Share this content

Discretionary Trustees have to Pay Out All Income?

Post-"Accumulation Period" - Do Trustees Need to Pay Out All of the Trust Income or Can They Retain?

Didn't find your answer?

According to the terms of the Will Trust (death was in 2003) the "Accumulation Period" is to last 21 years (ends some time during 2024) and the Closing Day is the day before the 80th anniversary of the death (ends some time in 2083) . So the Accumulation Period will end in two years' time.

According to the Will Trust clause, from the termination of the Accumulation Period to the Closing Day (a 59-year period), trust income is to be paid to the beneficiaries "in such manner as my Trustees shall from time to time in their absolute discretion think fit".

It would appear that the Will Trust binds the Trustees to pay out ALL income of the year during the post-"Accumulation Period" of 59 years.

Just looking at TSEM3780 attached, third bullet point regarding the end of accumulation periods, where it says "so the trustees cannot accumulate income and have to pay out all income to beneficiaries".

https://www.gov.uk/hmrc-internal-manuals/trusts-settlements-and-estates-...

So, my question is, are the Trustees permitted to pay out LESS than the annual income of the Trust, or are they obliged to pay out the whole lot.

What if it is anticipated that in the following year major repair works will have to be undertaken on trust property giving rise to a reluctance to pay out any income. of that earlier year (or indeed years if it is major repair work).

By coincidence, the Accumulation Period will end at roughly the same time as the youngest grandchild beneficiary starts work, so their personal tax allowance is no longer free to absorb discretionary income distributions. It seems that the Trustees are wanting to accumulate income again rather than distribute. Is this illegal from the point of view of the Will Trust provisions/general law and/or tax law.

By the way, for these old trusts (when HMRC used to peruse trust deeds in the "good old days") I suspect HMRC may be aware of the duration of "Accumulation Periods". It would not be too much of an effort for the HMRC computer to select trusts which have income during Accumulation Periods and which fail to distribute. Could HMRC create any tax issues even without broaching any trust deed/general law matters.

Any useful comments would be appreciated.

Replies (21)

Please login or register to join the discussion.

avatar
By AB_85
06th Jul 2022 16:32

Yes, the trustees are permitted to pay out less than the annual income each year. This isn't an interest in possession trust and the beneficiaries interest in income remains contingent. Surely the clause you quote from the deed spells this out: pay the income "in such manner as my Trustees shall from time to time in their absolute discretion think fit."

I would interpret "from time to time" relatively broadly. If the trustees believe that the repair work (which may or may not be an income expense - is this a property business?) is necessary for the preservation of trust property, and hence is in the interest of the beneficiaries, I think it's a perfectly reasonable exercise of their discretionary powers to hold back income distributions for a time to provide a contingency.

Whether the trustees can reaccumulate would depend on what the trust deed says. I suspect most modern trust deeds would allow for it as an exercise of the the trustee's discretionary powers. They may also have discretionary power to amend the trust deed sufficient to allow them to accumulate. I'm not sure it would be wise though; a positive decision to accumulate binds their hands as the income is then capitalised. Simply not distributing, with the income balance earmarked for future income distributions, is surely more flexible. As regards the reason cited for accumulating, unless the beneficiary is going to immediately walk into a job paying £150,000 per year, presumably there may still be some tax benefit in distributing income which carries a 45% tax credit.

Thanks (1)
Replying to AB_85:
avatar
By More unearned luck
06th Jul 2022 19:00

If reaccumulate means 'not pay out' then surely the power to do so is the corollary of the discretion over income distributions. But I suppose there might be a distinction between a permanent reaccumulation and a temporary ones.

Thanks (1)
Replying to AB_85:
avatar
By More unearned luck
06th Jul 2022 19:02

duplicate

Thanks (0)
Replying to AB_85:
avatar
By More unearned luck
06th Jul 2022 19:01

triplicate

Thanks (0)
Replying to AB_85:
By penelope pitstop
07th Jul 2022 03:00

Thanks for your comments.

