An introduction to the new special tax treatment for certain trusts with vulnerable beneficiaries

1. The Finance Act 2005 has introduced a new regime for certain trusts with vulnerable beneficiaries, which takes effect from 6 April 2004. This Guidance Note gives details of the new measures. It aims to provide some explanations and general guidance that will apply in all but a few cases. This Guidance Note is not however exhaustive, so if there are any points that are not covered please contact the office dealing with the tax affairs of the trust. The Trusts, Settlements and Estates Manual and the Capital Gains Manual, which are available on the HMRC website, are being amended to incorporate references to these new measures. The guidance in these manuals will be more detailed.

2. The broad aim of the special tax treatment is to ensure that the amount of tax charged on income and gains arising to the trustees is no more than it would have been had the income and gains arisen directly to the vulnerable person.

An overview of how the special tax treatment works

3. There are two parts to the process. Firstly, the trustees and vulnerable person jointly make an election (‘a vulnerable person election’). Then, once an election is in force, the trustees may be entitled to make a claim for any tax year for the special tax treatment to apply in relation to both income tax and capital gains tax (‘CGT’). Paragraphs 9, 10 and 65 below give details of occasions when the special tax treatment does not apply in relation to one or other of the taxes.

4. A claim can be made for any tax year from 2004-05 onwards provided that the vulnerable person election is in force for the whole or any part of the tax year in question. It is not necessary for trustees to make a claim for every tax year for which they are entitled to do so, but separate claims must be made in relation to each tax year for which the special tax treatment is to apply. The consequences where a claim has been made are set out in paragraphs 7 to 11 below.

5. The beneficiary must be a ‘vulnerable person’ – see paragraphs 12 to 15 below for the definition of this. The property held for the benefit of that vulnerable person must be held on ‘qualifying trusts’ – see paragraphs 16 to 26 below for the definition of this. Where there is more than one beneficiary capable of benefiting from the settlement during the vulnerable beneficiary's lifetime, it is sufficient for the property for the vulnerable person to be held in a specific fund or other defined part of the settled property on qualifying trusts for the benefit of that person. Only the income from or gains of that fund or part may qualify for relief in relation to that vulnerable beneficiary.

6. The income arising from property held on qualifying trusts is known as ‘qualifying trusts income’. Similarly, capital gains arising on the disposal of property held on qualifying trusts, which would otherwise be chargeable to tax on the trustees, are known as ‘qualifying trusts gains’. Further details can be found in paragraphs 51 to 56 below. Throughout this Guidance Note ‘property’ means assets, such as cash, investments and land.

The effects of making a claim for a tax year

7. For income tax, the trustees are entitled to a deduction in terms of tax against the amount they would otherwise pay so that the final amount payable by them is based on the particular circumstances of the vulnerable person. The trustees therefore calculate what their tax liability on the qualifying trusts income would be in the absence of a claim for special treatment, and then what the vulnerable person’s tax liability would be on the qualifying trusts income if that income were to have arisen directly to him or her, taking into account his or her other income, capital gains and certain allowances. The trustees then claim the difference between these two figures as a deduction from their own tax liability.

8. The trustees are not chargeable to CGT in respect of the qualifying trusts gains. Instead, the vulnerable person is chargeable to CGT on capital gains which are treated as arising to him or her. The amount of those gains is what remains of the qualifying trusts gains after relevant trust losses, if any, have been deducted from them. The vulnerable person should, where appropriate, include the net gains in his or her personal tax return. He or she has a right to recover from the trustees the amount of any tax he or she has paid in respect of those gains.

9. The special income tax treatment will not apply to income taxed on the settlor because he or she retains an interest in any property held in the trust (a settlor-interested trust).

10. The special capital gains tax treatment will not apply for the tax year in which the vulnerable person dies. The special income tax treatment can apply in that year but the election is in force only till the date of death. Paragraph 47 below gives further details of the situation when an election is in force for only part of a year.

11. The effects of a claim are different where the vulnerable person or the trustees are not resident in the UK. Further details concerning non-UK residents can be found in paragraphs 64 to 83 below.

Vulnerable person

12. There are two types of vulnerable persons who can benefit from the special tax treatment. The first is someone who is either mentally or physically disabled and the second is a child below the age of 18 who has lost a parent through death.

Disabled person

13. To qualify under this category, an individual must either be:

  • unable to administer his or her property or manage his or her affairs because of mental disorder within the meaning of the Mental Health Act 1983, or
  • in receipt of either attendance allowance or disability living allowance, by virtue of entitlement to the care component at the highest or middle rate.

