Malcolm Finney illustrates the impact of changes to dividend taxation pre and post-April 2016.
It is quite common for trustees of discretionary trusts to hold equities as part of a trust’s portfolio of investments. However, does this make sense?
Pre-6 April 2016
Trustees are liable to income tax on trust income at the trust rate, namely, 45% or the dividend trust rate of 37.5% where the trust income is dividend income. With respect to the latter, pre-6 April 2016, any such dividend income came with an attaching tax credit (although not reclaimable) of 10% (of the gross dividend).
Where trustees distribute any of their income to a trust beneficiary, the latter is subject to income tax at their marginal rate, albeit with an offsetting tax credit for any tax paid by the trustees on that income. However, for the beneficiary, even if the distribution is of the trust’s dividend income, it is not classified as dividend income for the beneficiary (basically, for the beneficiary it is simply income with an attaching tax credit of 45%).
Does it make sense to route dividend income via a discretionary trust?
Example 1: Distribution of trust dividend income
The trustees of James Brown’s discretionary trust receive a net dividend of £900 to which is attached a tax credit of 1/9th (or 10% of the gross). The beneficiaries of the trust include Albert, a non-taxpayer; Brian, a basic rate taxpayer; and Charlie a higher rate taxpayer.
The trustees distribute the £900 out to Charlie.
Charlie is treated as receiving a net distribution of £495 with an attaching tax credit of £405 (which represents the trustees’ liability at 45% on the £900), giving Charlie a gross income of £900.
He is subject to income tax at 40% (as a higher rate taxpayer) on £900, namely, £360 less the tax credit of £405, giving rise to a reclaim of £45.
Charlie’s net cash receipt is thus [£495 + £45] i.e. £540.
For Albert and Brian, their net receipt is £900 and £720 respectively.
Example 2: Receipt of dividend income without a discretionary trust
Had Albert, Brian, and Charlie simply held shares directly and each received a net dividend of 900, their respective net cash receipts would have been £900, £900 and £675.
Receiving the dividends directly shows an increase in net receipt of nil, £180 and £135 respectively for Albert, Brian, and Charlie.
Post-6 April 2016
Effective 6 April 2016, dividend income no longer carries an attaching tax credit and the rates of income tax levied on dividend income from that date are 7.5%, 32.5%, and 37.5% for basic rate, higher rate, and additional rate taxpayers.
Example 3: Distribution of trust dividend income
The trustees of James Brown’s discretionary trust distribute receive a dividend of £900, to which no tax credit is attached. The beneficiaries of the trust include Albert, a non-taxpayer; Brian, a standard rate taxpayer; and Charlie a higher rate taxpayer.
The trustees distribute the £900 out to Charlie.
For Charlie he is treated as receiving a net distribution of £495 with an attaching tax credit of £405 (which represents the trustees’ liability at 45% on the £900), giving Charlie a gross income of £900.
He is subject to income tax at 40% (as a higher rate taxpayer) on £900, namely £360 less the tax credit of £405 giving rise to a reclaim of £45.
Charlie’s net cash receipt is thus [£495 + £45] i.e. £540.
For Albert and Brian their net receipt is 900 and 720 respectively.
Example 4: Receipt of dividend income without a discretionary trust
Had Albert, Brian and Charlie simply held shares directly and each received a net dividend of £900 their respective net cash receipts would have been £900, £832.50 and £607.50.
Receiving the dividends directly shows an increase in net receipt of nil, £112.50 and £67.50 respectively for Albert, Brian and Charlie.
No account has been taken above of the nil rate dividend rate (more commonly known as the dividend allowance) (of £5,000 for 2017/18; £2,000 2018/19) which only exacerbates the difference between the two structures.
It is assumed in all the above examples that there was a sufficient amount of tax in the tax pool to cover any distributions by the trustees.
Practical Tip:
Think carefully before settling shares in a discretionary trust.
