Advanced Taxation (UK) · Capital gains tax and trusts

Trusts: Income Tax, Interest and Inheritance Tax

Updated 11 October 2026 · Fact-checked

A trust is taxed on its income, and gifts into and out of it can trigger inheritance tax. For relevant property trusts, IHT arises on entry (20% over the nil rate band), every ten years (up to 6%) and on exit. Interest runs on late tax at the rates in the tax tables.

Understand Trusts: Income Tax, Interest and Inheritance Tax

A trust holds assets for beneficiaries. The settlor puts assets in, the trustees manage them and the beneficiaries benefit. In ATX-UK you tax the trust on its income, tax the transfers in and out for IHT, and charge interest if tax is paid late.

Income tax depends on the trust type. In an interest in possession trust, the beneficiary has a right to the income. Trustees pay tax at the basic rate (20%) or the dividend ordinary rate (8.75%) and the beneficiary is taxed on the income at their own rates, with credit for the tax paid. In a discretionary trust, trustees choose who gets income. Trustees pay tax at the trust rates, which are the additional rate (45%) on non-dividend income and 39.35% on dividends. A small band at the start of the trust's income, the standard rate band, is taxed at the lower rates. Learn its amount from your studies, as it is not in the extract of the tax tables. Distributions to beneficiaries carry a 45% tax credit, so the trust keeps a tax pool of tax paid.

For IHT, most lifetime trusts you meet in the exam are relevant property trusts, such as discretionary trusts. A gift into one is a chargeable lifetime transfer. The entry charge is 20% on the excess over the available nil rate band (£325,000, reduced by the settlor's chargeable transfers in the previous seven years). If the settlor pays the tax, gross up the gift. If the settlor dies within seven years, extra tax is due at 40% with taper relief for deaths more than three years after the transfer.

The trust is then charged every ten years on its value. This is the periodic charge. The maximum rate is 6% (30% of the effective lifetime rate). When assets leave the trust between anniversaries, an exit charge applies, based on the number of complete quarters since the last anniversary or since the trust began. There is no exit charge in the first three months after creation or after a ten-year anniversary.

Interest runs on tax paid late. In the tax tables, the assumed rate on underpaid tax is 8.50% and on overpaid tax is 3.50%. Use the right one and count the months or days properly.

Key rules to remember

Trust income tax rates (discretionary): Non-dividend 45%; dividends 39.35%; These are the additional rates in the tax tables. The trust's standard rate band is taxed at lower rates. Learn its amount separately.
IIP trust income tax rates: Non-dividend 20%; dividends 8.75%; Trustees pay these rates. The beneficiary then gets credit for tax paid and is taxed at their own rates.
Nil rate band and lifetime rate: NRB £325,000; lifetime rate 20%; death rate 40%; Reduce NRB by the settlor's CLTs in the seven years before the transfer.
Entry charge: 20% × (CLT − available NRB); If the settlor pays the tax, gross up the net excess by 20/80.
Taper relief on death: 3-4 yrs 20%; 4-5 yrs 40%; 5-6 yrs 60%; 6-7 yrs 80% reduction; Applies to the death tax (40%), not to the value of the transfer. Credit lifetime tax paid.
Periodic charge: Value of trust × 30% × (tax on hypothetical transfer ÷ hypothetical transfer); Maximum effective rate is 6%. Hypothetical transfer is the trust value plus any related property in the trust, using lifetime rates.
Exit charge after a ten-year anniversary: Value leaving × rate at last anniversary × complete quarters ÷ 40; Complete quarters since the last anniversary. No charge in the first three months.
Interest on tax: Underpaid 8.50%; overpaid 3.50%; These are the assumed rates in the tax tables. Interest on underpaid tax runs from the due date.

How to solve Trusts: Income Tax, Interest and Inheritance Tax questions

Use this order for any question on trust income, IHT charges or interest. Identify the trust type first, because the rules differ.

1Identify the type of trust: interest in possession or discretionary (relevant property). Note the date it was created and any additions.
2For income, split it into non-dividend and dividend. Apply the trust rates for a discretionary trust, or the basic and dividend ordinary rates for an IIP trust.
3For a lifetime gift into the trust, list the settlor's CLTs in the previous seven years and work out the available NRB (£325,000 less those transfers).
4Compute the entry charge at 20% on the excess. Check who pays the tax and gross up by 20/80 if the settlor pays.
5For a ten-year anniversary, build the hypothetical transfer. Compute tax at 20% over the NRB, take 30% of that tax and divide by the hypothetical transfer to find the effective rate. Apply it to the trust value.
6For an exit, count the complete quarters since the last anniversary (or creation) and apply the rate × quarters ÷ 40.
7If the settlor dies within seven years, compute death tax at 40% over the NRB, apply taper relief if more than three years, and deduct lifetime tax paid. Never go below nil.
8Add interest if tax is paid late, at 8.50% on underpaid tax or 3.50% on overpaid tax. State the due date.

Quickest way: Fast route for trust IHT charges

When to use it: Use this when the question gives you a trust value, the settlor's history and a date, and asks for an IHT charge.

Write the NRB figure first: £325,000 less CLTs in the seven years before.
Tax = 20% × (value − NRB). That is the entry charge or the hypothetical tax.
For periodic charge, tax × 30% is the answer directly if you do the sum on the hypothetical transfer. Rate = that tax ÷ value.
For exits, multiply by quarters ÷ 40 and check the three-month rule.
For death within seven years, redo at 40%, apply taper, deduct tax paid, and floor at nil.

