The Bare Necessities – What Bare Trusts Mean For You

A bare trust (sometimes called a simple trust) is one in which trustees hold property for the beneficiary, with all capital and income derived from it belonging to the beneficiary by immediate and absolute right.

The most common use for bare trusts is to settle property on minors (under 18 years of age in England and Wales). The trustee has no discretion in the trust, and must surrender the property to the beneficiary on demand if there is no legal disability, for instance on attaining majority. A bare trust may have one or more beneficiaries, usually but not necessarily having an equal interest, but once the trust is established the beneficiaries cannot be changed. A later child, for instance, cannot be added; rather, a new trust fund would need to be established.

In the case of bare trusts for minors, any family member, or even a friend, can provide capital for a trust. However if the trust is set up by the parents, the tax situation can become more complex as Income Tax, Capital Gains Tax and Inheritance Tax all have specific rules which must be considered.

This is where bare trusts become most contentious; in some family cases, such trusts are set up by a husband so as to exclude his wife, in case of marital disharmony down the road. They would be called a ‘discretionary trust’ or some other vehicle which creates a smokescreen behind which the husband can hide his assets. Judges are able to look past the structure of the settlement on divorce, and conclude that all the assets are attributable and available to the husband, and therefore also available for distribution between the parties.

However, more commonly, bare trusts will be established by grandparents, either as a lifetime settlement or is as inheritance in a will. In the case of a lifetime gift, the transfer is potentially exempt from Inheritance Tax, which would only be payable should the donor die within seven years.

Disposal of any assets accruing capital gains would be liable for Capital Gains Tax, although the standard annual exempt allowance (currently £10,600) applies for minors. Any Capital Gains or Inheritance Tax due is treated as the liability of the beneficiary, but is discharged by the fund’s trustee from the trust fund.

It is when a bare trust fund generates an income that matters become more complex. Usually, any income is treated as belonging to the beneficiary, and for minors income of less than £100 per annum is exempt from Income Tax. If this allowance is exceeded the beneficiary’s marginal rate applies on all of the income. This rate can be advantageous compared to Income Tax applied to other types of trust.

However, in the case of a parental bare trust, the income is deemed for tax purposes to belong to the settlor, ie the parent. This must be accounted for in the parent’s tax returns and it will be taxed at their marginal rate. In this case it may be of benefit to vest the fund into assets which accumulate capital rather than generate an income. In any case, a parent looking to set up a bare trust for their child needs to consider the overall tax situation to avoid any unpleasant surprises.

Although bare trusts are predominantly used to benefit minors, they can also be used for transferring property between spouses to take advantage of individual tax allowances for capital gains and income, and to separate legal and beneficial title for more efficient tax planning. In these cases professional advice should be sought.

 

© Punam Denley, November 2012

 

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