Settlor-Interested Trusts: How the Settlor Is Taxed

A trust is settlor-interested where its property, or income from that property, can be paid to or applied for the benefit of the settlor or the settlor's spouse or civil partner. This is the case even if benefit is only a possibility rather than a certainty, and even if the settlor is only one of many potential beneficiaries in a discretionary trust. The settlor is the person who provided the funds, directly or indirectly.

For income tax there is an extra category. Where a parent settles funds for their own unmarried child who is under 18, the trust is treated as settlor-interested in respect of that child, and income paid to or for the child is taxed on the parent. This parental settlement rule applies only where the relevant settlement income for the child exceeds £100 in the tax year; below that de minimis figure the income is not caught.

The definition is deliberately wide. HMRC treats the settlor as retaining an interest if the settled property, or any property deriving from it such as accumulated income, is, will, or may become applied for the benefit of the settlor, their spouse or civil partner. Certain outcomes are ignored, for example a benefit that can only arise on the bankruptcy of a beneficiary or after the death of a child, but the general rule is that any realistic route back to the settlor or their spouse makes the trust settlor-interested.

• Settlor can benefit: the trust is settlor-interested.
• Settlor's spouse or civil partner can benefit: the trust is settlor-interested.
• Settlor's minor unmarried child benefits (income tax only), income over £100: caught by the parental settlement rule.
• Only adult children or other relatives can benefit, with the settlor and spouse fully excluded: not settlor-interested on that basis.

The income of a settlor-interested trust is treated as the settlor's income and taxed on the settlor as it arises, under section 624 of ITTOIA 2005. This applies whether the trust is discretionary, accumulation, or an interest in possession trust, and it applies even if the income is retained inside the trust and never paid out. The settlor reports it on their own Self Assessment return, using helpsheet HS270, and it is taxed at the settlor's own rates and in their own bands.

Because the trustees will usually have paid tax first, credit is given for that tax against the settlor's liability. Where the tax paid by the trustees is more than the settlor's own liability on that income, the settlor can reclaim the difference but must account for it back to the trustees, so the benefit stays within the trust rather than enriching the settlor personally. Trust management expenses cannot be used to reduce the amount charged on the settlor.

There is an important knock-on effect for beneficiaries of a settlor-interested discretionary trust. Because the income has already been taxed on the settlor, a discretionary income distribution to another beneficiary is not grossed up in the usual way. Under section 685A of ITTOIA 2005 the beneficiary is treated as having borne tax at the trust rate on the payment, and the payment is included in their total income, but the mechanics differ from a standard discretionary trust distribution. Advice on the specific facts is important here.

The practical takeaway is that a settlor-interested trust gives no income tax deferral or saving. The settlor pays tax on income they may never touch, which is precisely the outcome the legislation is designed to produce.

The capital gains position depends on where the trust is resident. For a UK-resident settlor-interested trust, chargeable gains are taxed on the trustees at trust rates in the normal way. Since 2008 gains are no longer attributed to a living UK-resident settlor of a UK trust automatically, so the trustees settle the CGT. The sharper point for UK trusts is on the way in.

Hold-over relief on gifts is denied where the gift is made to a settlor-interested settlement. Under TCGA 1992 s.169B, you cannot hold over the gain on assets transferred into a trust if the settlor, their spouse or civil partner, or their dependent child has an interest in that settlement, or if there is an arrangement under which the settlement could become settlor-interested. Relief that has been claimed can also be clawed back under s.169C if the settlement becomes settlor-interested within a set period. This means funding a settlor-interested trust with standing-gain assets can trigger an immediate CGT charge on the settlor.

For offshore trusts the position is different and tougher. Where a qualifying offshore settlement has a UK-resident settlor who, together with a defined circle of close family, can benefit, gains accruing to the trustees can be attributed directly to the settlor under TCGA 1992 s.86 and taxed on them as they arise. The settlor has a statutory right to recover the tax from the trustees. This charge is central to how UK-resident settlors of offshore structures are now taxed and links closely to the 2025 reforms below.

