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Bare-faced cheek

Anyone who runs an advice-led financial planning business will be well aware of the many uses that a trust can have in combination with a financial product.

Most of these combinations involve a pension arrangement of some form or an onshore or offshore insurance product. Increasingly, though, thought is being given to trusts in combination with other financial products, particularly collective investments.

Combining any financial product with a trust will usually have some inheritance tax planning objective. Clearly, with ordinary death benefit-based life policies, the combination is a killer. The person effecting the plan does not need the same degree of access to the product during lifetime and certainly not after death. But when it comes to collectives being held in trust, there is a greater likelihood that access to the product will be required.

That is not, however, the main reason for there being fewer combinations of collectives and trusts. I believe the main reason (apart from the fact that most investment houses seem reluctant to stretch their offerings beyond the core fund proposition) is that the collective is capable of producing income and capital gains and this has to be managed.

One of the exceptions to this very broad generalisation is where the collective is held subject to a bare trust or is designated for the benefit of a child. A number of investment providers have made such packages available for a number of years.

The designation, or holding of the investment in a bare trust, ensures that the collective is outside the taxable estate of the investor, who would usually be a parent or a grandparent of the beneficiary.

The income will be assessed on the child. However, if it exceeds £100 gross in a tax year, the settlor is the beneficiary&#39s parent and the beneficiary is under 18 and unmarried, then it will all be assessed on the settlor.

But the capital gains – well, that&#39s a different, less complex and better story. Regardless of who the settlor is, the capital gains will be assessed on the beneficiary. With all the “excitement” building around the child trust fund and alternatives, this seems relevant.

An arrangement founded on a bare trust could, with the benefit of taper relief and the annual exemption, deliver tax-free growth and, save for any assessable income, could replicate the child trust fund structure. This is because, as under the child trust fund, the child will be absolutely entitled from outset and the only impediment to securing access to the funds will be minority.

For those parents whose children born before September 1, 2002 do not qualify for the child trust fund, the bare trust/designation of a growth-based collective would get close to the same thing. Even the investment when made would be a transfer for inheritance tax purposes, as would a transfer to a child trust fund, there being no specific exclusion.

But wait a minute, let us just check if there is anything in the proposals for consultation on trust reform that might cause us to think again about this strategy. What do we see but a proposal to align the treatment of capital gains and income under parental trusts for minor unmarried children.

It would have been nice to have seen the alignment of the income tax rules with the capital gains tax rules and the removal of the parental assessment rules, even if only for income that was not paid or applied for the benefit of children – in other words, restoring the position that existed before March 9, 1999.

But, no, it is alignment the other way that the Inland Revenue is interested in. This means the assessment of capital gains on the parental settlor while the beneficiary of the trust/designation is under 18 and unmarried. If this amendment is implemented, this will cause disappointment to those who use the annual exemption to manage bare trust investments in a capital gains taxfree way. The change, if it is implemented, will operate in respect of all parental trusts, whenever established.

Those whose strategy is based on long-term holding in a capital gains tax-friendly environment with investment flexibility – such as a fund of funds or manager of managers structure – may be more sanguine. After all, holding investments within such a structure with a view to encashment to meet the costs of higher education after the beneficiary&#39s 18th birthday will enable the combination of taper relief and the annual exemption to operate to deliver tax reduction or tax freedom on realised capital gains.


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