Trusts & Tax

Types of Trust

UK trust law recognises several categories with different tax treatments. A bare trust (or absolute trust) holds assets for a beneficiary who has an immediate and absolute right to both the income and capital. Tax is assessed on the beneficiary as if they held the assets directly, making bare trusts very tax-efficient for children (subject to the parental settlement rules for income over £100). A interest in possession trust (also known as a life interest trust) gives one beneficiary the right to income (the life tenant), while the capital passes to others (the remaindermen). For IHT purposes, the life tenant is treated as owning the trust assets, which form part of their estate. For income tax, the trustees pay at the basic rate on non-dividend income and the dividend ordinary rate on dividends. A discretionary trust gives trustees discretion over how much income and capital to distribute and to which beneficiaries. These are subject to the relevant property regime for IHT and the highest trust tax rates for income and gains. A settlor-interested trust is one where the settlor (or their spouse/civil partner) can benefit. Such trusts are treated as transparent for income tax and capital gains tax — the settlor is taxed on all income and gains as if they still owned the assets, making them tax-inefficient but potentially useful for IHT planning if structured correctly (subject to the gifts with reservation of benefit rules).

Income Tax on Trusts

Trust income tax rates depend on the type of trust. For discretionary and accumulation trusts (relevant property trusts), the rates for 2026/27 are: 45% on all non-dividend income (the trust rate) and 39.35% on dividend income (the trust dividend rate). Trustees of such trusts must file an annual trust tax return (form 900) with HMRC. Expenses such as trustees' fees and professional costs can be deducted from income before the tax calculation. When income is distributed to beneficiaries, the trustees provide a tax certificate (form R185) showing the tax paid. The beneficiary then reports the gross income on their own tax return and claims credit for the tax paid by the trustees. If the beneficiary's marginal rate is lower than the trust rate, they can reclaim the difference. For interest in possession trusts, income tax is charged at the basic rate (20%) on non-dividend income and 8.75% on dividend income. The life tenant receives the net income and must declare it on their own tax return, paying tax at their marginal rate on the grossed-up amount. Bare trusts are effectively ignored for tax purposes — the beneficiary reports all income directly. Trustees must register the trust with HMRC's Trust Registration Service regardless of whether any tax is due, unless an exemption applies (for example, some bare trusts or will trusts that exist for less than two years).

Capital Gains Tax on Trusts

Trustees are liable for Capital Gains Tax on gains realised on the disposal of trust assets. For the 2026/27 tax year, the CGT rate for trustees and personal representatives is 20% on most assets and 24% on residential property (the same as the higher residential property rate for individuals). The annual exempt amount for trusts is limited — most trusts have an annual exemption of £3,000 (from 2026/27), but if the same settlor created multiple trusts, the exemption is divided between them, subject to a minimum of £600 per trust. Bare trusts are transparent for CGT — the beneficiary is treated as the owner of the assets and uses their own annual exemption and rates. When a beneficiary acquires an absolute interest in trust property (for example, when a life interest ends), there is no deemed disposal — the trustees' base cost carries over to the beneficiary. This is an important difference from the US system. Trusts can use the same reliefs available to individuals, including principal private residence relief (for a property occupied by a beneficiary with a qualifying interest in possession) and holdover relief under section 165 TCGA 1992 when assets are transferred into or out of a trust in certain circumstances. Gift holdover relief is available for transfers into trust for IHT purposes and for certain business assets, but the rules are complex and professional advice is essential.

IHT: The Relevant Property Regime

Discretionary trusts and most trusts created after 22 March 2006 are subject to the relevant property regime for IHT. This imposes two types of charge: periodic charges (every ten years) and exit charges (when capital leaves the trust). The periodic charge is calculated at a maximum rate of 6% on the value of the trust assets above the nil-rate band. The actual rate is lower for trusts with assets below the NRB or where the settlor has used some of their NRB on earlier transfers. The calculation is complex: HMRC first computes a "notional cumulative total" of chargeable transfers made by the settlor before and at the time the trust was created, then applies a deemed rate based on the period since the last 10-year anniversary. Exit charges use the same principles but are pro-rated for the time since the last periodic charge. Trusts set up on death (will trusts) are generally exempt from the initial 10-yearly charge for the first two years after death, as they are treated as part of the deceased's estate during the administration period. Interest in possession trusts created before 22 March 2006 are treated differently for IHT — the beneficiary with the interest in possession is treated as owning the trust assets (they form part of their estate), so no 10-yearly charge applies. These pre-2006 IP trusts are becoming less common as beneficiaries die or the trusts come to an end.

Trust Registration and Compliance

Most UK trusts must be registered with HMRC's Trust Registration Service (TRS) even if no tax is due. The register was introduced to comply with the EU's Fifth Anti-Money Laundering Directive and applies to express trusts with UK tax liabilities and certain non-UK trusts holding UK assets. Registration requires details of the trust, the settlor, the trustees, and the beneficiaries. The TRS is not the same as filing a trust tax return — you must do both. The deadline for registration is the same as the trust tax return deadline (31 January after the end of the tax year). Penalties apply for late registration. Trusts created on death via a will must be registered within 90 days of the distribution of the estate or the date the trust becomes taxable. Maintaining proper trust accounts and records is essential. Trustees have ongoing duties including: managing the trust assets in accordance with the trust deed, distributing income and capital as required, filing annual tax returns (unless the trust has no tax liability and gross income is below £500), and reporting changes to HMRC such as new trustees or beneficiaries. The cost of professional trust administration can be significant, so trustees should ensure the trust assets justify the ongoing compliance burden.

FAQs

What is the difference between a bare trust and a discretionary trust?

A bare trust gives the beneficiary an immediate and absolute right to both income and capital from age 18. The beneficiary is taxed directly on income and gains. A discretionary trust gives trustees discretion over distributions, is subject to higher trust tax rates (45%/39.35%), and incurs IHT periodic charges every ten years.

Do trusts need to register with HMRC?

Yes. Most UK express trusts must register with HMRC's Trust Registration Service, even if no tax is due. Exceptions include some bare trusts, certain will trusts during the first two years, and trusts for disabled persons. The registration requirement is separate from filing a trust tax return.

What are the IHT implications of setting up a trust?

If you set up a trust during your lifetime, the transfer of assets into the trust is a chargeable lifetime transfer (CLT). IHT at 20% is payable on any value above the £325,000 nil-rate band. The trust is then subject to 10-yearly periodic charges (up to 6%) and exit charges. Trusts set up on death in your will are treated as part of your estate for IHT.