What does grossing up mean for discretionary trust payments under section 494 of the Income Tax Act 2007?

Grossing up means working backwards from the net cash payment to the beneficiary to find the larger pre-tax figure from which, if income tax at the trust rate were deducted, the net amount would remain. The difference between the grossed-up amount and the actual payment represents a notional income tax deduction attributed to the recipient.

Who is treated as having paid the income tax on a grossed-up discretionary trust payment?

It depends on which condition in section 493 is met. If condition A applies, the beneficiary is treated as having paid income tax equal to the notional deduction. If condition B applies, meaning the income is treated as the settlor's under the settlements legislation, the settlor is deemed to have paid the tax instead.

Can a basic-rate taxpayer reclaim tax on a discretionary trust distribution?

Yes. Because the trust rate is currently 45%, a basic-rate taxpayer whose marginal rate is only 20% will have a deemed tax credit exceeding their actual liability on the grossed-up amount. The excess can be reclaimed through their self-assessment return, resulting in a repayment of the difference between the two rates.

How is the grossed-up amount calculated in practice for a discretionary trust payment?

Divide the actual cash payment by one minus the trust rate. For example, if the trust rate is 45% and the payment is £5,500, the grossed-up amount is £5,500 divided by 0.55, equalling £10,000. The notional tax deducted is £10,000 multiplied by 45%, giving £4,500.

Income Tax Act 2007 section 494

Grossing up of discretionary payment and payment of income tax

Section 494 explains how discretionary payments made by trustees are grossed up to include a notional income tax deduction at the trust rate, and who is treated as having paid that tax.

A discretionary payment is treated as having been made after deduction of income tax at the trust rate, calculated on the grossed-up amount of the payment
The grossed-up amount is the actual cash payment increased by reference to the trust rate so that, after deducting tax at that rate, the net figure equals the actual payment
The beneficiary (or the settlor, where the income is treated as the settlor's) is deemed to have paid income tax equal to the amount notionally deducted
Whether the deemed taxpayer is the beneficiary or the settlor depends on which condition in section 493 is met — condition A points to the beneficiary, condition B to the settlor

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