14. Where a person stops receiving attendance or disability living allowance he or she may in some circumstances still qualify as a vulnerable person. If the sole reason that the relevant allowance is no longer being received is that the person has been admitted into certain types of care, has certain accommodation provided or is receiving hospital treatment for renal failure, he or she will continue to qualify as a vulnerable person for the purposes of this special tax treatment. On the other hand, where someone has received an allowance in the past but has recovered sufficiently so as to be no longer entitled to it, he or she will no longer qualify as a vulnerable person. Paragraph 47 below provides details on the effect of an election that is in force for only part of a year.

A child who has lost a parent

15. To qualify under this category, the beneficiary must be under 18 and one or both of his or her parents must have died. A beneficiary who qualifies is known, for the purposes of the special tax regime, as a ‘relevant minor’.

Qualifying trusts

Disabled persons

16. The special tax treatment for disabled persons can apply where property is held on trusts for the benefit of a disabled person, provided that the terms of the trusts are such that during that person’s lifetime or until the termination of the trusts (if that happens before his or her death):

  • the property can be applied only for the benefit of the disabled person, and
  • either the disabled person is entitled to all the income arising from the property or, if the disabled person is not entitled to all of it, none of the income can be applied for the benefit of anyone else.

17. There are occasions when trust law gives the trustees the power to advance to a beneficiary in certain circumstances up to one half of the capital to which he or she will or may become entitled at a later date. The relevant provisions are section 32 of the Trustee Act 1925 in England and Wales and section 33 of the Trustee Act (Northern Ireland) 1958. The fact that they specifically allow certain advances to be made does not prevent trusts on which property is held from being qualifying trusts. But this is so only in those cases where the particular statutory provision applies automatically. It does not apply where there is a provision on similar lines in the deed or will, or where the statutory provision is modified, for instance by replacing the one-half limit by a larger amount.

Relevant minors

18. Where property is held on trusts for the benefit of a relevant minor it will be held on qualifying trusts for the purposes of the new regime in the following situations:

  • A parent of the minor dies without making a will and the statutory intestacy rules provide for the property in question to be held on trusts for the benefit of the child. See paragraphs 19 and 20 below for a further explanation of this.
  • A trust is established by the will of a deceased parent of the minor or by the Criminal Injuries Compensation Scheme and the trusts relating to the property secure that all the following conditions are met:
    • The minor, except in the event of his or her death before reaching 18, will on reaching the age of 18 become absolutely entitled to the property, all the income, if any, arising from it, and any income that has been accumulated before that time.
    • Until that time, for as long as the minor is alive, any of the property is applied only for the benefit of the minor.
    • Until that time, for as long as the minor is alive, either the minor is entitled to all the income arising from the property or, if the minor is not entitled to all of it, none of the income can be applied for the benefit of anyone else.

19. Under the intestacy laws in England and Wales, where a parent dies without making a will, some or all of the property may be held on 'statutory trusts' for any children under the age of 18. Property held on such statutory trusts will be held on qualifying trusts for the benefit of each child for the purposes of the new tax regime.

20. The intestacy rules currently in force in Northern Ireland and Scotland are different and do not involve the creation of statutory trusts. Property held for the benefit of children is held on bare trusts and so for tax purposes the income and chargeable gains are regarded as belonging to the child. However a Northern Irish or Scottish will can meet the test in the second bullet in paragraph 18 above.

21. The conditions set out in the second bullet of paragraph 18 above in respect of trusts established either by the will of a deceased parent or by the Criminal Injuries Compensation Scheme are designed to mirror those of the statutory trusts where a parent dies without having made a will. They are not met where income can be paid to someone else or the child becomes entitled to the capital only at a greater age.

22. The powers that trustees have of making payments of income to a parent or guardian or otherwise for the child's benefit do not prevent the trusts from qualifying. Similarly, trustees have, in certain circumstances (see paragraph 17 above), a statutory power to advance up to one half of the capital to which the relevant minor will or may become entitled. This fact will also not prevent the trusts on which property is held from being qualifying trusts.

23. Where a trust is established by the Criminal Injuries Compensation Scheme for a child the way in which income and gains are taxed will depend on the terms of the award and the deed establishing that trust. In many of these cases, it is HMRC’s view that the child should, in fact, be regarded as the settlor of the property in the trust. In these circumstances the income and gains would be chargeable to tax on the child, as in any other settlor-interested trust, and the special tax regime will not apply.

Property held for more than one beneficiary

24. The special tax treatment may apply only in relation to property which is held in a separate fund or other defined part of the settled property. A separate tax reference will not be set up for these separate funds.

25. There may be cases where a part of a particular asset is held on trusts for the benefit of a vulnerable person and that person is entitled to any income arising from that part of the asset. If it is possible to identify the relevant part of the asset concerned and the income arising from that part then, for the purposes of determining whether the trusts on which the part of the asset is held are qualifying trusts, that part of the asset is treated as if it were a separate asset.

