If a trust is set up for a vulnerable beneficiary, the trustees can claim special treatment for income tax and capital gains tax if it is a ‘qualifying trust’.
For a trust to be 'qualifying’ (relating to income tax and capital gains tax. There is a separate criteria for inheritance tax – outlined below), its assets must only be capable of being used to benefit a disabled person. The disabled person must be entitled to all the income or, if they are not so entitled (because there is no interest in possession), none of the income can be applied for the benefit of anyone else.
Making a vulnerable person election
To claim special tax treatment, trustees must complete form VPE1 (Vulnerable Person Election) and send it to HM Revenue & Customs (HMRC).
The trustees must sign VPE1 along with the vulnerable beneficiary (or with someone who can legally sign for the beneficiary).
A separate form VPE1 must be completed for each beneficiary.
Deadline for making a vulnerable person election
The special tax treatment takes effect from the date provided (elected for) on form VPE1. The election must be made no later than 12 months after 31 January following the tax year when it is to start.
Any income or gains before the election takes effect are taxed under normal trust rules – even if the election takes effect part way through the same tax year.
The special tax treatment is no longer effective after the death of the vulnerable beneficiary or the date on which the vulnerable beneficiary ceases to be vulnerable.
Where a trust has a vulnerable beneficiary, the trustees are entitled to a deduction of tax against the amount they would otherwise pay.
This is calculated as follows:
The trustees calculate their income tax liability on the ‘normal’ basis
They then calculate the income tax the vulnerable beneficiary would have had to pay if the trust income had been paid directly to them as an individual
The trustees then claim the difference between these two figures [ie (a) - (b)] as a deduction from their own income tax liability
Capital gains tax
Capital gains tax (CGT) is payable by the trustees. They can claim a relief calculated in a similar way to the income tax relief:
The trustees calculate the CGT as if there was no relief
The trustees then calculate the CGT if the gains arose directly to the vulnerable beneficiary
The trustees can claim the difference between these two amounts as a relief
This special treatment does not apply in the tax year when the beneficiary dies.
Trusts for vulnerable beneficiaries get special inheritance tax treatment if they are ‘qualifying trusts’.
A qualifying trust for a disabled person is one where:
For a disabled person whose trust was set up before 8 April 2013, at least half of the payments from the trust must go to the disabled person during their lifetime
For a disabled person whose trust was set up on or after 8 April 2013, all payments must go to the disabled person, except for up to £3,000 per year (or 3% of the assets, if that’s lower), which can be used for someone else’s benefit
When someone suffering from a condition that’s expected to make them disabled sets up a trust for themselves
For a bereaved minor, they must take all the assets and income at (or before becoming) 18
There’s no inheritance tax charge:
If the person who set up the trust survives seven years from the date they set it up
On transfers made out of a trust to a vulnerable beneficiary
When the beneficiary dies, any assets held in the trust on their behalf are treated as part of their estate and inheritance tax may be charged.
On 7 November 2018, HMRC issued a consultation document “The Taxation of Trusts: A review”. In simple terms, the consultation sets out the government’s thinking on making trusts fairer, simpler and more transparent. At the time of writing, the government is not making specific proposals for reform. Instead, the government will weigh up the views and evidence presented and consider the options for targeted reforms.