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Tax pools: the background

Tax pools apply to discretionary trusts where the trustees - who are responsible for paying all the trust's taxes - have 'discretion' over what to do with the income and sometimes the capital of the trust.

When trustees of a discretionary trust make a discretionary payment of income it's treated in the hands of the beneficiary as if Income Tax has already been paid at the trust rate (currently 50 per cent). This means the beneficiary could claim some or all of the tax back if they're a non-taxpayer or pay tax at 20 or 40 per cent.

Because of this, when trustees make a payment of income, they must ensure they have paid sufficient Income Tax (whether in the current year or in previous years) to cover the 50 per cent ‘tax credit’ (tax treated as deducted) that accompanies the income payment.

The tax pool keeps track of Income Tax the trustees pay. If the tax credit on subsequent income payments to beneficiaries can't be covered by the amount of tax recorded in the tax pool, the trustees must pay the difference through the Trust and Estate Tax Return.

How the tax pool works

The tax pool is a record that the trustees need to keep in order to show, at the end of a given tax year, the difference between:

• the total Income Tax entering the tax pool that year, plus the amount carried over in the tax pool from earlier years
• the total value of the 50 per cent tax credits attached to income payments to beneficiaries that year
  

When the trustees pay tax at the special trust rates, the tax pool increases by the amount of tax paid. This can vary between 20 and 50 per cent.

When the trustees pay income to beneficiaries the amount in the tax pool is reduced by the value of the 50 per cent tax credit that is carried with each payment.

The 'tax pool' itself is what's left at the end of the tax year of the tax paid by the trustees - excluding any non-refundable dividend tax credits - after the 50 per cent tax credits on any payments to beneficiaries have been deducted. Any balance is carried forward to the next tax year, and can be offset against payments then.

• Income Tax rates on discretionary trust income

How tax shortfalls can arise

A shortfall can arise where the amount of tax credits on payments to beneficiaries exceeds the amount available in the tax pool.

This situation may happen for the following reasons:

• some of the income received by the trustees falls within the 'standard rate band' and is taxed at the lower rates of 10 per cent for dividends and 20 per cent for other income - only the income taxed at 20 per cent enters the pool
• some of the income received by the trustees is from dividends and is taxed at 42.5 per cent, of which 10 per cent is non-refundable, so 32.5 per cent enters the tax pool

Using the calculator to help prevent a tax shortfall

You can use the HM Revenue & Customs (HMRC) tax pool calculator to:

• check for (and prevent) a potential tax pool shortfall when planning a distribution of income
• enter estimates in order to work out the maximum income you can distribute to beneficiaries over the tax year without incurring a tax shortfall
• work out how to maximise use of the tax pool if a trust is being wound up mid year
  

• Tax pool calculator Opens new window

When HMRC will work out your tax pool calculation

If you file your SA900 Trust and Estate Tax Return by 31 October you can ask HMRC to work out your tax. When they do this they will also work out your tax pool surplus or shortfall for the following year based on:

• the information provided at question 14 (a list of income payments made to beneficiaries during the tax year)
• the amount of unused tax pool brought forward from the previous tax year
  

They include the tax pool surplus or shortfall amount for the next tax year in your tax calculation.

If you choose to work out your own tax HMRC will check the tax pool only if they're reviewing your tax return for accuracy. It's therefore important to understand and get your tax pool figures right, so that you don’t accidentally overpay or underpay tax.

More useful links

• Form SA900 Trust and Estate Tax Return and guidance notes Opens new window

Useful contacts

• Contact HMRC Trusts & Estates