26. Where under the rules of intestacy property is held on statutory trusts in equal shares for the benefit of two or more children, the settled property held in these equal shares will be held on qualifying trusts for the purposes of the new regime.

The vulnerable person election

Requirements

27. The election must be made on form VPE1, which can be accessed by clicking on the attached link Election (RTF 287K). It is possible to enter the details on screen, but the form will then have to be printed and signed. It will not be possible to submit this form electronically because a hard copy will be required in all cases. If trustees or vulnerable persons cannot access the website they should contact the office dealing with the tax affairs of the trust to obtain a printed copy of the form.

28. Where, at the date on which the election becomes effective (the ‘effective date’), the trustees hold one or more assets and only parts of them are held on the relevant trusts, the election must include a statement listing each asset concerned. In each case, the part of the asset concerned must be identified, and details must be provided of the allocation of any income arising from it.

29. If there have been any relevant changes in circumstances which have occurred since the effective date up to the time the election is made the election must also contain a statement giving details. In particular, if the beneficiary has died or otherwise ceased to be a vulnerable person, or the trusts no longer qualify or have terminated, the election must contain details of the event. If arrangements relating to parts of assets have changed since the effective date, the election must contain a statement giving the relevant details.

30. Elections that do not contain all the relevant information, statements and declarations will not be valid. They will be returned and the items which have been omitted will be identified. This will not constitute an enquiry into the election (see paragraph 60 below). Elections containing all the necessary details will be acknowledged and in most cases nothing further will be needed.

31. The election must be made jointly by the trustees who hold the property on the qualifying trusts in question and the beneficiary concerned. Where the beneficiary is unable to make a legally valid election, it should be made on his or her behalf by someone who is legally entitled to do so. Depending on the circumstances this could be a parent, guardian or a person having the relevant powers of attorney.

More than one vulnerable beneficiary

32. If there is more than one vulnerable beneficiary of the same trust, a separate election is required for each beneficiary for whom the trustees wish to claim the special tax treatment.

Time limits

33. An election can be made at any time up to 12 months after the normal filing date for the trust tax return for the earliest tax year for which it is to have effect, that is 12 months after the first 31 January following the end of the tax year in question. The earliest tax year to which an election can apply is 2004-05, and the time limit for making an election for that year is 31 January 2007. A late election will be accepted only where the Board of HMRC allows further time by notice in writing.

The period for which the election is effective

34. Once made, the election is irrevocable. It remains effective from the effective date (though see paragraph 62 regarding HMRC determinations) until the date on which:

  • the person ceases to be a vulnerable person,
  • the trusts cease to be qualifying trusts, or
  • the trusts are terminated.

If any of these three events happens, the trustees must inform the office dealing with the tax affairs of the trust within 90 days of first becoming aware that the event has occurred. This must be done by notice in writing and include details of the event. If the trustees do not give the necessary notice they may be liable to an initial penalty of £300 and a continuing penalty of up to £60 a day for each day that the failure continues. The election will no longer be in force whether or not the trustees give the necessary notice.

Incorrect information - penalties

35. A penalty, up to a maximum of £3,000, is chargeable on the trustees where incorrect information, statements or declarations are supplied either negligently or fraudulently. Information given jointly by trustees and a vulnerable person is treated, for the purposes of penalties, as given by the trustees.

Claims

When and how to make a claim

36. The trustees can make a claim for special tax treatment for any tax year from 2004-05 if a valid election is in force for the whole or part of that year, where:

  • income arises (this includes items which are treated for tax purposes as income arising to the trustees) in the year to the trustees from property which is held on the qualifying trusts in question and/or
  • the trustees would, without the special tax treatment, be chargeable to CGT in respect of gains arising in the year on the disposal of property held on the qualifying trusts in question. If the trustees are not resident or ordinarily resident in the UK for CGT purposes in the year, the special capital gains tax treatment does not apply.

The vulnerable person is not a party to the claim. His or her consent is provided by the terms of the election.

37. Where a claim is made for any year it applies to both income tax and CGT, if any. It cannot apply to one and not the other except in the circumstances outlined in paragraphs 9 and 10 above or where the trustees are not resident in the UK (see paragraph 64 and 65 below for further details relating to non-resident trustees).

38. The normal rules apply to the making of claims. They should be made in the trustees’ tax return for the relevant tax year although they can be made at any time up to five years after the first 31 January following the end of that tax year. Where a tax return has been submitted but the time limit for amending that return has not yet expired the claim must be made by amending that return. Amendments to a return can be made within a year after the normal filing date, that is within 12 months from the first 31 January following the end of the tax year to which the return relates. If the claim relates to CGT the beneficiary will also need to amend his or her tax return or form R40.