Common mistakes in Trusts: Income Tax, Interest and Inheritance Tax

Using the full £325,000 NRB without deducting earlier CLTs.
Students forget that the seven-year look-back applies to the settlor before the transfer.
Fix: List all CLTs in the previous seven years and deduct them before computing the excess.
Not grossing up when the settlor pays the lifetime tax.
The gift looks like the whole transfer, so the extra tax is missed.
Fix: Read who pays. If the settlor pays, tax the net excess at 20/80 and add it to the gift.
Applying taper relief to the value of the transfer rather than to the tax.
Taper relief is easy to confuse with a reduction in the gift itself.
Fix: Compute death tax at 40% first, then reduce that tax by the taper percentage, then deduct tax already paid.
Charging a periodic charge at 30% of the value or at the lifetime rate.
Students stop at the 20% tax or at 30% without the effective rate step.
Fix: Use 30% × the tax on the hypothetical transfer. The effective rate cannot exceed 6%.
Counting part quarters in the exit charge.
Students round up to be safe.
Fix: Count only complete quarters. Check that the exit is not within the first three months.
Mixing up interest rates on underpaid and overpaid tax.
Both appear in the same table.
Fix: Use 8.50% where the taxpayer owes and 3.50% where HMRC owes the taxpayer.

Worked examples

Example 1

In August 2026, Ravi gives £500,000 cash to a discretionary trust. He made a CLT of £100,000 three years earlier and his annual exemptions are already used. Ravi pays any IHT. He dies 4 years and 6 months later. Compute the lifetime IHT on the gift and the additional tax on death. Ignore the NRB changes between dates.

Show the solution

Available NRB = £325,000 − £100,000 = £225,000.
Excess of net gift over NRB = £500,000 − £225,000 = £275,000.
Ravi pays, so gross up: tax = £275,000 × 20/80 = £68,750.
Gross transfer = £500,000 + £68,750 = £568,750. Check: (£568,750 − £225,000) × 20% = £68,750.
On death within seven years: tax at 40% = (£568,750 − £225,000) × 40% = £137,500.
Death after more than 4 but less than 5 years gives a 40% taper reduction: £137,500 × 60% = £82,500.
Deduct lifetime tax paid: £82,500 − £68,750 = £13,750.

Answer: Lifetime IHT is £68,750 (gross transfer £568,750). Additional tax on death is £13,750.

Example 2

A discretionary trust was created in 2016. At its ten-year anniversary it holds £400,000. There is no related property and the settlor made no CLTs in the seven years before creation. Compute the periodic charge. Then compute the exit charge when £100,000 leaves the trust nine complete quarters later. Use an NRB of £325,000 and a lifetime rate of 20%.

Show the solution

Hypothetical transfer = £400,000.
Tax at 20% on the excess: (£400,000 − £325,000) × 20% = £15,000.
Effective rate = £15,000 ÷ £400,000 = 3.75%.
Periodic rate = 30% × 3.75% = 1.125%.
Periodic charge = £400,000 × 1.125% = £4,500 (or £15,000 × 30%).
Exit after nine complete quarters: rate = 1.125% × 9 ÷ 40 = 0.253125%.
Exit charge = £100,000 × 0.253125% = £253 (rounded).

Answer: Periodic charge is £4,500. Exit charge is about £253.

Exam tips

Write out the NRB calculation as its own line. Markers give a mark for the figure, even if later steps contain errors.
Read who pays the tax. This decides whether you gross up, and it is the most common lost mark.
Show the full periodic charge steps (hypothetical tax, effective rate, 30%). A bare answer scores poorly if wrong.
Use the professional skills marks: briefly explain to the client why a discretionary trust rate of 45% matters and how distributions use the tax pool.
State the due date and interest rate when late payment is in the scenario, and show the days or months counted.

Practice questions from Capital gains tax and trusts

Trusts: Income Tax, Interest and Inheritance Tax in other exams

The same ground in other exams, if you are preparing for more than one or want another angle on it.

CMA FinalMeaning and Types of Trusts for Income Tax

Trusts: Income Tax, Interest and Inheritance Tax: frequently asked questions

What is a relevant property trust for IHT?

It is mainly a discretionary trust, and most lifetime trusts created after 22 March 2006. It is taxed with entry, periodic and exit charges. Some trusts, such as certain interest in possession trusts, are treated as part of the beneficiary's estate instead.

How is a discretionary trust taxed on income?

The trustees pay tax at 45% on non-dividend income and 39.35% on dividends, with the first slice, the standard rate band, taxed at lower rates. When trustees distribute income, beneficiaries receive it with a 45% tax credit and the trust keeps a tax pool.

What is the difference between an interest in possession and a discretionary trust?

In an interest in possession trust, the beneficiary has a right to the income, so they are taxed on it, with credit for the trustees' tax at basic rates. In a discretionary trust, trustees decide who gets income and the trust pays tax at the higher trust rates.

Does taper relief reduce the value of the gift?

No. It reduces the death tax payable on a chargeable transfer made more than three years before death. It does not reduce the value transferred, and it cannot take the tax below the lifetime tax already paid.