The nature of an income source changes as it passes through a discretionary trust. Dividend income loses its character and so doesn’t qualify for the £5,000 nil rate income tax band in the hands of the beneficiary when distributed.

A better result may be to create a revocable interest in possession for the beneficiary, if that meets the trustees’ wider objectives to give the beneficiary a regular income stream. The income then does remain dividend income and they are left with an increased net of tax amount of income.

Following the 2006 changes to IHT and trusts the revocable interest shouldn’t create any other tax problems for the trust.

As ever, care is required over the drafting of the deed of appointment, completion of the tax returns and the practical consequences for the trustees and beneficiary.

Another factor to consider, at the time of writing, is that s498 ITA 2007 appears to need amendment in the 2016 Finance Bill to allow full credit for the dividend tax in a discretionary trust tax pool. (Edit: this issue has now been corrected.)