Tax on Distributions from Discretionary Trusts: A Practical Guide for Trustees and Beneficiaries

Discretionary trusts occupy a distinctive and often misunderstood place in the UK tax system. Because no beneficiary has an absolute entitlement to any income or capital, HMRC treats the trust as a separate tax entity — one that pays income tax and capital gains tax at rates specifically designed to be punitive enough to discourage the indefinite accumulation of wealth in trust. However, a system of tax credits on distributions ensures that the combined tax burden on trustees and beneficiaries should not exceed the highest individual rate.

This guide sets out how the main trust taxes work in practice, with a focus on the tax treatment of distributions to beneficiaries.

Income in discretionary trusts: the 45% rate

Discretionary trusts pay income tax at the trust rate on income that is not distributed to beneficiaries and accumulates within the fund. For 2026/27:

• Non-dividend income (interest, rental income, trading income): taxed at 45% (the "trust rate")
• Dividend income: taxed at 39.35% (the "dividend trust rate")

There is a "standard rate band" of £500 of trust income which is taxed at the basic rate (20%) rather than the trust rate (for dividend income within the band, the dividend basic rate of 8.75% applies). Above this band, all income is taxed at 45% or 39.35%. Where the same settlor has created more than one trust, the £500 band is divided equally between them, subject to a minimum of £100 per trust.

These high rates reflect Parliament's deliberate policy of discouraging indefinite income accumulation in discretionary trusts: the rate is higher than even the additional rate for individuals (45% on non-dividend income, with the trust rate matching this but applied from a much lower income level).

Distributions of income: the tax credit system

When trustees make a distribution to a beneficiary from accumulated income, the distribution carries a 45% tax credit. The beneficiary receives:

• The net distribution (the amount physically received), and
• A tax credit of 45% on the grossed-up amount (effectively, 45/55ths of the net payment)

The grossed-up amount is calculated as: net distribution ÷ 55 × 100.

Example: trustees distribute £5,500 to a beneficiary.

• Grossed-up income: £5,500 ÷ 0.55 = £10,000
• Tax credit attached: £4,500
• The beneficiary is treated as having received £10,000 of income with £4,500 of tax already deducted

The tax treatment for the beneficiary then depends on their personal tax position:

Non-taxpayer (income below the personal allowance): can reclaim the full £4,500 tax credit from HMRC. This makes discretionary trust distributions very efficient for beneficiaries with no other income — for example, minor grandchildren (subject to the parental settlement rules) or adult children in early careers.

Basic rate taxpayer: basic rate tax on £10,000 = £2,000. Tax already deducted = £4,500. The credit exceeds the basic rate liability, but the excess is non-reclaimable (unlike the non-taxpayer scenario). The beneficiary has no further income tax liability and no refund.

Higher rate taxpayer (40%): tax at 40% on £10,000 = £4,000. Tax credit = £4,500. The credit exceeds the higher rate liability — no further income tax liability. Higher rate taxpayers effectively receive trust distributions at no additional personal tax cost.

Additional rate taxpayer (45%): tax at 45% on £10,000 = £4,500. Tax credit = £4,500. No further liability. The trust rate and the additional rate are aligned by design.

Trustees must maintain a "pool" of tax credits — their record of income tax paid at the trust rate — which supports the credits attached to distributions. If a trust has paid insufficient tax to support the credits on a distribution, additional tax becomes due.

Capital gains tax in discretionary trusts

Trustees of a discretionary trust pay CGT at 24% on chargeable gains (for disposals on or after 30 October 2024 — rates were 20% for most assets prior to that date). The trustees' annual exempt amount for CGT is one-half of the individual exempt amount: for 2026/27, this is £1,500 (individual: £3,000).

Where multiple trusts have been established by the same settlor, the exempt amount is divided equally between them, subject to a minimum of £600 per trust.

Capital distributions: are they a CGT event?

