Tax on beneficiaries
Distributions of income to UK resident beneficiaries (including the settlor) are subject to income tax. Distributions made under a power to advance capital may also be subject to income tax if tax avoidance motives are associated with the trust and the distributions are deemed to be made out of accumulated trust income.
A capital distribution not subject to income tax is treated as if it were a distribution of the accumulated trust capital gains. Gains are matched to capital distributions in the order of realisation ‘last in, first out’ or LIFO, taking each year of assessment as a whole. Where capital distributions exceed the total accumulated capital gains, the charge is limited to the total gains. However the excess is not truly free of tax unless the trust is fully distributed because it is carried forward and matched to future capital gains or income. Because the tax charge on trust gains can be deferred for many years if there are no capital distributions, a “supplementary charge” is also applied to gains not matched to capital distributions in the year they arise or the following year. This acts as a crude interest charge and can increase the tax rate to a maximum of 32% after six years.
If you are a UK resident beneficiary, domiciled outside the UK and claiming to be taxed on the remittance basis, then distributions received offshore are considered tax free, provided they are not ‘remitted’ to the UK (remittance is widely defined).