UK Trust Taxation Basics: Discretionary, IIP, Bare Trusts (2025/26)

What is a trust?

A trust splits the legal ownership of property from its beneficial enjoyment. Three roles are essential:

• The settlor — the person who creates the trust by transferring assets into it. A trust can be created in a lifetime declaration (a settlement) or in a will (a will trust).
• The trustees — typically two or more individuals (or a corporate trustee) who hold legal title to the trust assets and owe fiduciary duties to the beneficiaries. Trustees are jointly and severally liable for trust tax.
• The beneficiaries — those for whose benefit the assets are held. They may have a fixed entitlement (e.g. a right to income for life), an absolute entitlement (capital and income outright), or be members of a discretionary class with no fixed share.

For tax, the trustees are treated as a single notional person separate from the settlor and beneficiaries. They have their own UTR, file their own SA900 Trust and Estate Tax Return, and pay tax in their own right — even though they hold the money for someone else. This single notion is what makes "trust tax" a distinct subject from "personal tax".

The five common trust types

Two further specialised types appear in practice. A Vulnerable Beneficiary Trust(for a disabled person or bereaved minor) can elect for "vulnerable beneficiary" treatment, which reduces the trust's tax to what the beneficiary would have paid individually. An Accumulation & Maintenance trust(created before 22 March 2006) was a popular vehicle for grandchildren; new ones now fall into the relevant property regime, but legacy A&M trusts may still exist and follow transitional rules.

Income tax on trusts

The income tax regime depends entirely on the trust type.

Discretionary trusts

Trustees pay the trust rate: 45% on non-dividend income and 39.35% on dividend income. There is a small standard-rate band (currently £500) on which income is taxed at 20% / 8.75% — designed to avoid disproportionate tax on tiny trusts. Anything above the £500 band moves to the trust rate.

When the trustees pay out income to a beneficiary, the distribution is treated as having already borne 45% tax. The trustees give the beneficiary a form R185certifying the gross amount and the 45% credit. A basic-rate beneficiary can reclaim part of the credit because their personal rate (20%) is lower than 45%; a higher-rate beneficiary (40%) can reclaim the 5% margin; a 45% additional-rate beneficiary has no further liability and no reclaim.

Interest in Possession (IIP) trusts

Trustees pay only the basic rate (20% non-dividend, 8.75% dividend). The reason is that the income belongs automatically to the life tenant — they have an immediate right to it the moment it arises, whether the trustees physically pay it out or not. The life tenant declares the gross income on their SA100 and uses the 20%/8.75% trust credit as a payment on account; a higher-rate or additional-rate life tenant tops up the difference personally.

Bare trusts

No trust-level tax. The beneficiary is treated as the owner of the assets, the income goes on their own personal tax return, and they use their own personal allowance and rate bands. This makes bare trusts attractive for parents/grandparents settling assets on adult children at modest amounts — except where the "parental settlement" rule re-attributes income above £100 per year back to a settlor parent of a minor unmarried child.

Capital Gains Tax on trusts

Trustees pay CGT on gains realised by the trust. Two rules dominate:

• Half annual exempt amount. Trustees get half the individual AEA. For 2025/26, the individual AEA is £3,000, so a trust gets £1,500. If the settlor created multiple trusts, the £1,500 is divided equally between them — to a floor of £300 each where five or more sibling trusts exist.
• Single rate of 24%. Since 30 October 2024, both residential property and other chargeable assets are taxed at 24% for trustees (the previous 28% residential / 20% other distinction has gone). There is no equivalent of the personal 18% basic-rate slice for trustees.

Gift hold-over relief is often used to "lock in" the base cost when assets pass from the settlor into a relevant-property trust, deferring CGT until the trustees themselves dispose. Conversely, when capital leaves a trust to a beneficiary, hold-over can again defer the trustees' notional disposal (s.260 TCGA 1992 for relevant property trusts).

Inheritance Tax: the 10-year anniversary (periodic) charge

Most discretionary trusts and post-2006 IIP trusts sit in the relevant property regime. The headline rule: every 10 years from creation, HMRC values the trust assets and levies an IHT charge of up to 6%. The actual rate is rarely the headline 6% because of how the calculation works:

1. Take the value of the trust assets at the anniversary date.
2. Add any prior chargeable transfers by the settlor in the 7 years before the trust was created (the "cumulative total").
3. Apply the nil-rate band (currently £325,000) against this combined figure.
4. Tax the excess at the lifetime IHT rate (20%) to get a notional tax bill.
5. Divide by the trust value and multiply by 30% to get the effective rate.
6. Apply that effective rate to the trust value to get the actual 10-year charge.

The 30% × 20% = 6% ceiling explains the headline figure. A trust whose value at the anniversary is below the nil-rate band (and with no prior settlor cumulative total) pays nothing. A trust at exactly £1 million with no prior history pays roughly 4% effective. Hence active monitoring of value vs the nil-rate band matters.

Exit charges

When capital leaves the trust between 10-year anniversaries (typically a distribution to a beneficiary), an exit (proportionate) charge applies. The rate is:

For the first 10 years (before any anniversary has happened), a special start-up calculation is used based on the nil-rate band at the trust's creation date and the value transferred in. Many small trusts created within the nil-rate band pay no exit charge at all in their first decade.