39. The tax returns for 2005-06 and subsequent tax years will have the necessary entries for making a claim but, as these measures have only recently become law, it has not been possible to provide for the necessary entries on the tax return for 2004-05. Paragraphs 57 to 59 below give guidance on how to make claims in the 2004-05 tax return.

40. If a claim is made after the trustees' tax return has been submitted and the time limit for amending that return has expired, it must be made in writing and should be sent to the tax office that deals with the tax affairs of the trust. The claim must include, as appropriate:

  • the amount of the deduction claimed against income tax,
  • the amount of CGT chargeable on the vulnerable person.

The vulnerable person should also advise his or her own tax office of the amount of CGT chargeable.

Trustees who are not normally chargeable at the rate applicable to trusts

41. Even where trustees are not normally taxed at the rate applicable to trusts, currently 40%, or the dividend trust rate, currently 32.5%, on their income it may be worth making a vulnerable person election. This is because such trustees will still be chargeable at these higher rates on some sums that are capital in trust law but deemed to be income for tax purposes (e.g. distributions arising on a company purchase of own shares) as well as on gains which are chargeable to CGT.

The tax pool – discretionary and accumulation trusts only

42. Income distributed to a beneficiary by UK resident trustees of a discretionary or accumulation trust is treated as an amount from which tax payable at the rate applicable to trusts has been deducted. The trustees have to ensure that they have paid sufficient income tax to cover the amount of that deemed deduction, which is available as a tax credit to the beneficiary. Income tax paid by the trustees at the rate applicable to trusts or dividend trust rate (less the 10% non-payable tax credit) goes into what is called the ‘tax pool’. The tax pool can be used to cover the amount of the deemed deduction but income tax paid at basic or lower rates usually cannot (but see paragraph 43 below). Where the tax paid by the trustees on income received is reduced on a claim to special treatment, the tax that then remains payable will enter the tax pool.

43. Another measure introduced by the Finance Act 2005 is the standard rate band. Like the tax pool this applies only to trustees who are liable to income tax at the rate applicable to trusts. It provides that the first £500 of income otherwise taxable at the rate applicable to trusts or dividend trust rate is chargeable instead at the basic, lower or dividend ordinary rate. In these circumstances tax charged at basic or lower rates (but not tax charged at the dividend ordinary rate) will still go into the tax pool and can be used to cover the amount of the deemed deduction. This measure comes into effect on 6 April 2005 and so does not apply to the tax year 2004-05.

Calculating the deduction against the trustees’ income tax liability

44. The deduction that the trustees can claim is:

A. the amount of income tax the trustees would pay (before applying the special treatment) on the qualifying trusts income (see paragraph 6 above), less
B. the amount of any additional tax, that is income tax and CGT, that the vulnerable person would pay if the qualifying trusts income were to have arisen directly to him or her.

45. By applying this deduction to the tax payable, the trustees end up paying the same amount of tax as the vulnerable person would have paid had the income arisen directly to him or her – see example 1.

46. In calculating the amount A in paragraph 44 above, if the trustees have any income that is not qualifying trusts income, any management expenses claimed must be apportioned. The proportion of the total management expenses to be excluded from this calculation is equal to the proportion of the total income (qualifying and non-qualifying) which is non-qualifying income – see example 2.

47. Where the election is in force for only part of a tax year, only the income arising in that part of the year to which the election applies will qualify for special income tax treatment. Similarly, if there are both expenses of management and non-qualifying income then the apportionment mentioned in paragraph 46 above should be made to those items falling within the part of the year to which the election applies. See example 3.

48. The amount B in paragraph 44 above is the difference between what the vulnerable person’s total tax liability would be, if he or she were to have received the qualifying trusts income directly, and the amount that would have been due, without that income. Total tax liability means liability to income tax and CGT.

49. Income tax liability for the purpose of calculating amount B in paragraph 44 above is computed using the normal rules, but the following should not be taken into account when computing the actual and hypothetical income tax liability of the vulnerable person for the purposes of the calculation in paragraph 48 above:

  • income of the trustees which is distributed to the beneficiary in the tax year, and
  • any relief given to the vulnerable person by way of a reduction in the amount of income tax, for example married couple’s allowance.
    See example 4. Where the election is in force for only part of the year, the same rules as in paragraph 47 above apply.

50. The CGT element of amount B in paragraph 44 above is the vulnerable person’s CGT liability for the year, including the tax on any gains chargeable on the person under the special capital gains tax treatment – see paragraph 51 below. When calculating the additional tax, bear in mind that the inclusion of the qualifying trusts income may increase part or all of the CGT liability by pushing it into a higher tax rate band. This is so whether or not there are any gains subject to the special tax treatment.

