Much has been made recently of the tax benefits of bare trusts. What is a bare trust and what are its benefits?
A bare trust is simply a trust where property is held by the trustees for the absolute and indefeasible benefit of the beneficiary.
The beneficiary, on attaining the age of majority, is entitled to both capital and inc ome. They may demand that the trust fund be transferred to them at any time from age 18.
The most common use of a bare trust is where an investment is to be made for the benefit of a minor child. For example, a parent or grandparent may wish to make a gift to their child or grandchild and for that gift to take the form of an investment such as a unit trust.
A bare trust, where assets are vested in trustees' names for the benefit of a named individual, does not need to have a formal trust deed. In the above example, the investment would be made in the name of the parent or grandparent but be designated as for the benefit of the child or grandchild.
Regardless of the investment vehicle, the tax position of a minor child and the donor may be complex. Specific advice should always be sought. Generally, how are income-producing investments held under a bare trust treated for tax purposes?
Income exceeding £100 in the tax year from any assets given by a parent to a minor unmarried child is normally treated as the parent's income, by virtue of the anti-avoidance provisions contained in section 660B ICTA 1988. This, however, is not the case where the income is not paid or applied to or for the benefit of the child.
Thus, where investments are held under a bare trust, and to the extent that the income is retained by trustees, the income will be treated as that of the child and not the parent. Distributions from a unit trust will not be treated as the parent's income if they are either reinvested or paid to a trustee account.
Consequently, no income tax will be payable. Indeed, tax credits for this tax year may be reclaimed until April 5, 1999 where the child's total income does not exceed the personal allowance.
It should be noted that not only must the income be retained by the trustees but so must the capital. If any capital is paid to the child then, to the extent that income has arisen at any time previously, the capital payment will be treated as income and a tax liability will be incurred by the parent.
It can be seen that, in some circumstances, a non-income-producing investment may be more appropriate.
Where the assets are placed in the bare trust by the child's grandparent or anyone other than their parent, these anti-avoidance provisions do not apply and any income will be treated as that of the child.
Turning to capital gains tax, there is no legislation treating gains as those of the parent. However, any gains made on the disposal of assets by the trustees will be aggregated with those of the child, who will have his or her own annual exemption available to offset or reduce the gains arising.
It is to be noted that the full exemption is available rather than the one-half exemption that is generally available to trustees. This is set at £6,500 for 1997-98.
Contrary to the view expressed by many in the investment industry, the Inland Revenue has confirmed that an irrevocable designation of a unit trust investment for someone other than the unitholder constitutes a bare trust and, thus, has the income and capital gains tax effects described above.
Subject to any changes announced in the Budget, therefore, a simple and tax-effective form of investing for children can be achieved using irrevocable designations. This applies equally to unit trust administration services as well as unit trusts themselves.