Trusts for Vulnerable Beneficiaries
In the UK, trusts for vulnerable beneficiaries receive different tax treatment compared to ordinary trusts, thus providing specific tax advantages under certain conditions. These benefits span Income Tax, Capital Gains Tax (CGT), and Inheritance Tax (IHT), although the qualifying criteria vary between these taxes.
Definition of a vulnerable beneficiary
According to Nick Hughes, a leading Kent tax advisor and specialist in trusts for UK and non-UK domiciliaries, a vulnerable beneficiaryis typically someone who lives with a mental or physical disability. Minors or under 18s who have lost a parent are also classed as vulnerable individuals for tax purposes.
This article focuses on beneficiaries with disabilities.
Qualifying trusts for Income Tax and CGT
Trusts qualify for special tax treatment if they meet specific criteria which ensure their assets benefit a disabled person. The trust must either provide all income directly to the disabled beneficiary or, if there is no entitlement to income (non-interest in possession), ensure no income benefits anyone else. Special tax treatment is possible for portions of a trust specifically designated for a vulnerable beneficiary, provided these are distinctly accounted for.
Income Tax and CGT special treatment
Trustees can apply for special tax treatment by filing a vulnerable person election form (VPE1) with HMRC, signed by both the trustees and the beneficiary or their legal representative. The election must be made within 12 months after 31 January following the tax year in which the election is to take effect. Special treatment applies from the elected date until the death of the beneficiary or until they no longer meet the vulnerability criteria.
Tax deductions and relief calculation
For income tax, trustees use a two-step process to determine tax deductions for trusts with vulnerable beneficiaries.
- Calculate normal tax liability – The income tax owed on the trust’s income using the standard rules applicable to trusts.
- Estimate beneficiary’s tax – The amount of tax that the beneficiary would have paid if the income had been received directly by them, instead of through the trust.
The difference between these amounts is deducted from the trustees’ tax liability. A similar calculation applies for CGT, where trustees can claim a reduction based on what the beneficiary would have owed if the gains were theirs directly.
IHT special treatment
For IHT purposes, a trust qualifies if it directs at least half of payments (for trusts established before 8 April 2013) or all payments (for those established after) to the disabled person during their lifetime, with limited exceptions. These trusts face no IHT on transfers to vulnerable beneficiaries and are treated as having an interest in possession for the disabled beneficiary, which simplifies the taxation on transfers or terminations of the trust. Additionally, if the trust’s settlor survives seven years after setting it up, the trust can also qualify as a potentially exempt transfer (PET).
In simple terms, the aforementioned special arrangements aim to provide financial support without imposing the usual tax burdens on trusts, acknowledging the unique needs of vulnerable beneficiaries.
With the assistance of a Kent accountant for probate services, you can ensure that a trust is properly incorporated into estate plans, thus optimising asset management after an individual’s death.
