Chapter 7: Discretionary payments
1444.This Chapter concerns the tax treatment of a payment made by trustees to a beneficiary in the exercise of a discretion. It is mainly concerned with the taxation of the trustees, but contains some provisions affecting the beneficiary.
1445.The discretionary payment is treated as a net amount corresponding to a gross amount from which the trustees have deducted income tax at the trust rate.
1446.That gross amount is chargeable to income tax on the beneficiary as an annual payment within Chapter 7 of Part 5 of ITTOIA, and the beneficiary is treated as having paid the income tax deducted. The deduction of income tax at source provisions that normally apply to annual payments are disapplied by section 899(5)(d) and (e) of this Act.
1447.The trustees, who will be charged to tax on the income of the trust at either the dividend trust rate or the trust rate, with the total tax paid going into a “tax pool”, have to account for the tax deemed to have been deducted only to the extent that there is insufficient tax in the tax pool.
Section 493: Discretionary payments by trustees
1448.This section sets out what payments come within this Chapter. It is based on section 687(1) and (5) of ICTA.
1449.Subsection (1) provides that an annual payment is within this Chapter if it is made by trustees in the exercise of a discretion (exercised by the trustees or any other person) and provided that condition A or B is met. And it is made explicit that the trustees must be UK resident. See Change 89 in Annex 1.
1450.Condition A is that the payment is income of the beneficiary for either income tax or corporation tax purposes. “Beneficiary” is used instead of the phrase “person to whom [the payment] is made” in section 687(1)(a) of ICTA. The reference to corporation tax provides a link to section 687A of ICTA.
1451.A discretionary payment from an employment-related settlement may be taxed on a beneficiary as employment income. Such a payment is excluded from this section. But the income arising to the trustees out of which the payment is made is taxable at the special trust rates. In such circumstances there is effectively double taxation and the trustees may be able to claim a payment from HMRC. See ESC A68.
1452.Condition B is that the payment is treated as income of a settlor under section 629 of ITTOIA.
Section 494: Grossing up of discretionary payment and payment of income tax
1453.This section provides for the grossing up of discretionary payments and sets out the treatment of the tax deemed to have been deducted. It is based on section 687(2) of ICTA.
1454.Subsections (1) and (2) provide for the amount of the actual payment to the beneficiary to be grossed up by reference to the trust rate for the year in which the discretionary payment is made.
1455.The amount by which a payment is grossed up represents income tax. Subsections (3) and (4) provide that the beneficiary or the settlor (in a case where the discretionary payment is treated as income of the settlor), is treated as having paid the tax deemed to have been deducted.
Section 495: Statement about deduction of income tax
1456.This section provides for the recipient of the discretionary payment to be able to obtain a statement from the trustees giving details of the payment and tax treated as deducted. It is based on section 352 of ICTA as it applies to payments under section 687 of ICTA.
1457.In a case where the income is treated as that of the settlor, it is the settlor rather than the recipient who will need these details. Accordingly, this section gives authority to the appropriate person to require a statement from the trustees. See Change 90 in Annex 1.
Section 496: Income tax charged on trustees
1458.This section sets out the tax effect on the trustees of making a discretionary payment. It is based on section 687(2) of ICTA.
1459.The source legislation provides for all the tax deemed to have been deducted to be assessed on the trustees, subject to set-off under section 687(3) of ICTA (the “tax pool”). But the charge under this section is only on the amount of tax by which the amount treated as deducted exceeds the amount of the tax pool for that year. This is similar to the approach adopted in section 424 (gift aid).
Section 497: Calculation of trustees’ tax pool
1460.This section sets out the calculation of the trustees’ tax pool available for a tax year, in order to determine whether a charge on the trustees arises under section 496. It is based on section 687(3) of ICTA.
1461.To make the comparison in section 496, the amount of the tax pool available for a tax year is the amount at the end of the tax year (including tax going into the pool in that year) before reduction in respect of amounts of tax deemed to have been deducted from payments in the tax year. It follows that the amount of the pool available for the previous year has to be adjusted at Step 1 for the amount of tax deemed to have been deducted in the previous year in order to arrive at the correct brought forward figure. See also the transitional provision in Part 10 of Schedule 2.
1462.Subsections (2) and (3) ensure that tax only goes into the pool if it is tax paid at a time when the trustees were UK resident. This is a corollary to trustees having to account for tax only on discretionary payments made while UK resident, See Change 89 in Annex 1 and the commentary on section 493. It is also provided that the opening pool is nil if the settlement is established during the year.
Section 498: Types of income tax for the purposes of section 497
1463.This section sets out the types of income the tax on which goes into the tax pool. It is based on section 687(3) and (3A) of ICTA.
1464.The section streamlines many of the references to other provisions made by section 687(3) of ICTA. For example, following the amendments made by ITTOIA, section 687(3)(a2) and (aa) of ICTA are unnecessary because the sections mentioned there are within Chapter 3 of Part 4 of ITTOIA and so are already covered by section 687(3)(a1) of ICTA.
1465.Following its substitution by FA 2006, section 686A of ICTA brings together the charges on items that were previously charged at the trust rate under various separate provisions. This means that there may have been overlap between paragraph (bc) and other paragraphs of section 687(3) of ICTA and uncertainty about the amount of tax to go into the pool. That uncertainty is removed by this section.