Changes made in the Finance Act 2006 mean that property held on bare trust (that is, other than a settlement as defined by S43(2) IHTA 1984) is excluded from the definition of relevant property for the purposes of the inheritance tax discretionary trust regime. This means that:
l Gifts to bare trusts continue to be treated as poten-tially exempt transfers;
l The 10-year periodic charge will not apply to the trust fund; andl The trust fund will not be subject to exit charges.
Despite this, following legal advice, Her Majesty’s Revenue and Customs takes the view that a bare trust for a minor is a settlement. This is on the basis that because the trustees may need to accumulate income while the child is a minor (whether section 31(2) Trustee Act 1925 applies or not), the trust would fall within section 43(2) IHTA 1984 as a trust to accumulate the whole or any part of any income. It would therefore, in the view of HMRC, be a settlement for IHT purposes.
Many people (including a number of leading tax counsel) feel that HMRC is misguided in this interpretation and discussions are continuing.
Against this background, and certain press reports that have publicised HMRC’s view that such arrangements give rise to chargeable lifetime transfers, HMRC has gone out of its way to state that it is aware that other legal views exist and that it is considering the position before issuing final guidance. In particular, in a recent letter to Taxation Magazine, HMRC stated its position as follows:
“Following the changes last year to the inheritance tax treatment of trusts, HMRC have been discussing its technical guidance on the new rules with a number of professional representative bodies.
“Once these discussions are complete this guidance will be published on HMRC’s website. At the moment, a number of particular areas remain under discussion.
“Contrary to various reports the application of the law to “absolute trusts for minors” (sometimes called “bare trusts for minors”) is one area that HMRC are still considering before issuing final guidance.”
But while this is the basis of its current legal advice, it may not be the final outcome. Where does this leave the adviser? The action to take will depend on whether an absolute/ bare trust has already been established or one is being contemplated.
Where bare trusts have already been created for a minor since March 21, 2006, the “at worst” position is that such gifts could be gifts to a settlement.
If so, the gifts will have been chargeable lifetime transfers but no immediate IHT will be due if the gifts (less the donor’s available annual exemption(s)) do not cause the donor to exceed his available nil-rate band of £285,000 taking account of other chargeable lifetime transfers made in the seven years immediately preceding the gift.
A return of the gift would have to be made on forms 100, 100a and D34 (if a life policy or premiums payable under a life policy are involved), if it exceeded the current reporting thresholds.
As far as periodic charges are concerned, in broad terms (that is, assuming no added property and no exits), these will only arise if the trust fund exceeds the nil-rate band in 10 years time taking account of chargeable lifetime transfers made by the donor in the seven years before the trust is executed.
However, periodic changes are unlikely to arise unless the child is currently under the age of eight. This is because, even if the trust is a settlement, when the child beneficiary attains the age of 18, the child will then become absolutely entitled and a potential exit charge will arise.
From that point on, the property will be treated as part of the child’s taxable estate.
No inheritance tax will then be payable, provided, in general, that the settlor did not exceed his available nil-rate band when he created the trust, taking account of gifts he made in the seven years before the trust was executed.
With cases already written there will be reporting requirements to consider (within 12 months of the date of the gift) and, if the gift causes the settlor to exceed his nil-rate band, tax at 20 per cent on the excess to pay – payable six months from the end of the month in which the gift is made or on April 30 in the following year if the gift is made between October 1 and April 5.
Until a final decision is made by HMRC (and this could be challenged because HMRC’s view does not make this absolute under the law), advisers will need to be careful to consider what advice to give regarding new clients effecting bare trusts for minor children.
If these arrangements are regarded as settlements by HMRC and this view, if challenged, were upheld in court, then there will be reporting and administration requirements as well as potential tax due.
For example, if HMRC decided to follow its initial legal advice, then gifts to minors absolutely will be treated as CLTs rather than potentially exempt transfers. However, it is worth reiterating that no final decision has been made on this matter and that industry bodies continue to discuss this and other IHT issues with the authorities. It is also worth remembering that any such HMRC expression will be its view and not necessarily the law. Despite this, it will be important to take such a view seriously.
Until this issue is resolved, serious consideration should be given to avoiding the establishment of new bare trusts for minors if the main intention is to avoid the relevant property regime for IHT. It is essential that potential donors are made aware of this current state of affairs.