RSS feedsWhat are the main changes in personal injury trusts and why have they been brought in?
Individuals who derive income from personal injury trusts (PITs) will, from 2006/07, be required to register with HM Revenue & Customs, file a tax return and reclaim tax from the authorities.
PITs were devised in 1987 to ensure that recipients of large monetary awards following serious injury were able to safeguard their entitlement to state benefits. As of 2006/07, beneficiaries or settlors, as creators of trusts are also known will have to pay tax on interest or dividends and reclaim it from the taxman.
From discussions with HMRC it seems the purpose of introducing the change to trusts is to attack higher rate taxpayers who use settlor interested trusts (see below) as a tax assistance device.
Unfortunately, PITs have been caught up in this process, with additional compliance costs and cashflow disadvantages to injury victims. It has taken some time for HMRC to realise the impact on PITs, but the taxman does now acknowledge that this is a problem for a large number of personal injury and clinical negligence victims.
How does the new regime work in practice?
Up to and including 2005/06, the income paid to a creator of a trust, on the
income
generated by a trust from which he or she could benefit, could be returned
directly by the settlor on his or her personal tax return. (The income paid can
refer to such things as bank interest and dividend income).
Most personal injury trusts only pay income with tax already deducted and so historically, if there was no gross paid income, there was no need for a trust tax return.
For 2006/07, it is necessary to report all settlor interested trust income on a trust tax return whether paid net or gross. This means trustees have to pay tax at 40% on any income in excess of £1,000 and the tax is available as a credit to the settlor against his or her tax liability.
For example, the trust receives £8,000 bank interest, after deduction of £2,000 income tax. The settlor is a basic rate taxpayer. For 2005/06, this was entered on the settlor tax return, with no tax payable or repayable. For 2006/07, the trustee has to pay tax of £1,800 and the settlor will have to reclaim this.
Are there any exceptions to the new rule, or does it apply to any sort of trust?
The only exception relates to Bare Trusts, which are trusts only in name. Even though trustees hold the property, the settlor has the right to receive trust income and capital. The settlor remains directly taxable on trust gains and income and so there is no need for a trust return it is a trust in form rather than substance.
What difference is this likely to make to my clients’ tax returns?
Many trusts will have to make tax returns for the first time, disclosing and paying tax on various forms of income. Individuals will no longer return trust income as if it was their own. Instead, they will need to complete the trust income schedule to the personal tax return.
What will they have to do to recover their money?
This is the all important question. Completing a self-assessment return or a repayment claim will enable the settlor to recover any monies owed. If the settlor is not required to complete a self-assessment return then the repayment claim can be used.
If a settlor is just claiming trust income, this is a relatively straightforward process. If other income is involved it can get more complicated to complete the return. In this case, even settlers who are generally confident of handling their own tax returns might still be advised to seek professional assistance.
HMRC should not strictly repay the individual until trustees have made their 31 January tax payment. They will usually repay the personal tax before the trustees pay their tax as a matter of practice, but HMRC cannot be forced to do this.
Is it too late to register and so avoid a penalty? And where can clients get the forms they need?
No. The date by which taxpayers were supposed to register was 5 October. However, provided the return is made and the tax is paid by the 31 January no penalty will be levied.
If a trustee is not represented (i.e. if they do not employ an accountant’s services) and so does not notify the authorities that they need to be registered, they will not be sent a trust return. Subsequently, they might find they do not have the necessary forms. In such cases, they should notify HMRC as soon as possible or download the forms form the HMRC website.
What if a trustee has financial difficulties and cannot pay the tax due?
They can avoid a penalty. You should approach HMRC as early as possible and you should be able to agree a payment schedule to ease the financial burden for clients. An instalment schedule will be devised, but bear in mind that the largesse of the taxman is limited and will not extend to forgetting about interest, which will be charged on the outstanding balance. If a trustee fails to stick to the payment schedule, HMRC will demand all tax due immediately.
Mark Simpson is tax planning director of Simpson Burgess Nash
