Tax Implications of Winding up a Discretionary Trust
- Adil Akhtar
- May 13
- 18 min read
Updated: May 22
Index:
The Audio Summary of the Key Points of the Article:
Understanding the Tax Landscape When Winding Up a Discretionary Trust
So, you’re thinking about winding up a discretionary trust in the UK? Maybe it’s served its purpose, or perhaps the tax rules are making you rethink your strategy. Whatever the reason, closing a trust isn’t as simple as emptying a bank account. The tax implications can be a minefield, and getting it wrong could cost you or the beneficiaries dearly. Let’s break it down, starting with the key taxes you’ll need to consider: Inheritance Tax (IHT), Capital Gains Tax (CGT), and Income Tax. By the end of this part, you’ll have a clear picture of what’s at stake and why planning is everything.
What Happens When You Wind Up a Discretionary Trust?
Now, let’s get to the heart of it. A discretionary trust is a flexible setup where trustees decide how to distribute assets among beneficiaries. When you wind it up, you’re essentially closing the trust and distributing all its assets to the beneficiaries or, in some cases, transferring them elsewhere. This triggers a series of tax events, and HMRC will be watching closely. The tax implications depend on the trust’s structure, the assets involved, and how they’re distributed. For the 2025/26 tax year, here’s what you’re dealing with:
Inheritance Tax (IHT): Discretionary trusts are subject to the “relevant property regime,” which means they face IHT charges at three key points: when assets enter the trust (entry charge), every 10 years (periodic charge), and when assets leave (exit charge). Winding up triggers an exit charge if assets are distributed to beneficiaries.
Capital Gains Tax (CGT): Transferring assets to beneficiaries is treated as a disposal, which can trigger CGT if the assets have increased in value since the trust acquired them.
Income Tax: If the trust has accrued income (e.g., from investments or property rentals), the trustees must settle any Income Tax liabilities before winding up.
Winding Up a Discretionary Trust
Inheritance Tax: The Exit Charge Explained
Right, let’s talk IHT first, because this is often the biggest concern. When you wind up a discretionary trust, any distribution of assets to beneficiaries is treated as an exit charge for IHT purposes. The rate depends on the trust’s history and the value of the assets. For 2025/26, the IHT nil-rate band remains at £325,000, and the exit charge is calculated as a proportion of the periodic charge rate (up to 6% of the trust’s value above the nil-rate band).
Here’s how it works: The exit charge is based on the time since the last 10-year anniversary and the effective IHT rate from that point. If the distribution happens within two years of the settlor’s death (for a will trust), there’s a special rule: no exit charge applies, and the distribution is treated as if it was made by the deceased at the time of death. This can be a lifesaver for recently inherited trusts.
Table 1: IHT Exit Charge Calculation for 2025/26
Factor | Details |
Nil-Rate Band | £325,000 (frozen until 2028) |
Exit Charge Rate | Up to 6% of the value above the nil-rate band, pro-rated by time since last charge |
Special Rule | No exit charge if distributed within 2 years of settlor’s death (will trusts) |
Reporting Deadline | IHT100 form due within 6 months of the distribution |
Payment Deadline | IHT due by the end of the 6th month after the event |
Source: HMRC Trusts and Inheritance Tax Guidance, April 2025
Be careful! If the trust’s value exceeds the nil-rate band, the exit charge can add up quickly. For example, if a trust holds £500,000 in assets, the chargeable amount is £175,000 (£500,000 - £325,000). Assuming a full 6% rate (which depends on the trust’s history), you’re looking at a potential IHT bill of £10,500. Planning the timing of distributions can help minimise this.
Capital Gains Tax: Disposals and Holdover Relief
Now, consider this: When assets leave the trust, they’re treated as sold at market value, even if no cash changes hands. If the assets (say, shares or property) have grown in value, the trustees could face a CGT bill. For 2025/26, trusts get a CGT annual exempt amount of £3,000 (halved from the individual allowance of £6,000). Gains above this are taxed at 20% for most assets or 24% for residential property.
Here’s a real-world example. Imagine a trust holds shares bought for £100,000, now worth £200,000. On distribution, the gain is £100,000. After the £3,000 exemption, the taxable gain is £97,000, leading to a CGT liability of £19,400 at 20%. Ouch.
But there’s a silver lining: holdover relief. This lets trustees defer the CGT by transferring the asset to the beneficiary at the trust’s original cost (the “base cost”). The beneficiary then pays CGT when they sell the asset later. To claim holdover relief, you’ll need to file HMRC’s HS295 form, and both trustees and beneficiaries must agree. This is a game-changer for high-value assets like property or business shares, but it’s not automatic—miss the claim, and you’re stuck with the tax bill.
