There are different types of trusts. When someone mentions a ‘trust’ the usual reaction is to think of a separate trust entity that has trustees and owns and manages assets on behalf of beneficiaries.
This is the case with many ‘family trusts’ and in this case the trust is legally a completely separate entity from the beneficiaries and the settlor (ie the person who transfers assets to the trust), just as a company is legally separate from its shareholders.
The fact that the trust is a separate entity leads to many of the advantages of trusts (e.g. taking assets out of your estate for Inheritance tax purposes and making it more difficult for creditors to get their hands on assets held within a trust).
However, the separate legal entity principle also leads to some of the potential disadvantages of trusts such as the fact that income and assets are taxed in the hands of trustees, rather than the individual beneficiaries.
A bare trust can be a useful mechanism for holding the legal title to an asset whilst the capital gain (or part of the gain) arises on another individual.
Using the CGT annual exemptions
Let’s say you wanted to purchase some investments and were looking to maximise the use of annual exemptions. One option would be to gift cash to your children and for them to make investments as directed by you. They would have legal and beneficial entitlement to the investments and could therefore deal with the investments as they saw fit.
In addition, if your children were under the age of 18 they could not hold the investments in their own name.
You could consider establishing a trust, however this would not satisfy the key objective (which is to ensure that the annual CGT exemptions are offset) as the trust would itself only be entitled to offset half of the annual CGT exemption. In this case though if the beneficiaries were unmarried and aged under 18 the gains of the trust would be taxed on you in any case. Therefore, the downside to using a trust is that the various annual CGT exemptions won’t be offset. This is where a ‘bare trust’ comes into play. In this case you would own the legal interest on behalf of your children. They would therefore be absolutely entitled to the trust assets and income, and hold the full beneficial interest. Another way of expressing this would be that you/your wife would simply be nominees, holding the investments in name only.
As such in this case the beneficiaries of a bare trust have the right to take actual possession of trust property and should normally return the income and gains on their own personal tax returns (and you as the trustees would not be required to make a tax return).
Therefore, in tax terms, the use a bare trust is effective in that it allows the children capital gains allowances to be utilised against any future gains on disposal. The budget changes to both trusts and capital gains tax would not impact on this.
In the case of children aged under 18, you should ensure that you take detailed legal advice on the implications of using a bare trust.
In the case of minors, they would not be able to hold property personally and property has to be held on trust for them. In a trust where such a beneficiary has an ‘indefeasibly vested’ interest in the trust income and capital the trust is a bare trust and the income is classed as the beneficiaries irrespective of the fact that the trustee has duties to perform. Therefore, the bare trust analysis should still apply, thus allowing the children’s annual exemptions to be offset, providing any control that the parent had was limited.
Bare trusts can also be used to own property. You could therefore have the legal title held by the Father, but the beneficial interest held by the Son. In this case it would be the transfer of the beneficial interest by the Son that would lead to a potential tax charge.
It’s worth noting that whilst you can use a bare trust to allocate gains to other individuals (e.g. children) for income tax purposes this is not possible. There are anti avoidance rules that can tax settlements, and in this case any income that arose to the children (above £100) would be taxed on the parents.
Another issue is that unlike a ‘proper’ trust a bare trust does not bring into play the special inheritance tax regime for trusts. So, you could transfer substantial sums of cash to a bare trustee without this being a chargeable lifetime transfer for inheritance tax purposes. Instead it would be a potentially exempt transfer (‘PET’) and exempt after 7 years.
Turner Little can help you set up and manage Trusts. For more information, please visit our website, or call 01904 783101 to speak to one of our expert advisers.
