Following the changes in dividend taxation that apply to individuals for 2016/17, changes have also had to be made to the taxation of dividends and discretionary trusts. In basic terms, this means that because dividends are paid gross, dividends that fall within the trustee’s standard rate band will be taxed at 7.5% and to the extent they exceed the standard rate band, 38.1%.When trustees distribute dividend income to a beneficiary, they must have paid 45% on the income distributed. This would normally mean that the trustees will need to pay an extra 6.9% (45% less 38.1%) on distribution of the income to the beneficiaries. Any credit that the trustees have in their tax pool could be offset against this tax liability.Unfortunately there is currently a problem with the draft legislation.The Finance Bill 2016, deals with the tax pool and in particular the amount of credit that goes into the tax pool in relation to dividends received by trustees of a discretionary trust. Based on the way the legislation is currently drafted, this will have the effect of creating an additional tax charge for discretionary trusts when they distribute dividends.The background to this is that section 498 ITA 2007 sets the amount of tax that can be included in the tax pool. This sets the rate of tax that can enter the tax pool for dividend income as the nominal rate defined as ‘a rate equal to the difference between the dividend trust rate and the dividend ordinary rate’.The Finance Bill 2016 sets the dividend ordinary rate at 7.5% and at the same time abolishes the tax credit available to reduce the tax liability on the dividend income. So even though the trustees physically pay 38.1% tax on income above the standard rate band, on the current wording only 30.6% (i.e. the difference between the dividend trust rate of 38.1% and the ordinary rate of 7.5%) goes into the tax pool.Under the pre-April 2016 regime, the non-repayable tax credit attaching to dividends could not be added to the tax pool because of concerns that this could lead to it becoming repayable in the hands of a non-taxpaying beneficiary receiving a distribution from the trustees. However, now that there is no no-repayable tax credit, there seems to be no reason why the entire amount of the tax paid by the trustees should not be included in the tax pool.In addition, the legislation, as drafted, would mean that the tax liability for trustees and beneficiaries would be considerably increased and the overall tax rate would be approximately 11 per cent more than an individual would pay if they received the dividend direct and paid tax at the dividend additional rate.However, the good news is that following representation from STEP, HMRC has agreed to amend certain provisions in the Finance (No 2) Bill 2016 to rectify the position.HMRC have acknowledged STEP’s comments and responded to confirm that they are aware of the issue and have alerted ministers, who propose to table a government amendment to the Finance (No 2) Bill 2016 which will ensure that all of the tax paid on dividends by trustees of discretionary and accumulation trusts goes into the tax pool.COMMENTThis is a good outcome as it clarifies an area where there was clearly some uncertainty and concern.