Trusts appear in R03, R05 and almost every R06 case study, yet many candidates only learn the labels and never the tax treatment. That is a costly gap, because trust questions are formulaic. There are three main structures, three taxes to consider, and a small set of rates to hold in memory.
The three structures
Bare trust. The beneficiary has an absolute right to capital and income. The trustee is a nominee. In tax terms the beneficiary is the owner.
Interest in possession trust (IIP). One beneficiary, the life tenant, has a present right to income. Capital passes to remaindermen later.
Discretionary trust. The trustees decide who receives income or capital and when. No beneficiary has an entitlement until the trustees exercise their discretion.
Income tax treatment
| Trust type | Who is assessed | Rates |
|---|---|---|
| Bare | The beneficiary | Beneficiary own rates and allowances |
| IIP | Trustees, then the life tenant | 20%, or 8.75% on dividends, with credit to the life tenant |
| Discretionary | Trustees | 45%, or 39.35% on dividends, above the standard rate band |
Three details earn marks:
- The discretionary trust standard rate band is £1,000 divided by the number of trusts the settlor has created, subject to a £200 floor, and the current de minimis rule means trusts with income of £500 or less are not taxed at all.
- Payments of income to a discretionary beneficiary carry a 45% tax credit, so a basic rate beneficiary can reclaim a large part of it using form R40.
- A parental settlement for a minor child produces a charge on the parent where income exceeds £100 a year, which stops parents from using a child allowances.
Capital gains tax treatment
- Bare trust: gains are the beneficiary gains, with their own £3,000 annual exempt amount
- IIP and discretionary trusts: trustees pay CGT at 24%, with an annual exempt amount of £1,500, halved further where the settlor has created multiple trusts
- Holdover relief is generally available on transfers into and out of relevant property trusts, which defers the gain to the recipient
- Assets passing on the death of a life tenant of a qualifying IIP are rebased with no CGT charge
Inheritance tax treatment
This is the section that decides most trust questions.
Bare trusts are treated as gifts to the beneficiary, so funding one is a PET and the value sits in the beneficiary estate.
Relevant property trusts, which means discretionary trusts and, since 2006, most lifetime IIP trusts, are subject to their own regime:
- Entry charge: a chargeable lifetime transfer, 20% on the excess over the available nil rate band if the trustees pay, or an effective 25% if the settlor pays the tax
- Periodic charge: up to 6% of the value above the available nil rate band on each ten year anniversary
- Exit charge: a proportionate charge when capital leaves, based on the rate at the last anniversary and the number of complete quarters since
Qualifying IIP trusts, mainly those created on death or immediate post death interests, are different. The trust fund forms part of the life tenant estate on their death and is taxed at 40% with the life tenant own nil rate band.
Worked periodic charge
The Hall discretionary trust was created in September 2016 with £400,000. On its ten year anniversary in September 2026 it is worth £560,000. The settlor had made no gifts in the seven years before creation and no capital has left the trust.
- Value at the anniversary: £560,000
- Less available nil rate band: £325,000
- Chargeable: £235,000
- Effective rate: £235,000 × 20% = £47,000, then £47,000 ÷ £560,000 = 8.39%
- Charge at 30% of the effective rate: 8.39% × 30% = 2.52%
- Tax due: £560,000 × 2.52% = £14,112
The 30% multiplier is what produces the familiar 6% maximum. Show the effective rate working even if the question only asks for the tax, because method marks are available in written papers.
Choosing the right trust in a case study
| Client aim | Usual answer |
|---|---|
| Simple gift to a child with capital at 18 | Bare trust |
| Income for a spouse, capital to children | IIP trust |
| Flexibility over who benefits and when | Discretionary trust |
| Protection policy proceeds outside the estate | Discretionary or split trust |
| Retain access to capital while reducing IHT | Loan trust or discounted gift trust |
Where a question mentions vulnerable beneficiaries, look at the special treatment for disabled person trusts, which can be taxed on the beneficiary rates rather than the trust rates and can sit outside the relevant property regime.
Where candidates lose marks
- Applying discretionary rates to an IIP trust
- Forgetting the reduced annual exempt amount for trustees
- Treating a bare trust as a relevant property trust
- Missing the settlor interested rules, which assess income on the settlor where they or their spouse can benefit
- Skipping the exit charge in a question about capital advances
How to revise it
Draw a grid with the three trust types down the side and income tax, CGT and IHT across the top, then fill it in from memory. Repeat weekly until it takes under two minutes. Almost every R03 trust question is answered by one cell of that grid, and having the whole grid in your head means you never have to guess which one.