I wonder if the two Will Trust clauses dealing with a) the first 21-year Accumulation Period and b) the latter 59-year post-Accumulation Period give us some clues as to whether or not the trustees will be able to accumulate income during the post-21-year Accumulation Period.

In my original post I quoted part of trust clause 3(d)(ii) of the Will, which deals with the latter 59-year period from the termination of the 21 year Accumulation Period until year 80. That clause relates to how the trustees "apply the income arising from my Legacy Fund (i.e. the NRB discretionary trust) to or for the benefit of all or such one or more of the Beneficiaries...."

But the earlier clause 3(d)(i) of the Will, which relates to the initial 21-year Accumulation Period, mentions "to pay or apply the whole or any part of the income arising from my Legacy Fund to or for the benefit of all or such one or more of the Beneficiaries......"

Note carefully how the during the initial 21-year Accumulation Period the clause enables the trustees to apply all or part of the income to the trust beneficiaries.

However, for the final 59-year post-Accumulation Period there is no reference to the whole or any part of the income, merely the income arising. This is a subtle difference in expression, presumably the result of careful Will drafting. Is this to be understood that all of the net trust income during this 59-year period has to be distributed. This would seem to be supported by the HMRC TSEM3780 referred to in my original post.

Of course, if all of the income for this latter period has to be paid out, the trustees still have a discretion as to whom to pay it and some control as to the actual timing of the distribution.

Does this then lead to the eventuality that if all of the trust beneficiaries died out bar one, an interest in possession comes into effect the day after one of the beneficiaries becomes the sole surviving beneficiary. It would be helpful to have some confirmation on this point.

I am minded of the 1799 Thellusson v Woodford trust law case (when discretionary trusts were not very common), which seems to have resulted in the badly-drafted Accumulations Act 1800 ("the Thellusson Act"), whereby Parliament intervened in an attempt to prevent excessive accumulations.

I also wonder if any recent legislation has resulted in any extension to permit accumulation throughout the 59-year post-Accumulation Period. If so, I wonder if the original Will clauses can be over ridden by any such extension. Perhaps some "legal eagle" could pass comment on this, because it is beyond my ken.

Thanks (0)
Replying to penelope pitstop:
avatar
By Tax Dragon
08th Jul 2022 09:45

penelope pitstop wrote:

I also wonder if any recent legislation has resulted in any extension to permit accumulation throughout the 59-year post-Accumulation Period. If so, I wonder if the original Will clauses can be over ridden by any such extension. Perhaps some "legal eagle" could pass comment on this, because it is beyond my ken.

It's one for lawyers.

FWIW (zilch) I believe the, entirely reasonable, presumption is that the trust document records the settlor's wishes. It is the duty of the trustees to carry out those wishes. Overriding those wishes (by varying the document as you suggest) may be possible, but might need court approval, and if so that's probably prohibitively big fees for a NRB DT. I make no comment about whether such fees would be revenue or capital! :-)

But as you say, this isn't a matter for you to deal with.

Thanks (1)
Replying to Tax Dragon:
avatar
By leeanthonyblackshaw
08th Jul 2022 10:59

I agree, it needs legal input. It's a topic which occasionally arises on the STEP trusts discussion forum https://trustsdiscussionforum.co.uk/ , so also worth a search or query there.

Thanks (1)
Replying to penelope pitstop:
avatar
By More unearned luck
08th Jul 2022 12:25

The person who drafted the will might have set out in a second document (eg a letter to the testator) in non-technical language an explanation of what the trust clauses mean and achieve. But beware will drafters don't always understand the effect of the words they write in a will as was found in a recent case. We are all fallible human beings.

Thanks (0)
avatar
By More unearned luck
06th Jul 2022 19:14

Trustees can't pay out all the income - they need to retain sufficient to pay the income tax on the income and, if that is insufficient, the extra tax need to match the the sum of the tax on the R185s.

If IHT was due on the 1st ten-year anniversary and if that tax is being paid by instalments (as the the trust property is property it seems) then income is being retained to pay that tax, I would wager.