Calculating the CGT liability

51. A claim for special tax treatment means that the vulnerable person is chargeable to CGT as though certain capital gains had arisen to him or her rather than to the trustees. It is similar to the way gains may become chargeable on a settlor of a settlor-interested trust.

52. The special tax treatment applies to ‘qualifying trusts gains’. These are capital gains which arise:

  • to the trustees
  • in the tax year to which the claim relates
  • on the disposal of property that is held on qualifying trusts for the benefit of the vulnerable person.

If the gains are not chargeable to CGT on the trustees, for example because they are, in effect, treated as arising to a settlor, they are not ‘qualifying trusts gains’ and the special tax treatment cannot apply to them.

53. The effect of the special tax treatment is that the trustees are not chargeable to CGT on the qualifying trusts gains. The qualifying trusts gains are calculated in the normal way. After qualifying allowable losses have been deducted from the qualifying trusts gains, the resulting net gains are treated as if they were capital gains arising to the vulnerable person in the tax year to which the claim relates. An allowable loss qualifies to be deducted from the qualifying trusts gains if it has not been deducted from other gains and the two following conditions are met:

  • The loss must have arisen on the disposal of property which is held on the qualifying trusts for the benefit of the vulnerable person.
  • The loss must not be deductible from gains which are, in effect, treated for CGT purposes as arising to some other person.

54. What happens next is as follows:

  • The net gains (see paragraph 53 above) are added to any other personal gains of the vulnerable person.
  • The vulnerable person can then set any available unused personal allowable losses against the gains. Any surplus losses that the trustees may have cannot be set against the vulnerable person’s gains.
  • Where applicable, taper relief is applied to all the vulnerable person’s gains according to the usual rules, and account is taken of the vulnerable person’s annual exempt amount in determining his or her liability, if any, to CGT. No account is taken of the trustees’ annual exempt amount.

55. Although the trustees are not liable to CGT in respect of the qualifying trusts gains, they do have to include them in their tax return. The vulnerable person should include any gains attributed under the special tax treatment as appropriate in his or her tax return. The trustees should notify the vulnerable person about any gains that are attributable to him or her under the special capital gains tax treatment and provide sufficient information for any taper relief to be applied.

56. Where a vulnerable person pays tax on trust gains as the result of a claim to special treatment made by the trustees, he or she is entitled to recover the amount of that tax from the trustees. He or she can also require HMRC to provide a certificate to confirm the amount of the gains in question and the amount of tax paid. For the purpose of determining the amount of tax chargeable, the net gains (see paragraph 53 above) are treated as forming the highest part of the amount on which the vulnerable person is chargeable to CGT for the tax year.

Where to make the entries in the tax return

57. The tax returns for 2005-06 and later years will have the necessary entries for making claims for special tax treatment, showing the deductions in terms of tax and the amount of any gains that are chargeable on the vulnerable person as a result. However, as the special tax treatment can apply to 2004-05 but has only recently been enacted, it has not been possible to provide for the necessary entries on the return for 2004-05. Please do not claim the deductions in question 13 of the return. Instead, if trustees wish to claim special tax treatment for 2004-05 they should follow the instructions given in paragraphs 58 and 59 below. Paragraph 37 above explains that where a claim is made it applies to both income tax and CGT, subject to certain exceptions.

Self calculation of tax

58. Where a valid election is in force for the whole or any part of the tax year 2004-05 and the trustees intend to calculate their own tax by answering question 17 they should make the following entries:

i) In the case of a claim for special tax treatment which applies to income:
1) The net amount of total tax (income tax and CGT) due after claiming the deduction should be shown in box 17.1 (in example 1 this would be the figure of £1,949).
2) Full details of the claim should be notified in box 21.9 on page 12 of the return. This must clearly show that it is a claim under Chapter 4 of Part 2 Finance Act 2005 and include the following details:

  • the gross income tax due before the deduction,
  • the amount of the deduction, and
  • the net amount of income tax due.

(In example 1 these would be the figures £7,325, £5,376 and £1,949 respectively.) The net amount, together with any CGT due, must equal the entry in box 17.1. If necessary, details of the claim should be continued on a separate sheet.

ii) In the case of a claim for special tax treatment which applies to capital gains:
1) The supplementary capital gains pages of the return should be completed in the usual way.
2) The amount that is chargeable on the vulnerable person should be shown in box 5.6A. The net amount, if any, chargeable on the trustees is then carried across to box 5.7.
3) The word “settlor” next to box 5.6A should be scored through and the words “vulnerable person” substituted.
4) The claim itself must be made in box 21.9 on page 12 of the return. This must clearly show that it is a claim under Chapter 4 of Part 2 Finance Act 2005. If necessary, details of the claim should be continued on a separate sheet.
5) The vulnerable person’s name, address and tax reference must be shown in box 5.24.

