What is a discretionary trust and how is it taxed?
Answered 17 March 2026
Discretionary Trusts: Definition and Taxation
What the law says
IHT Regime — Two charging regimes for settled property: There are two separate IHT charging regimes for settled property: one where a person has an interest in possession, and one where "the settled property is held on trusts in which no qualifying interest in possession exists." This latter form is commonly called a discretionary trust.
IHT — Relevant property charges: The underlying design of the IHT charge is that tax on relevant property trusts should be comparable to a charge of 40% once a generation. This is achieved through:
- A 20% lifetime ("entry") charge on the settlor when assets are placed into the trust
- Ten-year anniversary (TYA) charges at a rate not exceeding 6% on the trustees
- Exit (proportionate) charges under IHTA84/S65 when property leaves the trust
HMRC guidance / practice
Definition
A discretionary trust is one where trustees generally have discretion about how to use the capital and income of the trust. They may be required to use income for the benefit of particular beneficiaries, but they can decide how much is paid and to which beneficiaries. Crucially, the beneficiary has no right over or interest in the capital or income of the trust.
The main function of a family discretionary trust is to give trustees a flexible facility to confer benefits on members of the family according to their current needs or general circumstances.
Income Tax
At the trust level: Income of UK resident discretionary trusts is taxed at the rate applicable to trusts on all income except dividends, which are taxed at the dividend trust rate. Credit is given for income tax and tax credits, and the trustees pay the additional amount.
The applicable rates have been:
- From 6 April 2004: dividends taxed at 32.5% (dividend trust rate); all other income at 40%
- 6 April 1999 – 5 April 2004: dividends at 25%; all other income at 34%
- Before 6 April 1999: rate applicable to trusts was 34% on all income with no separate dividend rate
Payments to beneficiaries: Trustees have the power to decide how to apply trust funds — from income or capital. Where a discretionary payment is made from income, trustees must provide the beneficiary with a Form R185 (Trust Income) if requested.
A distribution to a beneficiary is treated as an amount net of tax at the rate applicable to trusts (40%). The gross amount is regarded as an annual payment and is not identified with the underlying trust income.
Beneficiaries are taxed on payments at their marginal rate of tax, with credit given for tax already paid at the trust rate.
Inheritance Tax
Property held in a standard discretionary trust constitutes relevant property and is subject to:
- The entry charge (up to 20%) when assets are settled
- Ten-year anniversary charges (up to 6%) under IHTA84/S64
- Exit/proportionate charges under IHTA84/S65 when property leaves the trust
Certain excluded/special trusts (e.g. trusts for disabled persons, charitable trusts, employee trusts) do not contain relevant property and are therefore not subject to the ten-year anniversary and proportionate charges.
Capital Gains Tax
Trustees of a UK-resident discretionary trust are treated as a single and continuing body of persons and are chargeable to CGT in respect of chargeable gains accruing to them.
Citation sources
The Thalidomide Trust is a charitable trust. Charitable trusts are not taxed on their income, but payments to beneficiaries still fall within the normal rules. Up to 4 August 2004, income payments from the Thalidomide Trust to beneficiaries were discretionary. As such they were subject to the same rules that govern payments from all discretionary trusts (TSEM3755-3756). Income payments from the Trust counted towards the beneficiaries taxable income and reduced their level of entitlement to tax
In general this should not be regarded as giving rise to a new settlement. It is to be expected that a discretionary settlement will include a power to enable the trustees to confer distinct interests in the trust fund on particular beneficiaries. The main function of a family discretionary trust, leaving aside taxation matters, is to give trustees a flexible facility to confer benefits on members of the family according to their current needs or general circumstances. The principal power of the
A distribution to a beneficiary is treated as an amount that is net of tax at the rate applicable to trusts of 40%. The gross amount is regarded as an annual payment, and not identified with the underlying trust income (see TSEM3755). Where income underlying the distribution is from dividends, the difference between the dividend trust rate and the rate applicable to trusts is made up from the trust’s tax pool.
benefit of another person or persons (the beneficiary) (or for a specified purpose) usually subject to terms set out in trust deed and subject to duties imposed by law. (2) The Trusts, as “settlements”, are treated as follows under TCGA as regards the tax year in which the gains on the disposals arose: (a) The trustees of the Trusts from time to time are treated as “a single and continuing body of persons” (a “deemed trustee body”) under s 69. This provides that: “the trustees of a settlement sh
Trustees of a discretionary trust generally have discretion about how to use the capital and income of the trust. They may be required to use any income for the benefit of particular beneficiaries but they can decide how much is paid and to which beneficiaries. The beneficiary of a discretionary trust has no right over or interest in the capital or income of the trust.
Trustees of a discretionary trust have the power to decide how to apply the trust funds. They may pay from trust income or capital. Where the trustees make a discretionary payment from income, they usually give the beneficiary a formR185 (Trust Income). They have to do so if the beneficiary requests it. TSEM3755 explains the position for discretionary income payments to company beneficiaries. Sections TSEM3756-TSEM3759 explain the position for discretionary income payments to individual benefici
Overview The underlying design of the charge is that Inheritance Tax (IHT) on relevant property trusts should be comparable to a charge of 40% once a generation. To achieve this there would normally be a 20% lifetime (‘entry’) charge on the settlor (IHTM04067) and three TYA charges at 6% (3/10ths of 20%) on the trustees. The amount subject to the charge is the net value of the relevant property including any deemed relevant property (IHTM42166) after reliefs and exemptions. The rate of IHT on th
Types of excluded discretionary trusts known commonly as special trusts (or favoured trusts) are Temporary charitable trusts Protective trusts Trusts for disabled persons Employee and newspaper trusts Accumulation and maintenance trusts (A&M) prior to 22 March 2006. Other excluded trusts and property within IHTA84/S58 are Heritage Maintenance trusts Pension funds Trade or professional compensation funds Asbestos Compensation trusts Decommissioning Security trusts Excluded proper
Income of UK resident discretionary trusts is taxed at the rate applicable to trusts on all income except dividends, which are taxed at the dividend trust rate. Credit is given for income tax and tax credit, and the trustees pay the additional amount. From 6 April 2004 dividends (including foreign dividends) are taxed at the dividend trust rate of 32.5%; all other income is taxed at 40%. From 6 April 1999 to 5 April 2004 dividends (including foreign dividends) were taxed at the dividend trust ra