Income Tax: Settling the Final Bill
None of us loves dealing with Income Tax, but it’s a must when winding up a trust. If the trust has generated income (e.g., dividends, interest, or rent), the trustees are responsible for paying tax on it before distribution. For 2025/26, discretionary trusts pay Income Tax at 45% on non-dividend income and 39.75% on dividends, with no personal allowance. Income up to £500 is tax-free, but anything above that gets hit hard.
When income is distributed to beneficiaries, the trustees provide a form R185, showing the net amount paid and the tax credit (45% of the gross distribution). Beneficiaries can reclaim some tax if they’re basic-rate taxpayers, but higher-rate taxpayers won’t owe more. For example, if a trust distributes £550 of interest income, the trustees pay £247.50 in tax (45% of £550), and the beneficiary receives £302.50 with a tax credit.
Table 2: Income Tax Rates for Discretionary Trusts (2025/26)
Income Type | Tax Rate | Tax-Free Amount |
Non-Dividend Income | 45% | £500 |
Dividend Income | 39.75% | £500 |
Tax Pool Charge | 45% on distributions | N/A |
Source: HMRC Trusts and Income Tax Guidance, April 2025
So the question is: What if the trust has a mix of income and capital? You’ll need to carefully separate these for tax purposes. Income distributions carry a tax credit, but capital distributions don’t, which can affect the beneficiaries’ tax returns.
Practical Considerations for 2025/26
Now, let’s get practical. Winding up a trust feasibly in 2025 involves navigating HMRC’s Trust Registration Service (TRS). Even if the trust is closing, you must update the TRS and confirm the closure date online. Miss the 90-day reporting window for changes, and you could face a £5,000 penalty. Also, ensure all tax returns are filed for the year of closure, including any CGT or IHT due.
Here’s a hypothetical scenario. Meet Elowen, a 50-year-old business owner in Cornwall. Her late father set up a discretionary trust in 2015 with £400,000 in shares and property. In 2025, Elowen and the trustees decide to wind it up, distributing the assets to her and her siblings. The trust’s value is now £600,000. They face an IHT exit charge on £275,000 (£600,000 - £325,000), potentially £16,500 at 6%. The shares have a £150,000 gain, but they claim holdover relief to avoid CGT. The trust’s £10,000 in accrued income triggers a £4,500 Income Tax bill. By planning the distribution carefully, they minimise the tax hit, but it takes expert advice to get it right.
Tax Implications of Winding up a Discretionary Trust
Strategies to Minimise Tax and Navigate Complexities
Now, you’ve got the basics of the tax implications when winding up a discretionary trust, but let’s get tactical. How can you reduce the tax burden and avoid costly mistakes? This part dives into practical strategies to save money, explores complex scenarios that could catch you out, and offers real-life insights for UK taxpayers and business owners in 2025. We’ll cover timing tricks, reliefs, and the quirks of trusts with mixed assets or non-UK elements. Buckle up—this is where things get interesting.
Timing Your Distributions for Tax Savings
Let’s kick things off with a smart move: timing. The date you wind up the trust can make a big difference to your tax bill, especially for Inheritance Tax (IHT) exit charges. The exit charge is pro-rated based on the time since the last 10-year anniversary. For example, if you distribute assets just before the next 10-year charge (due every decade from the trust’s creation), you’ll pay a lower exit charge than if you wait a few months. Why? The charge is calculated using the number of complete quarters (three-month periods) since the last anniversary.
Here’s an example. A trust created in June 2015 had its last 10-year charge in June 2025. If you wind it up in August 2025, you’re only taxed on two quarters out of 40 (5% of the full rate). But wait until December 2025, and you’re taxed on six quarters (15% of the rate). For a £500,000 trust with £175,000 above the nil-rate band, this could mean the difference between a £525 IHT bill and a £1,575 one. Check your trust’s anniversary date and plan accordingly.
Be careful! Timing also matters for Capital Gains Tax (CGT). If the trust holds assets that are about to qualify for a relief (like Business Asset Disposal Relief, which reduces CGT to 10% on qualifying business assets), consider delaying the wind-up until the relief applies. Always weigh the IHT savings against potential CGT costs.
Maximising Holdover Relief and Other CGT Strategies
Now, let’s revisit holdover relief, because it’s a lifesaver for CGT. When winding up, transferring assets to beneficiaries triggers a disposal, but holdover relief lets you pass the asset at its original cost, deferring the tax until the beneficiary sells it. This is especially useful for assets like family business shares or property, where gains can be substantial.
