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Trustees of a Discretionary Trust generally have 'discretion' about how to use the income of the Trust. They may be required to use any income for the benefit of particular beneficiaries, but the trustees can decide
How much is paid.
To which beneficiary or class of beneficiaries payments are made.
How often the payments are made.
What, if any, conditions to impose on the recipients.
The trustees may, or may not, be allowed to 'accumulate' income within the Trust for as long as the law allows rather than pass it to the beneficiaries. Income that has been accumulated becomes part of the capital of the Trust.
The trustees are liable to tax on income received at the rate applicable to trusts (40% from 2004/05; 34% for 2003/04 and previous years), but dividends and other similar income are chargeable at the trust rate that applies to dividends (32.5% from 2004/05; 25% for 2003/04 and previous years).
All income paid to the beneficiaries carries a credit at the rate applicable to trusts. So, the payment is treated as if it had been made after the deduction of tax at that rate. If beneficiaries are basic or starting rate taxpayers, or non-taxpayers, they will be able to reclaim some or all of the tax paid. If they are liable at higher rates no further tax will be due.
If the trustees also have power to accumulate income, they can choose to do so and that income becomes additional capital of the Trust. If, in later years, the trustees distribute some of the accumulated income to the beneficiaries the payment is a capital distribution, and not an income distribution. Beneficiaries are not taxable on capital distributions.
When trustees of a Discretionary or Accumulation and Maintenance Trust pay income to beneficiaries they have to ensure that they have paid enough tax to cover the tax credit at the rate applicable to trusts. Trustees, therefore, need to keep a record of tax payments, known as the 'tax pool'.
The tax pool consists of tax paid by the trustees on income they have received, and tax deducted at source, for example, by banks or building societies on interest. It does not include non-payable tax credits, such as the tax credit on dividends.
When the trustees pay income to beneficiaries the tax pool is reduced by the tax credit on that income.
If the tax in the tax pool is not enough to cover the tax credit needed for the payment to beneficiaries the trustees must pay the difference in their Self Assessment Tax Return for the year.