No self calculation of tax

59. Where a valid election is in force for the whole or any part of the tax year 2004-05 and the trustees have submitted their tax return in time to choose not to calculate their own tax liability they should make the following entries:

i) In the case of a claim for special tax treatment in respect of income full details of the claim should be notified in box 21.9 on page 12 of the return. This must clearly show that it is a claim under Chapter 4 of Part 2 Finance Act 2005 and the amount of deduction (in example 1 this would be the figure of £5,376).

ii) In the case of a claim for special tax treatment in respect of capital gains:
1) The supplementary capital gains pages of the return should be completed in the usual way.
2) The amount that is chargeable on the vulnerable person should be shown in box 5.6A. The net amount, if any, chargeable on the trustees is then carried across to box 5.7.
3) The word “settlor” next to box 5.6A should be scored through and the words “vulnerable person” substituted.
4) The claim itself must be made in box 21.9 on page 12 of the return. This must clearly show that it is a claim under Chapter 4 of Part 2 Finance Act 2005.
5) The vulnerable person’s name, address and tax reference must be shown in box 5.24.

Enquiries

60. In addition to the usual enquiry powers into returns and claims HMRC can enquire into the election itself. Notice of the enquiry into the election will be given in writing and specify what information, documents or other particulars HMRC needs to determine whether:

  • the requirements for making the election were satisfied, or
  • the election has ceased to apply because the person is no longer a vulnerable person, or the trusts for which the election was made are no longer qualifying trusts or have terminated.

61. The notice will also give the time within which the information, documents or other details must be provided. This will not be shorter than 60 days. If any of the information, documents or details are not provided, the trustees may be liable to penalties. The initial penalty cannot exceed £300 but further daily penalties can be imposed up to a maximum of £60 for each day on which the failure continues. Daily penalties can only be imposed from the day after the initial penalty is determined and no penalty can be imposed once all the information has been provided. As in paragraph 35 above, providing incorrect information either negligently or fraudulently can result in a penalty up to a maximum of £3,000.

62. If HMRC find that either:

  • the requirements for the election were not satisfied, or
  • the election no longer applies because the beneficiary has ceased to be a vulnerable person, the trusts in relation to which the election was made are no longer qualifying trusts or have terminated,

it can issue a written determination to this effect. Where relevant the notice of determination will state the date on which the election ceased to apply. In other cases it will state that the election was never valid.

63. When a determination is made, all necessary assessments, adjustments, repayments or discharges of tax will be made. There is a right of appeal to the General Commissioners against such a determination. Any appeal must be made in writing within 30 days of the date the determination was issued.

Non residents

Trustees who are not resident in the UK

64. The new regime is not restricted to trustees who are resident or ordinarily resident in the UK. Trustees who are not resident or ordinarily resident in the UK in a tax year will normally be liable to income tax, at the rate applicable to trusts, only in respect of income arising in the UK and will be able to claim the special income tax treatment where the necessary conditions are met. It is that income alone which is taken into account in calculating any deduction from the trustees’ income tax liability.

65. If the trustees are not resident or ordinarily resident in the UK in a tax year for CGT purposes the special capital gains tax treatment does not apply.

Beneficiaries who are not resident in the UK – vulnerable person

66. A beneficiary does not have to be resident in the UK to be a vulnerable person for the purposes of the special tax regime. The place of residence makes no difference to the question as to whether the beneficiary is regarded as being a vulnerable person on the basis of:

  • being a relevant minor, or
  • being a disabled person owing to mental disorder.

67. The situation is different if the beneficiary is claiming to be a vulnerable person on the basis of being physically disabled. This is because there is a residency requirement for entitlement to attendance or a disability living allowance by virtue of entitlement to the care component at the highest or middle rate throughout the relevant period. However a beneficiary may still be treated as a vulnerable person as long as he or she can demonstrate to the satisfaction of the officer dealing with the tax affairs of the trust that he or she would have been entitled to receive either allowance had the necessary residence requirements been met.

68. It is up to the trustees and the vulnerable person to establish and provide the details that are required, as the vulnerable person would have to do so if he or she were making an actual claim to either of the allowances. They must also supply the supporting evidence. The details and supporting evidence must be provided at the same time as the election. If they are not the election will not be valid (see paragraph 30 above).

69. Further details of the attendance and disability living allowances themselves can be found on Department for Work and Pensions (DWP). This also provides details of the information that would be needed to make claims for them, for the purpose of making an election, as explained in paragraph 68 above.