Of course, the second 10-year anniversary is nigh.

Thanks (1)
Replying to More unearned luck:
By penelope pitstop
07th Jul 2022 01:29

Thanks for that comment. When I meant income, in the case of, say, rental income I meant rental income after expenses and taxes, which of course includes rental income tax. In other words the bottom line income figure.

As Jon P Zigmond once said (the ace author of many articles on the taxation of discretionary trusts) 10-year anniversary IHT charges are typically small and can usually be paid out of trust income.

So, I would have assumed that these 10-year IHT charges would have been paid out of trust income, leaving the balance to distribute to beneficiaries under any discretionary powers to distribute.

Thanks (0)
Replying to More unearned luck:
By penelope pitstop
07th Jul 2022 01:33

Thanks for that comment. When I meant income, in the case of, say, rental income I meant rental income after expenses and taxes, which of course includes rental income tax. In other words the bottom line income figure.

As Jon P Zigmond once said (the ace author of many articles on the taxation of discretionary trusts) 10-year anniversary IHT charges are typically small and can usually be paid out of trust income.

So, I would have assumed that these 10-year IHT charges would have been paid out of trust income, leaving the balance to distribute to beneficiaries under any discretionary powers to distribute.

Thanks (0)
avatar
By Tax Dragon
07th Jul 2022 05:59

IMHO IHT is chargeable to Capital Account.

I'm principle, all the income is payable to beneficiaries, but even with IIP trusts it's commonplace to have an unpaid balance at year end.

I have come across at least one lawyer say that, once the power to accumulate ends, the trust becomes equivalent to an IIP. (I couldn't get my head round the comments as made though. Maybe that's why I'm a tax person not a lawyer.)

Thanks (1)
Replying to Tax Dragon:
avatar
By More unearned luck
07th Jul 2022 11:39

"IMHO IHT is chargeable to Capital Account."

Indeed, but that doesn't solve the trustees' funding problem. If the trust fund is held in shares some shares could be sold to pay the IHT . But in this case it is not practical to sell, say, a 1% interest in the property for that purpose (or any purpose), so what choice do the trustees have but to retain (ie accumulate) income?

Could they borrow? Would trust law permit the trustees to mortgage the property to pay a capital tax? Would a bank be prepared to lend for the 100 years or so that the trust could last? Distributing the property in specie to reduce CGT on a sale would become more difficult, especially if any of the beneficiaries are non-resident. Is it wise to borrow as opposed to retaining income?

Thanks (1)
Replying to More unearned luck:
avatar
By Tax Dragon
07th Jul 2022 12:54

How do property-holding IIP trustees deal with the funding issue?

Thanks (0)
Replying to Tax Dragon:
avatar
By More unearned luck
07th Jul 2022 21:29

Dunno.

But have there been many such trusts with that funding problem? Broadly speaking, they would be LT trusts created 2006 to 2012 where the value of the property was more than £325K on the 10-year anniversary date.

There is a danger that the trust becomes settlor interested if the life tenant pays. Including by forgoing income?

Thanks (1)
Replying to More unearned luck:
avatar
By AB_85
07th Jul 2022 22:08

Hopefully there would have been a settlement of cash at the outset to fund at least the first ten year charge, in order to avoid this issue.

It may also be possible to agree with the beneficiary that a small amount of income must to be held back (not accumulated, as an IIP) each year in order to fund IHT. I don’t think this would constitute a settlement by the life tenant - the income isn’t written off, it’s just not immediately available to distribute. I’m aware this would put the trustees in an awkward position, but it’s easy to imagine it happening, because a life tenant would be ill advised to bring a claim for loss of income against his trustees when the consequence is an unpaid IHT bill or CGT on a forced property sale.

Thanks (1)
Replying to More unearned luck:
paddle steamer
By DJKL
12th Jul 2022 09:30

Surely some of the trust running costs every year are anyway capital(legal fees being apportioned between revenue and capital etc) and thus part of the trust income is not distributed every year and is effectively loaned to capital?