But here’s a lesser-known tip: you can combine holdover relief with strategic beneficiary selection. If a beneficiary is a basic-rate taxpayer with an unused CGT allowance (£6,000 for individuals in 2025/26), they could sell the asset later and pay less tax than the trust would at 20% or 24%. For example, transferring £100,000 in shares with a £50,000 gain to a beneficiary like Tamsin, a 30-year-old teacher with no other gains, could mean zero CGT if she sells within her allowance.
Watch out, though! Holdover relief isn’t available for all assets. It’s typically restricted to business assets or transfers to individuals, not other trusts. If the trust holds residential property, you might face a 24% CGT rate with no holdover option. In such cases, consider spreading distributions over multiple tax years to use the trust’s £3,000 annual exempt amount each year.
Table 3: CGT Strategies for Trust Wind-Up (2025/26)
Strategy | Benefit | Considerations |
Holdover Relief | Defers CGT to beneficiary’s future sale | Requires HS295 form; not available for all assets |
Spread Distributions | Uses £3,000 annual exempt amount multiple times | Delays wind-up; administrative complexity |
Select Low-Tax Beneficiaries | Beneficiaries with unused CGT allowance reduce tax | Requires coordination with beneficiaries |
Source: HMRC Capital Gains Tax for Trusts, April 2025
CGT Strategies to Use During Trust Wind-Up
Handling Mixed Assets: Property, Shares, and Cash
So, what if your trust holds a mix of assets—like a rental property, a portfolio of shares, and some cash? This is where things get tricky. Each asset type triggers different tax rules, and you’ll need to handle them separately. Let’s break it down with a hypothetical case.
Meet Idris, a 45-year-old entrepreneur from Cardiff. His discretionary trust, set up in 2013, holds a rental property worth £400,000 (bought for £200,000), £150,000 in shares (bought for £100,000), and £50,000 in cash. In 2025, he decides to wind it up. Here’s what he faces:
Property: The £200,000 gain triggers CGT at 24% after the £3,000 exemption. Without holdover relief (unavailable for non-business property), the tax is £47,280. The property also contributes to the IHT exit charge.
Shares: The £50,000 gain qualifies for holdover relief, deferring CGT. Idris transfers the shares to his sister, who plans to sell them later using her personal allowance.
Cash: No CGT, but it’s included in the IHT calculation. The trust’s total value (£600,000) means an IHT exit charge on £275,000, potentially £16,500 at 6%.
Idris’s solution? He spreads the wind-up over two tax years, distributing the cash and shares in 2025/26 and the property in 2026/27. This uses the trust’s CGT exemption twice, saving £720 in tax, and reduces the IHT charge by timing the property distribution closer to the next 10-year anniversary.
Trusts with Non-UK Elements: A Hidden Trap
Now, here’s something you might not have considered: what if the trust has non-UK assets or beneficiaries? This is a growing issue in 2025, with more UK families holding overseas property or having relatives abroad. Non-UK assets (like a villa in Spain) are subject to UK CGT and IHT, but you’ll also need to check the tax rules in the asset’s country. Double taxation agreements (DTAs) can help avoid paying tax twice, but they’re complex.
For non-UK resident beneficiaries, the tax picture shifts. They’re exempt from UK IHT on distributions of non-UK assets, but they’ll face CGT if they receive UK assets and later sell them. For example, if a trust distributes a £300,000 London flat to a beneficiary in Australia, the trust pays CGT on any gain, and the beneficiary might face Australian tax on a future sale. Always check the DTA between the UK and the beneficiary’s country.
Practical Steps to Avoid HMRC Penalties
None of us wants to tangle with HMRC’s penalty system, so let’s cover the compliance side. When winding up, you must:
Update the Trust Registration Service (TRS) within 90 days of closure, confirming the end date and final distributions.
File an IHT100 form for the exit charge within six months, along with payment.
Submit a Self-Assessment Trust and Estate Tax Return for the final year, reporting Income Tax and CGT.
Issue R185 forms to beneficiaries for any income distributions, detailing tax credits.
Miss these deadlines, and you’re looking at penalties starting at £100 for late filings, escalating to £5,000 for TRS failures. Set calendar reminders or, better yet, get a tax accountant to handle it.
Real-Life Complexity: A 2024 Case Study
Now, consider this: In 2024, a Manchester-based trust faced a unique challenge. The settlor, a retired doctor named Gwendolyn, had died in 2022, and the trustees wanted to wind up the trust by 2025. The trust held £700,000 in assets, including a commercial property and a share portfolio. The catch? One beneficiary, Gwendolyn’s son, lived in Canada, and the commercial property qualified for Business Asset Disposal Relief. By delaying the property distribution to 2025/26 and claiming holdover relief for the shares, the trustees saved £30,000 in CGT and reduced the IHT exit charge by £4,000 through careful timing. This case shows how tailored planning can make a huge difference.
