I was wondering if anyone has come across the situation of a settlor interested discretionary trust, which owns a UK rental property over which there is a mortgage?
The tax software (and HMRC’s software as confirmed to me by the provider) calculates the usual tax payable with the 50% deduction of the finance costs, and then deducts a non-refundable credit at basic rate for the other 50% of the finance costs.
However as it is settlor interested, my understanding from the notes on the R185 for a settlor is that this non-deductible 50% of finance costs should be passed out to the settlor who declares all the net income with the credit at BR or RAT, and then applies the non-refundable BR credit. This is the same as the treatment for estates and IIP’s.
The settlor is subject to income tax at his marginal rate on the trust’s gross income with no deduction for trust expenses.
In calculating the settlor’s taxable income (tax year 2018/19) re the gross trust rental income, 50% of the interest will be tax deductible with the balancing 50% interest taken as a basic rate tax credit.
The settlor will then be entitled as a tax credit to any tax paid by the trustees effectively on his behalf. The tax paid by the trust would seem to be their charge at 45% (levied after the deduction of 50% of the interest charge) less the 20% tax credit re the balancing 50% interest charge.
Hi Malcolm. Thanks for your answer. We are definitely in agreement with how the settlor is taxed. My issue is that the income declared on the R185 (settlor) must be at BR or RAT and there is no way to include the credit for the balancing interest charge in the trust income section of the settlor’s return as the income is disclosed net and the gross is automatically calculated. Adjusting for the credit would throw out the gross income calculation.
Instead the R185 states that for a settlor interested DT, the financing costs are shown on the R185 for the settlor to claim their own credit at BR. That is passed through the trust as it would do for an IIP trust or estate.
I had a discussion with a helpful HMRC trust technical officer yesterday who agreed that the trust should not claim the non-refundable financing cost credit. This should instead be passed out via the R185. If the return is not calculated correctly they will amend it manually for me.
Interestingly, there is a known fault that the balancing 50% non refundable credit in a non-settlor interested DT, which would be claimed by the trust, is not flowing through correctly at their end and at the moment and you need to phone in to have them adjust the calculation.