Calculating the deduction against the trustees’ income tax liability

70. If the vulnerable person is not resident or ordinarily resident in the UK at any time in the relevant tax year, for the purposes of computing amount B in paragraph 44 above, he or she is treated as being resident and domiciled in the UK throughout that year. Therefore the computation of that person’s actual income should be made in the normal way, taking into account any allowances, such as the personal allowance to which he or she would be entitled. However, as in paragraph 49 above, the following should not be taken into account:

  • income of the trustees which is distributed to the beneficiary in the tax year, and
  • any relief given by way of a reduction in tax liability.

71. In addition, the qualifying trusts income must also be computed. That is the income arising to the trustees but treated as arising to the vulnerable person for the purposes of the special income tax treatment. For the purposes of arriving at the amount B, CGT liability should be computed on the basis that the vulnerable person’s ‘CGT taxable amount’ for the year (see paragraph 77 below) is equal to his or her ‘deemed CGT taxable amount’ (as described in paragraph 76 below).

Calculating the CGT liability

72. Where the vulnerable person is not resident or ordinarily resident in the UK at any time in the tax year, any liability to CGT remains with the trustees. The gains and the amount of any tax liability are calculated in the normal way but the trustees can claim a claim a deduction in their tax liability in terms of tax. This deduction is calculated, on the assumption that the vulnerable person is resident and domiciled in the UK throughout the tax year, as follows:

C. the amount of CGT the trustees would pay (before applying the special treatment) on the qualifying trusts gains, less
D. the difference between the vulnerable person’s

  • deemed total tax liability, including any CGT liability in respect of the qualifying trusts gains, and
  • deemed total tax liability, excluding any CGT liability in respect of the qualifying trusts gains.

‘Deemed total tax liability’ is explained in paragraph 74 below.

73. Effectively this means that the CGT chargeable on the trustees is the same as would be chargeable on the vulnerable person if that person were resident and domiciled in the UK. However, in order to compute that liability, it is necessary to calculate what the vulnerable person’s total tax liability (the ‘deemed total tax liability’) would be if he or she were resident and domiciled in the UK.

74. Therefore, for the purposes of calculating the amount D in paragraph 72 above, the deemed total tax liability is the amount of income tax and CGT to which the vulnerable person would be liable for the year, if resident and domiciled in the UK, on:

  • his or her actual income (see paragraph 75 below), plus
  • any qualifying trusts income, that is income arising to the trustees but treated as arising to the vulnerable person for the purposes of the special income tax treatment, plus
  • his or her deemed CGT taxable amount for the year (see paragraph 76 below), plus
  • the net gains referred to in the third sentence of paragraph 53 above, that is the qualifying trusts gains (see paragraph 52 above) less any qualifying allowable losses (see paragraph 53 above).

75. Actual income means all income arising to the vulnerable person that would be chargeable to income tax, on the assumption that he or she were resident and domiciled in the UK throughout the tax year concerned.

76. The deemed CGT taxable amount is:
E. the CGT taxable amount (see paragraph 77 below) for the year resulting only from any ‘actual gains’ and ‘actual losses’ (see paragraph 78 below) of the vulnerable person, plus
F. the CGT taxable amount for the year resulting only from any ‘assumed gains’ and ‘assumed losses’ (see paragraphs 79 and 80 below) of the vulnerable person for the tax year concerned.

77. An individual’s ‘CGT taxable amount’ for a tax year is what remains of the total amount of chargeable gains arising to him or her in the tax year after deductions have been made for any available allowable losses, and after any taper relief has been applied.

78. For the purposes of calculating the amount E in paragraph 76 above, ‘actual gains’ are chargeable gains which arise to the vulnerable person in the tax year on which he or she is actually chargeable to CGT. And ‘actual losses’ are allowable losses which actually arise to the person in that tax year or in an earlier tax year that have been carried forward and have not already been deducted from chargeable gains.

79. For the purposes of calculating the amount F in paragraph 76 above, ‘assumed gains’ are chargeable gains (other than actual gains mentioned in paragraph 78 above) to which the vulnerable person would have been chargeable to CGT for the year, on the assumption that he or she was resident and domiciled in the UK throughout the year. No account is taken of any claims or elections that could be made in relation to the assumed gains.

80. For the purposes of calculating the amount F, ‘assumed losses’ are allowable losses (other than actual losses mentioned in paragraph 78 above) which, on the same assumption, would arise to the vulnerable person in the year. The vulnerable person is treated as if he or she had given the relevant notice for such losses to be allowable losses. No account is taken of assumed losses of earlier years. Also, no account is taken of any claims or elections that could be made in relation to assumed losses.