Tax Implications of Winding up a Discretionary Trust
How a Tax Accountant Can Guide You Through Winding Up a Discretionary Trust
So, you’ve seen the tax complexities and strategies for winding up a discretionary trust. It’s a lot, right? Between IHT exit charges, CGT calculations, and HMRC deadlines, it’s easy to feel overwhelmed. That’s where a professional tax accountant comes in—like the team at Pro Tax Accountant (https://www.protaxaccountant.co.uk/). In this final part, we’ll explore how expert help can save you money and stress, with a detailed case study showing how a real UK family navigated this process in 2025. Plus, we’ll invite you to reach out for a free consultation with Pro Tax Accountant’s CEO, Mr. Adil, to tackle your trust wind-up with confidence.
Why You Need a Tax Accountant for Trust Wind-Ups
Let’s be honest: tax law isn’t exactly a page-turner. Winding up a discretionary trust involves juggling Inheritance Tax (IHT), Capital Gains Tax (CGT), and Income Tax, all while staying compliant with HMRC’s Trust Registration Service (TRS). A tax accountant doesn’t just crunch numbers—they act like a guide, spotting opportunities to save tax, avoiding penalties, and ensuring every form is filed on time. Firms like Pro Tax Accountant specialise in trusts, offering tailored advice that generic software or DIY approaches can’t match.
Here’s what they bring to the table:
Tax Minimisation: Identifying reliefs like holdover relief or timing distributions to reduce IHT and CGT.
Compliance: Handling TRS updates, IHT100 forms, and Self-Assessment returns to avoid fines.
Custom Planning: Crafting strategies for complex trusts, like those with mixed assets or non-UK beneficiaries.
Beneficiary Support: Explaining tax credits (via R185 forms) to beneficiaries and coordinating with their tax advisors.
Case Study: The Penrose Family Trust Wind-Up
Now, let’s dive into a real-life example to see how a tax accountant makes a difference. Meet the Penrose family from Bristol. In 2025, they decided to wind up a discretionary trust set up by their late grandmother, Morwenna, in 2010. The trust held £800,000 in assets: a rental property worth £450,000 (bought for £250,000), £250,000 in shares (bought for £150,000), £50,000 in cash, and £50,000 in accrued rental income. The beneficiaries were Morwenna’s three grandchildren: Lowen (a 35-year-old nurse), Kerensa (a 40-year-old business owner), and Jago (a 28-year-old student).
The trustees initially planned to distribute everything in one go, but they were worried about the tax hit. They contacted Pro Tax Accountant, and Mr. Adil, the CEO, took charge. Here’s how he helped, step by step:
Step 1: Assessing the Tax Liabilities
Right, first things first: Mr. Adil reviewed the trust’s assets and tax history. He calculated the potential tax bills for a single distribution in 2025/26:
IHT Exit Charge: The trust’s value (£800,000) exceeded the nil-rate band (£325,000), so the chargeable amount was £475,000. Assuming a 6% rate (based on the trust’s 10-year anniversary in 2020), the IHT bill was £28,500.
CGT: The property had a £200,000 gain, and the shares had a £100,000 gain. After the trust’s £3,000 CGT exemption, the taxable gains were £297,000. At 24% for the property (£47,280) and 20% for the shares (£20,000), the total CGT was £67,280.
Income Tax: The £50,000 rental income was taxed at 45%, resulting in a £22,500 bill, leaving £27,500 for distribution.
Total tax without planning? £118,280. Ouch.
Step 2: Crafting a Tax-Saving Strategy
Now, here’s where the magic happened. Mr. Adil proposed a two-year wind-up plan to spread the tax burden and maximise reliefs:
Year 1 (2025/26): Distribute the shares and cash. The shares qualified for holdover relief, deferring the £100,000 gain to the beneficiaries. Lowen and Jago, both basic-rate taxpayers, received the shares, planning to sell them later within their £6,000 personal CGT allowances. The cash (£50,000) was distributed tax-free but contributed to a smaller IHT exit charge of £1,500 (on £50,000 above the nil-rate band, pro-rated for timing).
Year 2 (2026/27): Distribute the property to Kerensa, who planned to keep it as a rental. The £200,000 gain triggered a CGT bill of £47,280 (24% after the £3,000 exemption), but spreading the distribution used the trust’s CGT exemption again, saving £720. The IHT exit charge was £26,100 (on £425,000, timed closer to the next 10-year anniversary for a lower pro-rated rate).
