Last week, I ended in Michael Caine mode. No, you weren't supposed to blow the bl*@!y doors off. But you were made aware that there is a proposal (on which consultation was sought) to align the tax treatment of capital gains under bare trusts, established for the benefit of minor unmarried children by their parents, with the tax treatment of income in excess of £100 gross in a tax year under such trusts. Not a lot of people know that.
Okay, a tenuous link to the Cockney thespian but the point is an important one, don't you think? Of course, the change would also extend to designations.
Financial planners will have to think about what, if any, impact this change would have if it were implemented.
The most obvious consequence is for plans based on a growth-oriented collective being held in a bare trust with a view to capital gains falling within the child's annual capital gains tax exemption, regardless of their age or marital status. As it stands, for most investors, this rule ensures that capital gains can be made in the course of fund management and kept within the annual capital gains tax exemption, regardless of whether the parent has any exemption to use. As far as capital gains go, this structure can be equated to a kind of children's Isa.
If this rule changes and gains are assessed on the parent during the child's unmarried minority, how much does this diminish the utility of the strategy? Well, not at all if the parental settlor has an unused annual capital gains tax exemption. In this context, you should be aware of, say, a conditional gift from a taxpaying settlor using their annual CGT exemption to a non-CGT-paying settlor to facilitate a parental settlement under which capital gains will be assessed on the spouse who has an intact annual exemption. Genuinely unconditional gifts would be worth considering, however.
Leaving aside this opportunity, the key will be the extent to which the annual exemption will have been used in the management of the investment up to the child reaching the age of majority.
If investment is into a structure that encourages long-term holding with investment flexibility, such as a fund-of-funds or manager-of-managers structure, then the need to use the annual exemption to exempt gains realised in investment management through capital gains-taxable realisations may be minimised or even removed.
Of course, one would not choose such a structure purely to avoid having to use the annual CGT exemption to frank realised gains but it is useful. Investors would, of course, look at investment performance, style, choice, flexibility and cost – to name a few factors – before choosing.
However, it is important to note that, apart from the potential investment qualities of the multi-manager structure, the structure does enable effective capital gains management – in other words, deferral. The outer shell enables disposals and rebalancing inside the shell to take place CGT-neutrally.
This, in turn, enables an investor to accrue a healthily long ownership period for taper relief purposes. With taper relief enabling gains to be reduced by 40 per cent after 10 years, this is not to be sneezed at. As I have said many times, taper relief applies before the annual exemption, which has the effect of stretching it – the exemption, that is. Maybe the increasing momentum that is getting behind manager-of-managers and fund-of-funds structures will result in the average holding period for investments improving.
This leads us to consider that children's investment strategies to provide for, say, the burgeoning costs of higher education, founded on collectives held in bare trusts or designated for children by their parents, may not be too adversely affected by the proposed change addressed in this article.
After all, if the investment structure used is one that enables investment management within a single outer shell, for example, a fund of funds or manager of managers, then the deferment of any realisable capital gains until the child is over 18 – say, when they first go to university – would neatly sidestep any new provisions. Gains made after the child's 18th birthday or earlier marriage will be assessed on the child.
It is also worth mentioning, though, that neither the income tax anti-avoidance rule (the £100 rule) nor the proposed new CGT rule apply where other than the parent of the beneficiary is the settlor.
However, those parents who are considering “funding” their own parents (the child's grandparents) to enable them to make the gift ought to be made aware of the wide definition of settlor for the purposes of income tax and capital gains tax (and common definitions are on the trust tax reform agenda, anyway) before getting carried away with any thoughts of easy avoidance.
In closing, I would like to remind advisers of the importance of awareness of the rules in connection with children's investments in the run up to the launch of the child trust fund and the inevitable increase in interest in the subject that will be sparked by the Government noise around the child trust fund at the start of 2005.