Until 5 April 2025, a non-domiciled settlor of an offshore trust could benefit from protected settlement status. Foreign income arising in the trust (protected foreign-source income) and, broadly, offshore trust gains were not taxed on the settlor as they arose, provided the trust was not tainted. Tax generally only arose when distributions or benefits were paid out. This protection was a cornerstone of offshore trust planning for non-doms.

From 6 April 2025 that protection was removed. The relevant protected foreign-source income provisions in ITTOIA 2005 were repealed, and the concept of protected foreign-source income no longer exists. The change was part of the wider abolition of the remittance basis and the move from a domicile-based system to one based on residence.

The result is stark. A UK-resident settlor of an offshore trust who can benefit from it, and who is not eligible for the new 4-year foreign income and gains (FIG) regime, is now taxed on the trust's worldwide income and gains as they arise, in the same way as any other UK-resident individual. The 4-year FIG regime gives 100% relief on eligible foreign income and gains, but only for new or returning arrivals in their first four years of UK residence, and only where they have not been UK resident in any of the previous 10 tax years. Settlors who fall outside that window face full arising-basis taxation on the trust's foreign income (via the settlements code and transfer of assets abroad rules) and on its gains (via s.86 for offshore trusts).

Foreign income and gains that arose inside a genuinely protected trust before 6 April 2025 are not retrospectively taxed on the arising basis, but they can still be caught when matched to later distributions or benefits paid to a UK resident who cannot claim FIG relief. Our offshore trusts guide covers these matching and transitional rules in more depth.

Inheritance tax and income tax use different tests, so a trust that is settlor-interested for income tax is not automatically treated in any special way for IHT. Most lifetime discretionary trusts, including settlor-interested ones, fall within the relevant property regime. Placing assets into such a trust is a chargeable lifetime transfer: to the extent the value exceeds the available nil-rate band of £325,000, there is an entry charge of 20% (the lifetime rate), which can rise to the full 40% if the settlor dies within seven years.

Once in the regime, the trust faces its own periodic charges. On each 10-year anniversary there is a principal charge of up to 6% of the value above the trust's available nil-rate band. When assets leave the trust between anniversaries, a proportionate exit charge applies. Each trust has its own nil-rate band of £325,000, although trusts created by the same settlor and property added later can reduce the band available, so the own-band point should not be over-relied on.

There is a further trap specific to settlor-interested trusts. If the settlor can benefit from the trust, they have reserved a benefit in the gifted property. This is a gift with reservation of benefit, so the trust assets are also treated as remaining in the settlor's estate on death and can be charged to IHT at 40% then, potentially alongside the relevant property charges. The interaction of the two regimes needs careful handling to avoid a double exposure.

Several 2025 and 2026 reforms change the backdrop. From 6 April 2025, whether non-UK trust assets are excluded property (and so outside IHT) turns on the settlor's long-term UK residence, meaning UK residence in at least 10 of the previous 20 tax years, rather than domicile. From 6 April 2026, business relief and agricultural relief are capped: for individuals, 100% relief applies only to the first £2.5 million of combined qualifying property per person (raised from the £1 million originally announced in 2024, transferable between spouses so a couple can pass up to £5 million, and refreshing on a rolling seven-year basis), with 50% relief above that, and relief on AIM and most unlisted shares falls to 50%. For trusts, the confirmed position is that trustees receive a £1 million allowance for the 100% rate on each 10-year and exit charge, with anti-fragmentation rules for multiple trusts set up on or after 30 October 2024 (whether the trust allowance also rose to £2.5 million alongside the individual figure is to confirm on the final legislation). From 6 April 2027, most unused pension funds and death benefits are brought into the estate for IHT. Residence-based IHT and offshore trusts are covered in our related guides.

The standard death rate remains 40%, reduced to 36% where at least 10% of the net estate passes to charity. The residence nil-rate band is £175,000, tapered away by £1 for every £2 of estate above £2,000,000. The nil-rate band, residence nil-rate band and taper threshold are frozen until April 2030.