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Following Budget 2006 and the
subsequent Finance Act, bare trusts have become ’fashionable’ in
financial planning circles. However, changes to bare trusts
proposed in the Chancellors pre-budget report mean that they
will no longer be an efficient option when the beneficiaries of
the trust are children.
What is a bare trust?
Because a transfer to a bare trust
still qualifies as a potentially exempt transfer (PET) for
inheritance tax purposes and avoids the onerous relevant
property regime that applies to most other trusts. It is
therefore important to know what constitutes a bare trust for
inheritance tax purposes.
A statutory definition would be a
useful starting point but the IHT legislation refuses to be so
helpful. A bare trust is generally regarded as a trust which is
not a ’settlement’. Happily, the term ’settlement’ is
defined for inheritance tax purposes:
“’Settlement’ means any disposition
or dispositions of property,…whereby the property is for the
time being –
(a) held in trust for persons in
succession or for any person subject to a contingency, or
(b) (i) held by trustees on trust
to accumulate the whole or part of any income of the property or
(ii) with power to make payments
out of that income at the discretion of the trustees or some
other
person, with or without power to
accumulate surplus income, or
(c) charged or burdened (otherwise
than for full consideration in money or money’s worth paid for
his own use or benefit to the person
making the disposition) with the payment of any annuity or other periodical payment payable for a
life or any other limited or terminable period…”
[Inheritance Act 1984 section
43(2), for those keen to read it in its natural environment.]
So if an ’arrangement’ (to use a
neutral term) falls within the definition of a settlement it
can’t be a bare trust.
Bare Trusts with Children as
Beneficiaries
What happens if a beneficiary of
the purported bare trust is under 18 - a ’minor’ or ’infant’ in
legal terms? If the trust fund (property) generates income then
Trustee Act 1925 section 31 would be in point:
(1) “Where any property is held by
trustees in trust for any person for any interest whatsoever,
whether vested or contingent, then, subject to any prior
interests or charges affecting that property
(i) during the infancy of any such
person, if his interest so long continues, the trustees may, at
their sole discretion, pay to his parent or guardian, if any, or
otherwise apply for or towards his maintenance, education or
benefit, the whole or such part, if any, of the income of that
property as may, in all the circumstances, be reasonable, …”
This empowers the trustees to uses
the income for the benefit of the beneficiary, but what happens
to income not so used? The Trustee Act 1925 section 31 goes on
to provide that:
(2) “During the infancy of any such
person, if his interest so long continues, the trustees shall
accumulate all the residue of that income by investing it, and
any profits from so investing it from time to time in authorised
investments, and shall hold those accumulations as follows:
(i) If any such person
(a) attains the age of eighteen
years, or marries under that age, or forms a civil partnership
under that age and his interest in such income during his
infancy, or until his marriage or his formation of a civil
partnership, is a vested interest; or
(b) on attaining the age of
eighteen years or on marriage, or formation of a civil
partnership, under that age becomes entitled to the property
from which such income arose in fee simple, absolute or
determinable, or absolutely, or for an entailed interest; the
trustees shall hold the accumulations in trust for such person
absolutely … ;
(ii) In any other case the trustees
shall, notwithstanding that such person had a vested interest in
such income, hold the accumulations as an accretion to the
capital of the property from which such accumulations arose, and
as one fund with such capital for all purposes … but the
trustees may, at any time during the infancy of such person if
his interest so long continues, apply those accumulations, or
any part thereof, as if they were income arising in the then
current year.”
Thus, in summary, where there is a
minor beneficiary the trustees can either:
(1) apply the income for the benefit of
the beneficiary, or
(2) accumulate any income not so
applied and if required apply it for the benefit of the
beneficiary in later years.
The above analysis is based on
English trust law – equivalent considerations apply to trusts
governed by the law of Scotland or Northern Ireland (bearing in
mind that the age of majority in Scotland for the purposes of
the legislation is 16).
And here comes Gordon Brown…
HM Revenue & Customs (HMRC) has now
thrown a spanner in the works! HMRC has suggested that in view
of the ability to accumulate income [(2) above],
purported bare trusts for minors are not, as a matter of law,
bare trusts but are settlements. This conclusion would have
unattractive IHT consequences!
Candour Consultancy does not accept
the HMRC analysis. In common with most life offices and tax
barristers we believe that the Trustee Act 1925 use of the word
’accumulation’ does not confer a power to accumulate
income but provides merely an administrative convenience
enabling undistributed income to be retained. A subtle but
important distinction!
The Association of British Insurers
(ABI) has made strong representations to HMRC on this issue but
currently HMRC seems reluctant to change its view and is still
considering the position before issuing final guidance.
What should we do?
In the circumstances it would seem
sensible to consider deferring establishing bare trusts where
any of the intended beneficiaries is a minor until the tax
position is clear. Bare trusts could continue to be used where
all the beneficiaries are adults.
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