What is a ‘vulnerable beneficiary’?
A beneficiary is anyone who benefits from a trust. A ‘vulnerable beneficiary’ is either:
- a person who is mentally or physically disabled
- someone under 18 – called a ‘relevant minor’ – who has lost a parent through death
Trusts that qualify for special tax treatment
If a trust is set up for a vulnerable beneficiary, the trustees can claim special treatment for Income Tax and Capital Gains Tax if it’s a ‘qualifying trust’. It can’t be a qualifying trust if the person who sets it up can get some benefit from it.
Qualifying trusts for a disabled person
The property in these trusts can be used only to benefit a disabled person. The disabled person must be entitled to all the income or, if they are not, none of the income can be applied for the benefit of anyone else.
Qualifying trusts for a relevant minor
These trusts are commonly set up:
- by the Will of a parent who has died (the property and income must be used only for the relevant minor, and when they reach 18 they must get all the trust property)
- under the ‘rules of intestacy’ – the special rules for when someone dies without making a Will
More than one beneficiary
If there are other beneficiaries who aren’t vulnerable, the property and income that’s for the vulnerable beneficiary must be identified, kept separate and used only for the vulnerable beneficiary. Only that part of the trust gets special tax treatment.
Making a ‘vulnerable person election’
To claim special tax treatment, trustees must fill in form VPE1 (Vulnerable Person Election) and send it to the HM Revenue & Customs (HMRC) Trusts Office that deals with their trust. They must sign it, along with the vulnerable beneficiary – or someone who can legally sign for the beneficiary.
Trustees have to give details of all the property in the qualifying trust, including anything used only partly for the vulnerable beneficiary. They’ll also have to show how the trust income is shared out. (As mentioned earlier, it can’t be a qualifying trust if the person who sets it up can get some benefit from it.)
The election applies to both Income Tax and Capital Gains Tax – you can’t claim the treatment for only one tax.
Making an election if there’s more than one vulnerable beneficiary
A separate form VPE1 must be completed for each beneficiary.
Deadline for making a vulnerable person election
The election takes effect from the date on the form VPE1. You must make the election no later than 12 months after 31 January following the tax year when you want the election to start.
Any income or gains before the date the election takes effect are taxed under normal trust rules – even if the election takes effect part way through the same tax year.
If the vulnerable person dies or is no longer vulnerable
You must tell HMRC if the vulnerable person dies or is no longer vulnerable. The special tax treatment is no longer effective after this date.
Income Tax for trusts with vulnerable beneficiaries
Where a trust has a vulnerable beneficiary, the trustees are entitled to a deduction of tax against the amount they would otherwise pay. This is calculated in the following way:
- trustees calculate what their trust Income Tax would be if there was no claim for special treatment – this will vary according to which type of trust it is
- they then calculate what Income Tax the vulnerable person would have had to pay had the income of the trust arisen directly to them as an individual – this must take into account their other income, capital gains and any allowances
- trustees can then claim the difference between these two figures as a deduction from their own Income Tax liability
Capital Gains Tax for trusts with vulnerable beneficiaries
Capital Gains Tax is a tax payable on ‘gains’ (profits) made from the disposal of assets.
Capital Gains Tax is paid by the trustees. They can claim a relief, which is calculated in a similar way to the Income Tax Relief:
- they work out what they would ordinarily pay if there was no relief
- they then work out what the beneficiary would have to pay if the gains arose directly to them as individuals they can claim the difference between these two amounts as a relief on what they have to pay in Capital Gains Tax at box 5.6E on form SA905 – the Capital Gains supplementary pages
This special Capital Gains Tax treatment does not apply in the tax year when the beneficiary dies.
Inheritance Tax for trusts with vulnerable beneficiaries
Trusts for vulnerable beneficiaries get special Inheritance Tax treatment if they’re ‘qualifying trusts’ for Inheritance Tax.
Qualifying trust for a disabled person
A qualifying trust for a disabled person is one where:
- at least half of the payments from the trust must go to the disabled person during their lifetime
- someone suffering from a condition that’s expected to make them disabled sets up a trust where all the capital is set aside for themselves
Qualifying trust for a ‘bereaved minor’
A qualifying trust is made on the death of a parent for their child, who must take all of the capital and income at (or before) becoming 18.
Special Inheritance Tax treatment
A gift or transfer into a qualifying trust for a disabled person is treated as a ‘potentially exempt transfer’ (PET) – this means that there is no Inheritance Tax charge on the transfer if the person who made it survives seven years from the transfer date.
There is no Inheritance Tax on transfers made out of either type of qualifying trust to the vulnerable beneficiary – but when the beneficiary dies, any assets held in the trust on their behalf are treated as part of the their estate and may be liable for Inheritance Tax.
There are no ten-year Inheritance Tax charges on trusts with vulnerable beneficiaries.