Claims

81. Claims should be made in accordance with the guidance in paragraphs 38 to 40 above. If a claim gives rise to special capital gains tax treatment and is made after the time limit for amending the trustees' tax return, ignore the second bullet in paragraph 40. Instead the claim must include the amount of the deduction against CGT.

Where to make the entries in the 2004-05 tax return

82. Where a valid election is in force for the whole or any part of the tax year 2004-05 and the trustees intend to calculate their own tax by answering question 17 they should make the following entries:

i) In the case of a claim for special tax treatment which applies to income only, the guidance in paragraph 58(i) above should be followed.

ii) In the case of a claim for special tax treatment which applies to capital gains only:
1) The supplementary capital gains pages of the return should be completed in the usual way and the total taxable gains recorded in box 5.11.
2) The net amount of total tax (CGT and income tax) due after claiming the deduction should be shown in box 17.1.
3) Full details of the claim should then be notified in box 21.9 on page 12 of the return. This must clearly show that it is a claim under Chapter 4 of Part 2 Finance Act 2005 and include the following details:

  • the gross CGT due before the deduction,
  • the amount of the deduction, and
  • the net amount of CGT due.

The net amount, together with any income tax due, must equal the entry in box 17.1. If necessary, details of the claim should be continued on a separate sheet.

iii) In the case of a claim for special tax treatment which applies to both income and capital gains:
1) The supplementary capital gains pages of the return should be completed in the usual way and the total taxable gains recorded in box 5.11.
2) The net amount of total tax (CGT and income tax) due after claiming the deductions should be shown in box 17.1.
3) Full details of the claim should then be notified in box 21.9 on page 12 of the return. This must clearly show that it is a claim under Chapter 4 of Part 2 Finance Act 2005 and include the following details:

  • the gross income tax due before the deduction, the amount of the deduction in respect of income tax and then the net amount of income tax due, and
  • the gross CGT due before the deduction, the amount of the deduction in respect of CGT and then the net amount of CGT due.

The two net amounts added together must equal the entry in box 17.1. If necessary, details of the claim should be continued on a separate sheet.

83. Where a valid election is in force for the whole or any part of the tax year 2004-05 and the trustees have submitted their tax return in time to choose not to calculate their own tax liability they should make the following entries:

i) in the case of a claim to special tax treatment which applies to income only the guidance in paragraph 59(i) above should be followed.

ii) In the case of a claim to special tax treatment only in respect of capital gains full details of the claim should be notified in box 21.9 on page 12 of the return. This must clearly show that it is a claim under Chapter 4 of Part 2, Finance Act 2005 and state the amount of the deduction. If necessary, details of the claim should be continued on a separate sheet.

iii) In the case of a claim for special tax treatment in respect of both income and capital gains full details of the claim should be notified in box 21.9 on page 12 of the return. This must clearly show that it is a claim under Chapter 4 of Part 2 Finance Act 2005 and state the amounts of both the income tax and CGT deductions. If necessary, details of the claim should be continued on a separate sheet.

Other definitions

Attendance allowance means an allowance under section 64 of the Social Security Contributions and Benefits Act 1992 or section 64 of the Social Security Contributions and Benefits (Northern Ireland) Act 1992.

Bare trust means a trust where the beneficiary has an immediate and absolute entitlement to the property held in trust and any income that arises from it. For tax purposes income and gains are chargeable on the beneficiary and not on the trustees.

Criminal Injuries Compensation Scheme means:

  • Schemes established under the Criminal Injuries Compensation Act 1995,
  • Arrangements made by the Secretary of State before the commencement of those schemes, or
  • The scheme established under the Criminal Injuries (Northern Ireland) Order 2002.

Disability living allowance means an allowance under section 71 of the Social Security Contributions and Benefits Act 1992 or section 71 of the Social Security Contributions and Benefits (Northern Ireland) Act 1992.

Domicile is a concept of general law and there are many factors which affect a person’s domicile. Details can be found in leaflet IR20 Residents and non-residents. Broadly speaking, a person is domiciled in the country where he or she has his or her permanent home.

Ordinarily resident refers to a person who is resident year after year. A person who is resident in the UK year after year is also ordinarily resident in the UK. A person who is resident in the UK for one tax year only is not usually ordinarily resident in the UK.

Resident: full details of residence can be found in leaflet IR20 Residents and non-residents. To be regarded as resident in the UK a person has to be physically present in the UK at some point during the tax year. A person who spends 183 days or more in the UK in any tax year is resident in the UK for that tax year, but this is not the only test.

Settlor means a person who has put property into the trust.

Settlor-interested trust means a trust where a settlor has an interest in property held in the trust.

Tax year means a year of assessment, starting on 6 April in one year and finishing on 5 April in the following year.

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