Income Tax: The £50,000 rental income was distributed in 2025/26, with the £22,500 tax paid by the trustees. Mr. Adil issued R185 forms, ensuring Lowen and Jago could reclaim part of the 45% tax credit as basic-rate taxpayers, boosting their net payout.
Total tax with planning? £97,600—a saving of £20,680 compared to the original plan.
Step 3: Ensuring Compliance
Be careful! HMRC doesn’t mess around with deadlines. Mr. Adil’s team handled all the paperwork:
Updated the TRS within 90 days of each distribution, confirming the trust’s partial closure in 2025 and full closure in 2026.
Filed IHT100 forms for the exit charges, paying £1,500 in 2025 and £26,100 in 2026.
Submitted the trust’s Self-Assessment return for 2025/26, reporting the Income Tax and CGT.
Issued R185 forms to Lowen, Kerensa, and Jago, detailing the income tax credits.
By managing these tasks, Pro Tax Accountant saved the Penrose family from potential penalties, including a £5,000 fine for missing TRS updates.
Step 4: Supporting the Beneficiaries
None of us wants to be left confused about our tax obligations. Mr. Adil went beyond the trustees’ needs, advising the beneficiaries on their responsibilities. For Lowen and Jago, he explained how to report their share sales on their personal tax returns, ensuring they maximised their CGT allowances. For Kerensa, he provided guidance on managing the rental property, including allowable deductions for future Income Tax.
This holistic approach gave the family peace of mind.
Table 4: Penrose Family Trust Tax Savings (2025-2026)
Tax Type | Original Plan (£) | Planned Strategy (£) | Savings (£) |
IHT Exit Charge | 28,500 | 27,600 | 900 |
CGT | 67,280 | 47,280 | 20,000 |
Income Tax | 22,500 | 22,500 | 0 |
Total | 118,280 | 97,600 | 20,680 |
Why Pro Tax Accountant Stands Out
So, what makes Pro Tax Accountant the go-to choice? Their expertise in UK trust taxation, led by Mr. Adil, ensures no detail is overlooked. They don’t just file forms—they analyse your trust’s unique setup, from mixed assets to non-UK beneficiaries, and craft a bespoke plan. Their proactive approach, like spotting holdover relief opportunities or timing distributions, can save thousands. Plus, their client-first attitude means clear communication, no jargon, and support for both trustees and beneficiaries.
Take the Next Step with Pro Tax Accountant
Now, consider this: Winding up a discretionary trust is a big decision, and the tax implications can feel like a maze. Why go it alone? Pro Tax Accountant, led by Mr. Adil, offers a free initial consultation to assess your trust and outline a tax-efficient wind-up plan. Whether you’re dealing with property, shares, or international assets, their expertise can save you money and stress. Contact Mr. Adil today at https://www.protaxaccountant.co.uk/ to book your free consultation and take control of your trust wind-up.
Summary of the Most Important Points
Winding up a discretionary trust in the UK triggers Inheritance Tax exit charges, Capital Gains Tax on asset disposals, and Income Tax on accrued income.
Inheritance Tax exit charges can reach 6% on assets above the £325,000 nil-rate band, based on trust value and timing.
Capital Gains Tax applies at 20% or 24% for residential property on gains exceeding the trust’s £3,000 annual exemption.
Holdover relief can defer Capital Gains Tax by transferring assets to beneficiaries at the trust’s original cost.
Income Tax is levied at 45% on non-dividend income and 39.75% on dividends, with a £500 tax-free threshold.
Timing distributions before a 10-year anniversary reduces Inheritance Tax exit charges by lowering the pro-rated rate.
Spreading distributions over multiple tax years maximizes the trust’s Capital Gains Tax exemption, potentially saving significant amounts.
Trusts with non-UK assets or beneficiaries face complex tax rules, requiring checks on double taxation agreements.
Compliance with HMRC’s Trust Registration Service and timely filing of IHT100 and Self-Assessment returns prevents penalties up to £5,000.
Pro Tax Accountant, led by Mr. Adil, offers expert strategies and free consultations to optimize trust wind-up tax efficiency.
FAQs
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The Author:
Adil Akhtar, ACMA, CGMA, CEO and Chief Accountant of Pro Tax Accountant, is an esteemed tax blog writer with over 10 years of expertise in navigating complex tax matters. For more than three years, his insightful blogs have empowered UK taxpayers with clear, actionable advice. Leading Advantax Accountants as well, Adil blends technical prowess with a passion for demystifying finance, cementing his reputation as a trusted authority in tax education.
Email: adilacma@icloud.com
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