Meg Saksida considers the purpose and application of form R185.
If a trust beneficiary receives a Form R185 from a trustee, it is good news. It means they have been paid some income during the tax year.
The R185 shows the net income a beneficiary received from the trust, and the associated tax paid on their behalf by the trustee. The taxation system for trustees and beneficiaries in the UK is designed such that the beneficiary cannot fail to pay at least basic rate tax on the income received from the trust. The system differs slightly if the trust is an interest in possession (IIP) to that of a discretionary trust (DT).
Interest in possession trust
There are two beneficiary parties in an IIP trust. The ‘remainderman’ beneficially owns the trust capital and is entitled to it at some time in the future - after the life tenant is no longer entitled to benefit from the trust.
The life tenant is only eligible to the income from the capital, not to the capital itself. However, unlike a discretionary trust, the life tenant is entitled to all the income in the trust every year. The trustees have no discretion over this.
When the income is received in the trust, the trustees are charged to basic rate income tax. Form R185 shows the beneficiary how much tax the trustees have paid. The beneficiary then adds the gross income received from the trust to their own income in the self-assessment tax return and pays tax at their personal applicable rate. They can offset, as a deduction, the tax already paid by the trustees.
If the beneficiary does not have income above the personal allowance (e.g., a school-aged beneficiary), they will receive a refund for the tax paid by the trustee. If they are a basic rate taxpayer, they will owe no more and no less on the trust income, and if they are a higher or additional rate taxpayer, they will have another 20% or 25% to pay to HMRC.
Discretionary trust
A DT only has one beneficiary (known as ‘the beneficiary pool’). The trustees have the ‘discretion’ to pay either the income or capital over to any, all, or none of the beneficiaries every year. The beneficiaries therefore have only a ‘spes’ (Latin for ‘hope’) of receiving an amount from the trust. Because the trustees are not obliged to pay anything out to the beneficiaries they could, if they were minded, accumulate the income inside the trust. With no chance of the income being distributed to a higher or additional-rate taxpayer, HMRC would only ever get basic rate income tax if the taxation system of the DT matched that of the IIP. For this reason, the taxation of the DT is at a much higher and punitive rate; in fact, the rate is equal to the additional rate of individual taxpayers. This shifts the cashflow advantage from the taxation of the accumulated income from the trustees to HMRC.
Once the trustees use their discretion to distribute income to a beneficiary, the R185 will show the income alongside a 45% tax credit, which can be offset against the beneficiary’s eventual tax liability. Unless the beneficiary is in the minority 5% of additional-rate UK taxpayers, they will get a refund from HMRC, bringing their rate down to 40%, 20% or 0%.
Practical tip
Do not ignore the R185. Not only does it show the beneficiary the amount that is taxable, but it also highlights the amount of tax paid by the trustees on the beneficiary’s behalf. This amount can be offset or deducted against the beneficiary’s income tax liability, which in a DT will lead to a tax repayment from HMRC 95% of the time.
