Interest in Possession Trust
For Income Tax purposes, an 'interest in possession' trust is one where the beneficiary is entitled to trust income as it arises.
What is an interest in possession trust?
From an Income Tax perspective, an interest in possession trust is one where the beneficiary has an immediate and automatic right to the income from the trust after expenses. The trustee (the person running the trust) must pass all of the income received, less any trustees' expenses, to the beneficiary.
The beneficiary who receives income (the 'income beneficiary') often doesn't have any rights over the capital held in such a trust. The capital will normally pass to a different beneficiary or beneficiaries in the future. The trustees might have the power to pay capital to a beneficiary even though that beneficiary only has a right to receive income. However, this will depend on the terms of the trust.
Example
Roger is married to Mary. On his death Roger's will creates a trust and all the shares he owned are to be held in that trust. The dividends (income) earned on the shares are to go to Mary for the rest of her life. When she dies the shares pass to the children.
Mary is the income beneficiary. She has an 'interest in possession' in the trust as she is entitled to the dividend income from the trust assets for the rest of her life. Mary has no right to the capital. When she dies the trust ceases and all the capital (the shares) passes to the children.
Interest in possession trusts and Income Tax
Trustees are responsible for declaring and paying Income Tax on income received by the trust. They do this on a Trust and Estate Tax Return each year.
There are different rates depending on the type of income - as shown in the table below.
Type of income
Rent, trading and savings
UK dividends (such as income from stocks and shares)
Rent, trading and savings
UK dividends (such as income from stocks and shares)
Income Tax rate 2014 to 2015 tax year
20% (basic rate)
10% (dividend ordinary rate)
20% (basic rate)
10% (dividend ordinary rate)
Interest in possession trusts aren't normally taxed at the special trust rates of tax that apply to non-interest in possession trusts. However some items that are capital in trust law are treated as income for tax purposes when received by trusts. Depending on the type of item they're either taxed at the trust rate of 45% or the dividend trust rate of 37.5%.
This is a complicated area of trust taxation. You can find out more about capital items that are treated as income in HM Revenue & Customs' technical guidance - Trusts, Settlements and Estates Manual.
Special tax rules apply to interest in possession trusts with beneficiaries who are disabled or who are children who have lost a parent through death.
Capital Gains Tax on an interest in possession trust
Capital Gains Tax is a tax on the gain in the value of assets such as shares, land or buildings. A trust may have to pay Capital Gains Tax if assets are sold, given away or exchanged (disposed of) and they've gone up in value since being put into trust. The trust will only have to pay the tax if the assets have increased in value above a certain allowance. This allowance is known as the 'annual exempt amount'. Trustees are responsible for paying any Capital Gains Tax due.
Beneficiaries aren't taxed on any trust gains and don't get credit for any tax paid by the trustees.
Inheritance Tax on an interest in possession trust
An interest in possession may also include the right to enjoy a non-income producing asset, for example the right to live in a house.
Inheritance Tax may be due when:
- assets are put into an interest in possession trust
- an interest in possession trust reaches a 10-year anniversary
- assets are taken out of an interest in possession trust or the trust ceases