As is well known, in the case of a member of a pension scheme dying aged 75 or over and a lump sum being paid to a personal discretionary/flexible trust (such as a by-pass trust), a 45% SLSDBC income tax charge will arise. On later payment of some or all of this amount to a beneficiary, the beneficiary will be taxed on the grossed-up amount but be entitled to a credit for tax previously suffered by the trustees.
Two issues arise out of this:-
• Where the individual has a tax liability on other income that is less than the tax credit on the payment out of the trust, can the excess tax suffered be recovered from HMRC?
• Where a payment is made out of a trust to a beneficiary, how is that payment attributed to the earlier lump sum payment from the pension scheme? This will be relevant where the lump sum has grown in value or other payments have also been made to the trust.
We now address these issues in more detail.
• Reclaiming the 45% tax deduction
Section 21 Finance Act (No. 2) 2015 amended section 206 of the Finance Act 2004 to deal with cases where a lump sum is paid to a non-qualifying person (such as trustees) from a registered pension scheme and that lump sum attracts a 45% tax charge, and a subsequent payment is made to a beneficiary. It provides as follows:-
‘the amount received by the beneficiary, together with so much of the tax charged under this section on the lump sum as is attributable to the amount received by the beneficiary, is income of the beneficiary for income tax purposes but the beneficiary may claim to deduct that much of that tax from the income tax charged on the beneficiary’s total income for the tax year in which the payment is made to the beneficiary.’
Further explanation on the interpretation of this section is given in part 3 of Pension Flexibility in Pension Schemes Newsletter 77. Here it states that:
‘the individual will be able to set off the tax paid on the lump sum death benefit by the Scheme Administrator (or a proportion of it, where the trust payment is funded by only part of the lump sum death benefit the trustees received) against the tax due on this trust payment. This may lead to a refund of tax.’
Does this mean that the payment (grossed up by 45%) from the trust will be treated as part of the individual’s total income for that year so that some of the deemed 45% tax payment would be recoverable if the individual does not pay tax at 45% on all of the payment from the trust and the tax on other income in that year? Or is any tax that is “recoverable” limited to the tax the individual pays on other income in that tax year?
Let’s take an example. Assume that in 2017/18 an individual has other taxable income of £10,000 on which he has a £2,000 tax charge. Say he receives £10,000 from a pension scheme trust on which the 45% SLSDBC had been paid on receipt by the trustees.
The £10,000 is treated as a grossed-up payment of £18,182 to the individual and so is treated as having suffered tax of £8,182.
The individual’s actual tax bill on the grossed-up £18,182 is £3,636. Therefore there is overpaid tax of £4,546.
The question is:-
• can he offset £2,000 of this £4,546 against the tax on his other income and the balance, £2,546 against the deemed tax paid on the distribution from the trust? This would mean he could recover £4,546 (assuming he has already settled the £2,000 basic rate tax charge on the other income) or
• can he only offset £2,000 of £4,546 against the tax paid on the other income in that tax year?
HMRC has confirmed to us that section 206(8) Finance Act 2004 requires the beneficiary to include both the lump sum received and the tax attributable as pension income – so both elements are part of total income. On the basis that the individual would declare £18,182 as pension income and tax previously paid of £8,182, there is no requirement that any resulting overpayment of tax should be restricted and therefore, in the above example, it would be possible to obtain a repayment of tax of the full £4,546 (assuming the tax on the other income had been paid).
• Attribution of payments made to beneficiaries
In what way is any payment made to a beneficiary attributed to the original payment from the Scheme Administrator to the trustees?
For example, say a member died aged 76 and lump sum death benefits of £100,000 were payable. If these were paid to the trustees of a personal trust, the Scheme Administrator would deduct tax of £45,000 and pay that to HMRC leaving them with £55,000 to pay to the trustees. Let’s say the trustees invested the £55,000 and after 5 years the trust fund is worth £85,000, having enjoyed capital growth and accumulated income. The trustees then make a capital distribution of £10,000 to a beneficiary. How much of that payment is attributed to the original £55,000 payment?
It would seem to us that there are 2 possibilities, as follows:-
• The whole of the payment to the beneficiary is attributed to the original payment to the trustees. So, in this case, the beneficiary would be treated as having received a grossed-up payment of £18,182 on which tax of £8,182 had been suffered. This would give the beneficiary a tax credit of £8,182.
• A proportionate part of the payment to the beneficiary is attributed to the original payment to the trustees and a part to capital growth.
So, in this situation £6,471 (55/85 of £10,000) would be treated as being attributable to the original payment with £3,529 representing the capital growth. This would give the beneficiary a tax credit of £5,294 on the overall payment.
In this case, HMRC has confirmed to us that it is up to the trustees to decide how to attribute the lump sum death benefit to beneficiaries within the trust rules. Section 206(8)(b) Finance Act 2004 states that payment of any part of that lump sum received by the beneficiary is treated as pension income. The treatment therefore can apply only to the part of any payment attributable to that original amount of lump sum or, it seems, the whole payment. The trustees can make this decision.
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