Lesson 23 of 25 · 7 min

Where the tax lands when a settlor is treated as the owner

Income can arise in one set of hands and be reported by another, and the payment shrinks only one of them.

Some systems attribute the income of an arrangement to the person who created it, even though the assets are legally held by someone else. Where that happens, three consequences follow, and they surprise people in sequence.

The first is reporting. Income arising inside the arrangement is reported by the person rather than by the arrangement, in full, whether or not anything was distributed to anyone. The arrangement may hold the cash while the person holds the obligation.

The second is that transactions between the two can be disregarded. Where a person is treated as owning the arrangement's assets, a sale from the person to the arrangement may be treated as a transaction with themselves: no disposal, no recognised gain, and basis carried across unchanged. A loan between them can be treated the same way, which is why lending into an arrangement of this kind is a mechanically different act from lending into one treated as separate.

The third is the direction of the cash. Income of $286,400 attributed to the person produces, at an assumed 34 percent, a figure of $97,376. Paying it from the person's own funds reduces the person's assets by $97,376 and reduces the arrangement's assets by nothing. Over nine years at the same income that is $876,384 which has left one balance sheet and never touched the other.

The percentage is an assumption of the example. Whether attribution of this kind applies, which powers trigger it, whether it can be switched off, and whether the payment is itself treated as a further transfer are questions that differ by system and by document, and every one of them belongs with a qualified adviser.

Key terms

Attribution: Treating income that arises in one party's hands as belonging to another for reporting purposes, because of powers the second party retained.
Disregarded transaction: A dealing between two parties that a rule treats as a dealing with oneself, so no disposal occurs and basis carries across.
Balance-sheet direction: Which party's assets actually fall when an obligation is paid. Under attribution it is not the party whose assets produced the income.

Worked example

Income in one place, payment from another

An arrangement producing $286,400 of income attributed to the person who created it. The 34 percent is an assumption of the example.

Income arising inside the arrangement: $286,400
Amount attributed to the person: $286,400
At an assumed 34 percent: $97,376
Reduction in the arrangement's assets: $0
Reduction in the person's own assets: $97,376
Over nine years at the same income: $876,384

Nine years moved $876,384 off one balance sheet while the other one was untouched. Neither party transferred anything to the other.

Check yourself

An arrangement produces $286,400 of income that is attributed to the person who created it, who pays the resulting amount from their own funds at an assumed 34 percent. Whose assets fall, and by how much over nine years?

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Educational only. Nothing in this lesson is investment, legal or tax advice, or a recommendation to enter into any transaction. Figures are illustrative and computed from the inputs stated in the lesson.