I was a trustee of a trust that for years operated in this manner (though we had no obligation to distribute income beyond a fixed annuity each year so had plenty of surplus income to lend to the capital side)

Thanks (1)
Replying to DJKL:
avatar
By Tax Dragon
12th Jul 2022 17:29

A power, say, to improve property from income may defeat an IIP (i.e. you thought the thing you were looking at was an IIP trust deed, but it has property and can improve it - maybe it's not an IIP trust after all...)

.oO (Presumably such a power lapses at the end of the accumulation period, but now you're getting legal on me. Hmm..., dunno)... anyway I was going to say a power to pay capital expenses from income, written into the trust deed, apparently does not involve accumulating income and so afaik does not defeat an IIP.

See also s500 ITA 2007 and TSEM8335, which seem to support this thinking.

Thanks (1)
avatar
By Tax Dragon
07th Jul 2022 06:04

And both AB and MUL said on another recent thread that a failure to distribute within 3-5 years was equivalent to accumulating. If they stand by that view, the corollary is surely that there is a time limit of 3-5 years on paying out income post accumulation period.

It might well be difficult to justify carrying more than a year or two's income. It really is supposed to be paid out.

Thanks (1)
avatar
By AB_85
07th Jul 2022 09:56

On the accumulation point, I think 3-5 years is certainly a good guide as to when you have an issue, and when HMRC would, in principle, want to dispute. Trying to construct an argument for why one was not accumulating, I would say that accumulation is an exercise of trustee power, which implies a positive decision, not simply an absence of distribution. I would (hopefully) point to trust minutes regarding how the income is earmarked for future distribution (pending urgent property repair work in this case). In the case of say a trust holding a share portfolio, I would (hopefully) point to the trust accounts, which show income is being held in cash at bank and hasn't been reinvested in capital. This is almost entirely a legal question though, the tax consequences simply follow on from trust law. And I'm not a lawyer.

Incidentally, if these property repairs are a revenue expense of a property business, I don't see how you are holding back distributions by paying them in priority. Rather you are realising a reduced surplus on the income account so there is less income to distribute. That's not the same thing. And realising property losses / reduced profits because you have to fund periodic refurbishment is likely entirely proper conduct for a property business.

On the IIP point, if all of the beneficiaries fall under a bus bar one, I don't believe you would have an IIP trust. An IIP means the beneficiary has an absolute interest in income. In this case you would still be subject to the clause quoted in the OP which gives discretion as regards timing etc, and the trustees may well have discretion to add a new member to the discretionary class of beneficiaries.

Having said that, we're told that all of the beneficiaries are grown adults. It may not be right for the trustees for non-tax reasons, but could an IIP suit them better? It can be achieved without tax consequences and the tax burden on the trustees would be far lower.

Thanks (1)
By Lawskills
11th Jul 2022 18:31

In older trust deeds (ones created before 6 April 2010) the accumulation period was indeed 21 years from commencement and this means all the income has to be distributed to the beneficiaries once the accumulation period has expired. The discretion which exists is merely over which beneficiaries are given the income not whether income is distributed or not.

As was hinted at the answer is usually to appoint the trust on a revocable interest in possession trust so that the income arising is payable to particular beneficiaries even if the capital cannot be advanced to them until any age contingency has been met.

Expenses referable to income can be met out of income but frankly these are usually limited. Many expenses, including legal fees and IHT, are capital expenses and come out of capital. If there is no liquid capital you may have to borrow against the capital usually from the beneficiaries who will ultimately entitled to capital. You need a power to borrow in the administrative provisions.

As had been suggested by others, you need to go to a STEP member near you with the trust document and ask for an opinion based on the facts. You should be able to find one on the members list here www.step.org

For new trusts created on or after 6 April 2010, there is a statutory perpetuity period of 125 years and accumulation may take place for the whole period. It does not apply retrospectively.

Good luck!

Thanks (1)
Share this content