Gerry Brown, consultant with QB Partners, provides a quick overview of what constitutes as a bare trust, the benefits of this type of trust and how they can be used with clients.
What is a bare trust?
A bare trust is one in which each beneficiary has an immediate and absolute entitlement to both capital and income.
If a trust imposes conditions that need to be satisfied before the beneficiaries become entitled to the trust funds then it will not be a bare trust.
However if the terms of the trust simply defer payments until the beneficiary reaches a specified age it will be a bare trust.
Mrs A left her share portfolio to such of her grandchildren as were alive at the date of her death. Her will specified that the grandchildren were not to receive any payment until they respectively reached 21 years of age.
This is a bare trust. All of her grandchildren who were alive when Mrs A died are entitled to an equal share of the portfolio. There are no other conditions to be fulfilled. The deferral of payment until attainment of age 21 does not affect entitlement.
Mr B left £100,000 to ‘such of my grandchildren as survive me and attain age 21 years’. If any grandchild dies before age 21, his/her prospective share goes to the other grandchildren who do attain that age.
There are two conditions to be met before a grandchild becomes entitled to a shares of the £100,000:-
- they must survive Mr B; and
- they must attain age 21 years
The grandchildren have no immediate entitlement on B’s death. This is not a bare trust.
As the beneficiary has an ‘immediate and absolute entitlement to capital and income’ it must logically follow that the income generated on the trust fund is taxed as income of the beneficiary.
There is an exception to this treatment where the trust is a ‘parental settlement’.
In the context of bare trusts a parental settlement is one where a trust has been set up by a parent and the beneficiaries include their children who are unmarried and under 18 years of age. All of the income arising in such a trust is treated as income of the settlor where it exceeds £100 per annum.
Capital Gains Tax
Again because of the beneficiary’s immediate and absolute entitlement to capital ,any chargeable capital gains on assets in the trust fund are taxed as gains of the beneficiary. The beneficiary’s annual capital gains tax exemption could be set against such gains.
The ‘parental settlement’ rules do not apply to capital gains tax.
As the beneficiary has an immediate and absolute entitlement to capital, a transfer to trustees of a bare trust is treated ,for inheritance tax purposes, as a transfer to the beneficiary. It is therefore a potentially exempt transfer (PET). The value of the
trust fund is in the beneficiary’s ‘estate’ .
Inheritance tax 10 yearly and ‘exit’ charges are not levied on trustees of bare trusts.
Most bare trusts will be ‘express trusts’ and as such will be required to register unless they come within the specific exclusions.
Certainty v Flexibility
The key advantage of use of a bare trust is that it gives certainty – once a beneficiary has been selected he/she can’t be changed. The flip side of this certainty is the lack of flexibility. As flexibility is the main reason for using trusts, use of bare trust structures has largely, but not exclusively, been confined to providing gifts for minors – children or grandchildren.