Some trusts for disabled people and children get special tax treatment which means they may pay less tax. These trusts are known as trusts for 'vulnerable beneficiaries'. This guide explains how these trusts work, the tax advantages, how to claim them and where to get more information.
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A beneficiary is anyone who benefits from a trust. A 'vulnerable beneficiary' is either:
If a trust is set up for a vulnerable beneficiary, the trustees can claim special treatment for Income Tax and Capital Gains Tax if it's a 'qualifying trust'. It can't be a qualifying trust if the person who sets up the trust can benefit from the income of the trust. However it can be a qualifying trust in respect of Capital Gains Tax for the years 2008/9 onwards.
The assets in these trusts such as money, land or buildings, can be used only to benefit a disabled person. The disabled person must be entitled to all the income or, if they're not, none of the income can be applied for the benefit of anyone else.
These trusts are commonly set up:
The rules of intestacy are different in Scotland and Northern Ireland. If a trust is set up there for children who have lost a parent, and there is no will, it will usually be treated as a 'bare trust' for tax purposes.
If there are other beneficiaries who aren't vulnerable, the assets and income that's for the vulnerable beneficiary must be:
Only that part of the trust gets special tax treatment.
To claim special tax treatment, trustees must fill in form VPE1 (Vulnerable Person Election) and send it to HM Revenue & Customs (HMRC). They must sign it along with the vulnerable beneficiary - or someone who can legally sign for the beneficiary.
Trustees have to give details of all the assets and income in the qualifying trust, including anything used only partly for the vulnerable beneficiary. They'll also have to show how the trust income is shared out. It can't be a qualifying trust if the person who sets it up can get some benefit from it.
A separate form VPE1 must be completed for each beneficiary.
The election takes effect from the date you provide on the form VPE1. You must make the election no later than 12 months after 31 January following the tax year when you want the election to start. So, if you want it to take effect from 1 July 2011, you must send form VPE1 to HMRC by 31 January 2014.
Any income or gains before the date the election takes effect are taxed under normal trust rules - even if the election takes effect part way through the same tax year.
You must tell HMRC if the vulnerable person dies or is no longer vulnerable. The special tax treatment is no longer effective after this date.
Where a trust has a vulnerable beneficiary, the trustees are entitled to a deduction of tax against the amount they would otherwise pay. This is calculated in the following way:
Capital Gains Tax is a tax on the gain in the value of assets such as shares, buildings or land. A trust may have to pay Capital Gains Tax if assets are sold, given away or exchanged (disposed of) and they've gone up in value since being put into trust. The trust will only have to pay the tax if the assets have increased in value above a certain allowance known as the 'annual exempt amount'. Trustees are responsible for paying any Capital Gains Tax due.
The Capital Gains Tax is paid by the trustees. They can claim a relief, which is calculated in a similar way to the Income Tax Relief:
This special Capital Gains Tax treatment does not apply in the tax year when the beneficiary dies.
Trusts for vulnerable beneficiaries get special Inheritance Tax treatment if they're 'qualifying trusts' for Inheritance Tax.
A qualifying trust for a disabled person is one where:
A qualifying trust is made on the death of a parent for their child, who must take all of the capital and income at (or before) becoming 18.
Assets transferred into a qualifying trust for a disabled person are treated as a 'potentially exempt transfer' - this means that there is no Inheritance Tax charge if the person who made the transfer survives seven years from the transfer date.
There is no Inheritance Tax on transfers made out of either type of qualifying trust to the vulnerable beneficiary. However when the beneficiary dies, any assets held in the trust on their behalf are treated as part of their estate and Inheritance Tax may be charged.
There are no ten-year Inheritance Tax charges on trusts with vulnerable beneficiaries.
You can find detailed technical information about vulnerable beneficiaries in HMRC's Trusts, Settlements and Estates Manual.