage maintenance property must be subject to the terms of the trust for at least six years from the time it goes into the trust.

1506.     An HMS may also have subsidiary purposes, such as the maintenance of property held under the trust for maintenance of the qualifying property. During the six-year period the trust must provide that any other application or devolution of income or capital outside these main and subsidiary purposes must be for the benefit of a charity with heritage purposes or a body listed in Schedule 3 to IHTA.

1507.     In the absence of the rules in this Chapter, the ordinary income tax rules would apply for charging the settlors of certain settlements under Chapter 5 of Part 5 of ITTOIA. In such cases all income, and certain capital sums paid to the settlor, are charged on the settlor as income. (The nature of an HMS means that any settlor of any HMS will fall within both the definition of settlor in clause 467 of this Bill and the definition in section 620 of ITTOIA.)

1508.     By contrast, clauses 508 and 509 make it possible for the trustees of an HMS to elect, for a tax year, that:

• the income not be treated as that of the settlor; and

• any sum applied out of the heritage maintenance property not be treated as the income of an owner or occupier of the qualifying property.

1509.     But the trustees may not consider it appropriate to make such an election. In such cases clause 510 ensures that, if in a tax year any sum applied for a property maintenance purpose is greater than the trustees' income for that year, the settlor is not charged to tax on the excess.

1510.     And, in the absence of an election, clause 511 protects the settlor from double taxation if the trustees' income is applied for a property maintenance purpose through a trade carried on by the settlor and would therefore ordinarily be a receipt of that trade. The settlor is only charged under Chapter 5 of Part 5 of ITTOIA, not also on the trading receipt.

1511.     The Chapter also charges the trustees to tax in cases where the conditions for property to be qualifying property, or the rules concerning the purposes of the HMS, are breached (clauses 512 to 517).

Clause 507: Overview of Chapter

1512.     This clause draws together a number of important definitions. It is based on sections 690, 691(1), 692(1), 693 and 694(1) of ICTA.

1513.     "Heritage maintenance property" is defined as property to which a direction (a "heritage direction") under paragraph 1 of Schedule 4 to IHTA has effect. The property here is not the qualifying property mentioned in paragraph 3(2) of Schedule 3 to IHTA, but the property in the trust set up for the maintenance of that qualifying property.

1514.     A "heritage maintenance settlement" is defined as a settlement that comprises heritage maintenance property.

1515.     If there is in the settlement some property that is heritage maintenance property and some that is not, the two blocks of property are treated for the purposes of this Chapter, and for three other purposes, as being comprised in separate settlements - the "separate settlements rule".

1516.     The first of those purposes relates to certain trade losses under Chapter 2 of Part 4. The source legislation refers only to sections 380 to 387 of ICTA, thus excluding sections 388 and 389 of that Act (terminal loss relief) from the operation of the rule.

1517.     The second purpose of the separate settlements rule relates to sections 686 to 689B of ICTA, now rewritten in Chapters 2 to 8 of this Part.

1518.     The third purpose of the separate settlements rule concerns amounts assessed on the settlor of a settlement under Chapter 5 of Part 5 of ITTOIA. The right to make an election under clause 508 can therefore only apply to that part of the settlement that comprises heritage maintenance property. And the special rules about capital sums paid to the settlor (see section 633 of ITTOIA) will also apply only to that part.

Clause 508: Election by trustees

1519.     This clause provides that the trustees of an HMS may make an election for this section to have effect for a tax year. It is based on section 691(1), (2) and (4) of ICTA.

1520.     The first effect of an election is that income of the HMS is not to be treated as income of the settlor, as it otherwise would be under Chapter 5 of Part 5 of ITTOIA. So such income will be taxed on the trustees and at trust rates.

1521.     The second effect is that certain sums applied from the trust are not to be treated as income of the recipients.

1522.     Subsection (4)(a) is concerned with any person who has an interest in, or occupies, the qualifying property in respect of which the sum is applied. One example is a sum applied in repairing qualifying property when the occupier is an employee not wholly exempted from the benefit of such expenditure by section 315 of ITEPA. Another example is a sum applied in reimbursing an expense of an owner or occupier (other than the settlor, see clause 511) who is carrying on a trade in respect of the qualifying property.

1523.     Subsection (4)(b) is concerned with section 633 of ITTOIA. Under that provision a capital sum paid to the settlor is taxable on the settlor as income. But if the sum is applied for a property maintenance purpose, the effect of the election is that the sum does not form part of the settlor's income.

1524.     The election is to be made to an officer of Revenue and Customs, rather than to the Commissioners for Her Majesty's Revenue and Customs. See Change 5 in Annex 1.

1525.     Accordingly, parts of section 691(4) of ICTA are no longer not necessary and are omitted. The election is one to which Schedule 1A to TMA applies, as it is not made on the trustees' self-assessment tax return. So paragraph 2(1) of that Schedule is sufficient to ensure that the election is to be made to an officer of Revenue and Customs. And paragraph 2(3) of that Schedule is sufficient to ensure that it "shall be in such form as the Commissioners may require".

Clause 509: Change of circumstances during a tax year

1526.     This clause provides for the splitting of a tax year if there is a change of circumstances, eg if a heritage direction takes effect, or ceases to have effect, during the year. It is based on section 691(5) of ICTA.

1527.     Without this provision, if a heritage direction were not in force for the full tax year, no election could be made for that year. The effect of the clause is to treat each of the parts of the tax year (before and after the change of circumstances) as a separate tax year, in respect of which an election may be made.

1528.     For this section to apply it must be the case, in one of the two parts of the tax year, that a heritage direction applies and the HMS income is taxable on the settlor under Chapter 5 of Part 5 of ITTOIA. In the other part of the tax year, either or both of these statements will not be true.