The income tax rates for trusts remain unchanged. Trusts with an interest in possession pay income tax at the basic rate on general income, savings rate on interest and lower rate on dividends.
A discretionary trust pays income tax at the higher rates (40% on general and savings income, 32.5% on dividends), but a "standard rate band" of £500 was introduced for 2005/06. This is extended to £1,000 for 2006/07, and income up to this amount will only bear tax at 10% (dividends), 20% (interest) or 22% (general income).
Inheritance tax (IHT) changes
A very significant change to the IHT treatment of trusts will apply to new trusts set up, or property added to existing trusts, from 22 March 2006. Trusts with an "interest in possession" (where someone is immediately entitled to income or to use the trust property) have up to now been treated as if that person owned the property absolutely for IHT, which means that transfers to such a trust during the settlor's lifetime have not been immediately charged to tax. "Accumulation and maintenance trusts" (typically set up for beneficiaries within the same family up to the age of 25) have been exempted from certain IHT charges that are levied on "discretionary" trusts (in which the trustees have the power to accumulate or distribute income).
For new trusts, with very limited exceptions, there will be an immediate charge to IHT on entry even if the settlor is still alive; and there will be further IHT chargeable events on the property in the trust after 10 years, and on property leaving the trust, as there have been for many years on discretionary trusts.
These entry, periodic and exit charges will not apply to trusts set up for a disabled person; and the periodic and exit charges will not apply to a very restricted number of trusts set up in a will. They will also apply when an existing beneficial interest comes to an end from 22 March 2006 onwards and another beneficiary enjoys an interest in possession - this will be treated as if it is the creation of a new trust.
Unification of rules
As announced last year, the rules are being changed (mainly from 6 April 2006) so that the income tax and CGT treatment of trusts will be more consistent. This includes tests of what is a settlement, who is the settlor, and where trustees are treated as resident for tax (from April 2007).