When trustees make a capital distribution to a beneficiary — handing over an investment, a sum of cash representing realised gains, or a specific asset — the position for the beneficiary is important:

A capital distribution from a trust does not trigger a CGT liability for the beneficiary at the time of receipt. The asset is treated as having been acquired by the beneficiary at its market value at the date of distribution. There is therefore no immediate CGT event in the beneficiary's hands on the distribution itself — their gain will be calculated only when they subsequently dispose of the asset.

For the trustees, the transfer of an asset out of the trust to a beneficiary is a disposal at market value. This is a CGT event for the trustees; any gain above the acquisition cost (adjusted for trust administration) is taxable at 24%.

Holdover relief: section 260 TCGA 1992

Section 260 of the Taxation of Chargeable Gains Act 1992 provides holdover (gift) relief on certain trust distributions — specifically, on the transfer of an asset from trustees to a beneficiary where the distribution constitutes a chargeable transfer for IHT purposes (which discretionary trust distributions typically do, as they may trigger an exit charge).

Where holdover relief applies under s.260:

• The trustees' gain is "held over" — not charged at the time of the distribution
• The beneficiary acquires the asset at the trustees' original acquisition cost (reduced by the gain held over)
• The beneficiary pays CGT on the full gain (including the gain accrued during the trust's ownership) only when they eventually dispose of the asset

Holdover relief under s.260 is not automatic — an election must be made by both the trustees and the beneficiary, and the time limit for making the election is four years from the end of the tax year in which the distribution was made.

Note that holdover relief is not available where the trust is a "settlor-interested trust" (see below), or where the distribution is to a non-UK resident beneficiary who might take the asset outside the UK CGT regime.

Settlor-interested trusts and section 2(2) TCGA

Where a trust is "settlor-interested" — the settlor, their spouse, or their minor children can benefit from the trust — a special attribution rule applies under section 2(2) of the TCGA. In this case, any CGT gains realised by the trustees are attributed to and taxed on the settlor personally, rather than on the trustees at the trust rate. This significantly affects the tax planning position, particularly where the settlor is a non-UK resident or has a different tax position from what the trust rate would imply.

A settlor-interested trust is common where the settlor wishes to maintain indirect access to trust assets (for example, to fund living costs during retirement). The CGT attribution means that gains cannot be sheltered within the trust; they pass through to the settlor's tax return annually.

The ten-year charge and exit charges: IHT context

Although beyond the scope of this guide's focus on distributions, it is worth noting that discretionary trusts are subject to a periodic IHT charge of up to 6% of the trust fund value every ten years (the "anniversary charge"), and a proportionate "exit charge" when assets leave the trust (on a distribution to a beneficiary, for example). The exit charge is a fraction of 6% depending on how much of the decade has elapsed since the last ten-year charge. These IHT charges are separate from and in addition to the income tax and CGT treatment of distributions.

Record-keeping for trustees

Trustees should maintain comprehensive records of:

• All income received by the trust, by category (dividends, interest, rental income, etc.)
• Income tax paid by the trustees, creating and maintaining the tax pool
• All capital gains realised and losses available
• All distributions made, whether income or capital, with the associated tax credit
• All holdover relief elections made

HMRC requires trusts with income above £500 or CGT above the annual exempt amount to register with the Trust Registration Service and file annual self-assessment tax returns.

Compliance note

Trust taxation is a specialist area. The rates and thresholds quoted apply to the 2026/27 tax year under legislation current as of mid-2026. Trust and beneficiary tax positions can vary significantly based on the specific terms of the trust deed, the residence status of settlor, trustees, and beneficiaries, and the types of assets held. Nothing in this guide constitutes personal tax advice. Trustees should instruct qualified trust tax specialists for advice on their specific situation.

How Global Investments Can Help

Global Investments works closely with trustees and their professional advisers on the investment and planning aspects of discretionary trust administration. We can model distribution strategies to optimise the tax position across the trust and its beneficiaries, advise on holdover relief elections, and provide investment management services within the trust's agreed IPS framework. Contact our private client team to discuss your trust requirements.