Settlor-Interested Trusts: Tax Consequences and How to Avoid Them
If you create a trust and can still benefit from it, the trust is settlor-interested — trust income and gains are taxed on you as if you had received them directly, and the IHT benefit of giving the assets away may be lost through the gift with reservation rules.
Tax Consequences at a Glance
| Tax | Settlor-interested rule | Legislation |
|---|---|---|
| Income tax | Trust income taxed on settlor at their marginal rate | ITTOIA 2005 ss619-648 |
| CGT | Trust gains attributed to settlor at their CGT rate | TCGA 1992 s77 |
| IHT (GWR) | Trust property still in settlor's estate for IHT | FA 1986 s102; IHTA 1984 Sch 20 |
| Parental settlements (income only) | Parent taxed on child trust income >£100/yr if minor, unmarried child | ITTOIA 2005 ss629-632 |
Frequently Asked Questions
What makes a trust 'settlor-interested'?
A trust is settlor-interested when the settlor (or their spouse or civil partner) can benefit from the trust property or income, either immediately or at some future date. The ITTOIA 2005 and TCGA 1992 settlements legislation casts this very widely: a trust is settlor-interested if: (1) the trust income or capital can be paid to or applied for the benefit of the settlor or their spouse/civil partner in any circumstances; (2) the trust fund can revert to the settlor in any circumstances (e.g. a power of revocation); (3) the settlor or their spouse/civil partner is a potential beneficiary of a discretionary trust (even if never actually paid anything). The rules are anti-avoidance provisions — they prevent a settlor from directing income to a trust and paying less tax on it than if they had received it themselves.
How is income from a settlor-interested trust taxed?
Under the ITTOIA 2005 ss619-648 'settlements legislation', all income arising under a settlor-interested arrangement is treated as the income of the settlor and taxed at their marginal income tax rate — not the trustee rate (45% for discretionary trusts) or the beneficiary's rate. This applies regardless of whether the income is actually paid to the settlor: if the trust income could potentially benefit the settlor, the anti-avoidance rules apply. The settlor may be able to reclaim tax from the trustees to cover the liability, but the rules mean there is typically no income tax advantage to a settlor-interested trust. A trust where the settlor is irrevocably excluded (and their spouse/civil partner) can be genuine income-shifting to lower-rate beneficiaries.
What happens to capital gains in a settlor-interested trust?
Under TCGA 1992 s77, capital gains arising in a settlor-interested trust are attributed to the settlor and taxed at their rate of CGT (up to 24% for residential property, 18% for other assets as at 2026). As with the income tax rules, this applies if the settlor or their spouse/civil partner is a potential beneficiary. The s77 attribution does not apply if the settlor is non-UK resident, but anti-avoidance rules may still apply in some cross-border situations. Once the settlor dies, s77 attribution ceases — gains arising thereafter are taxed on the trustees (or beneficiaries on distribution) in the normal way. The settlor can reclaim the CGT paid from the trustees.
How do the IHT gift with reservation rules interact with settlor-interested trusts?
If a settlor creates a trust but retains a benefit from the trust property, the gift with reservation (GWR) rules under IHTA 1984 Schedule 20 and Finance Act 1986 s102 apply. The trust property is treated as still forming part of the settlor's estate for IHT purposes. This means the settlor has the worst of both worlds: income tax and CGT are attributed to them as a settlor-interested trust, AND the IHT benefit of making the gift is lost because the property is still in their estate for IHT. The GWR trap is a common pitfall in DIY trust planning. The pre-owned assets tax (POAT) under Finance Act 2004 Schedule 15 may also apply where the settlor occupies trust property or enjoys trust benefits without the strict GWR conditions being met.
Do the settlor-interested rules apply to trusts created for children?
The settlements legislation has a specific additional rule for trusts created by parents for their minor children (under 18, unmarried). Under ITTOIA 2005 ss629-632, income from a settlement made by a parent on an unmarried minor child is taxed on the parent if it exceeds £100 per year. This is the 'parental settlements' rule — separate from the settlor-interested rules — and it applies even where the parent has no power to benefit themselves. The rule prevents income-splitting between parents and their young children for tax purposes. Once the child turns 18 or marries (or enters a civil partnership), the income is taxed on the child in the normal way. The rule does not apply to trusts made by grandparents, aunts, uncles, or other third parties for a child.
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