How is a Trust Taxed?

The taxation of trusts is not straightforward. Because a trust is a relationship, not a person, it does not fit neatly in the categories of individual or corporation. Further, even though the trustee has legal title to the trust assets, the assets really belong to someone else, i.e. the beneficiary or beneficiaries.

Despite this, most jurisdictions treat trusts as persons for tax purposes and require the trustee to file a separate tax return for the trust, distinct from its own tax return.

In the UAE, trusts are not subject to income tax. This is not because trusts have a special status, but simply because only oil companies and branches of foreign banks pay income tax at the emirate level in the UAE, and no other corporations or individuals.

However, in order for a trust to be resident in the UAE, we need to take a careful look at the cast of characters who make up the trust relationship.

Generally, the settlor is the least important figure in the trust. This may seem counter-intuitive because the settlor contributes assets to the trust, but often this initial contribution is nominal, and other entities, such as family members, will later contribute cash or other assets to the trust. For this reason, the settlor may vanish from the picture as soon as the trust is formed, even though generally the settlor must make its contribution with the intention to contribute to the trust.

Where the settlor – or contributors – to the trust become especially important for tax purposes is if they reside in a taxable jurisdiction. Very often, a contribution to a trust, whether of cash or other property, results in a taxable disposition for the contributor or renders the contributor liable for gift tax. It is a good idea to consult your tax advisor before making any contributions to a trust.

Conversely, the trustee – or trustees – are crucially important to the trust. Similar to how the residency of a corporation is determined by where its mind and management is located, and not necessarily the statute under which it is formed, the residency of a trust is determined largely by where its trustee(s) reside.

This can lead to conflicts between jurisdictions who both claim the trust as a resident. Fortunately, tax treaties (discussed further in this article) can help iron out these disputes.