Settlor-interested trusts — anti-avoidance

If the settlor (or their spouse/civil partner, or in some cases their minor unmarried child) can benefit from the trust, the trust is settlor-interested. The income tax rules at ITTOIA 2005 s.624–632 and the CGT rules at TCGA 1992 s.77 then re-attribute the trust's income and gains back to the settlor personally, taxable at their own marginal rates. The trustees still report and may still pay tax, but the settlor receives a credit for tax already paid at trust level.

This rule destroys most "split-the-income" planning. A typical scenario: a 45% additional-rate taxpayer creates a discretionary trust naming themselves and their spouse as potential beneficiaries. The trust earns £50,000 of interest. Without the anti-avoidance rule the trustees would pay 45% and that would be the end of it. With it, the £50,000 is treated as the settlor's own income — they pay 45% personally, and the 45% paid by the trustees is credited. Net: no saving.

The "minor unmarried child" extension means parents cannot easily settle income on their own minor children either — the £100 de minimis aside, all income from a parental settlement is taxed on the parent until the child is 18 or marries.

Excluded Property Trusts — the April 2025 reform

Historically, a non-UK-domiciled settlor could place non-UK situated assets into an offshore trust and those assets would remain outside the UK inheritance-tax net indefinitely — even if the settlor later became UK-domiciled or died UK-resident. These "Excluded Property Trusts" (EPTs) were a cornerstone of non-dom planning for decades.

From 6 April 2025, the UK switched its IHT system from a domicile basis to a residence basis. The new test asks whether the settlor is a long-term resident — broadly, UK-resident for at least 10 of the last 20 tax years. While the settlor is not a long-term resident, the trust remains excluded property and IHT-free. Once the settlor becomes a long-term resident, the trust assets enter the relevant property regime — 10-year and exit charges apply — even if the settlor is outside the UK at the time.

Transitional rules apply to EPTs in existence on 5 April 2025: the test is applied to the settlor's residence status from that date forward. There is no automatic grandfathering. For trustees and settlors, the practical step is to determine the settlor's "long-term residence" status year by year and treat the trust accordingly.

Worked example — discretionary trust

R185 mechanics in practice

Form R185 (Trust Income) bridges the trust's tax position and the beneficiary's. The certificate states the type of income paid (dividend, interest, property income, other), the gross amount and the tax already accounted for at trust level. The beneficiary attaches the figures to their SA100 Self Assessment return:

• IIP / life interest trust: 20% (non-dividend) or 8.75% (dividend) credit. Beneficiary tops up to their marginal rate.
• Discretionary trust: 45% credit on the distribution (treated as having borne the trust rate). A basic-rate beneficiary reclaims 25%, a higher-rate beneficiary 5%, an additional-rate beneficiary nothing.
• Bare trust: R185 not needed — the income is already the beneficiary's.

Trustees must keep a "tax pool" — a record of tax actually paid by the trust. If distributions in a year exceed the tax pool, the trustees pay extra to top up the pool so the 45% credit on the distribution is fully funded. This is the most-missed calculation in trust admin; an unfunded credit triggers a charge on the trustees.

Reporting — TRS and SA900

Two reporting layers apply.

Trust Registration Service (TRS). Almost every UK express trust must register on the HMRC TRS, regardless of whether it has a tax liability. Registration must happen within 90 days of creation. Trustees must also keep the register up to date annually — confirming or correcting information on settlor, trustees, beneficiaries and assets. Limited exemptions exist for bare trusts for minors, will trusts wound up within two years, certain pension trusts and registered charities, but the default is "register".

SA900 Trust and Estate Tax Return. Trustees of taxable trusts file an SA900 each year — 31 October (paper) or 31 January (online) following the end of the tax year. This reports income tax, CGT and the operation of the tax pool. The SA900 is separate from the trustees' own personal returns and is filed under the trust's own UTR.

Where to find HMRC's detailed manuals

For the technical detail behind everything above, HMRC publishes free, searchable manuals:

• Trusts, Settlements and Estates Manual (TSEM) — income tax and CGT computation, settlor-interested trusts, life interest trusts.
• Inheritance Tax Manual (IHTM) — relevant property regime, periodic charges, exit charges, excluded property (post-April-2025).
• Trust Registration Service Manual (TRSM) — TRS scope, exemptions, registration mechanics.
• Capital Gains Manual (CG) — trust-specific CGT rules including hold-over relief s.165/s.260.

Bringing it together

Trust taxation looks intimidating but resolves to a few clear questions. What kind of trust is it? determines the income-tax regime: 45%/39.35% for discretionary, 20%/8.75% for IIP, nothing trust-level for bare. Did anyone settlor-interested benefit?decides whether income and gains bounce back to the settlor. Is it in the relevant property regime? tells you whether 10-year and exit IHT charges apply. Is the settlor a long-term UK resident? matters from April 2025 onwards even for offshore trusts. And in every case, registering on the TRS and filing the SA900 are not optional. For non-trivial trusts — particularly cross-border or with substantial assets — a specialist trust accountant or STEP-qualified adviser is essential.