Gains in bare trusts

[mbs1986]

My recently deceased nan placed a sum of money in a bare trust for the benefit of my mum and uncle in the form of an offshore life assurance policy. The initial payment was over 7 years prior to death and so a potentially exempt transfer. IHT was not paid on this sum. The trust provider did not confirm anything other than the current value of the trust. The trust provider was utterly useless and a nightmare to deal with. After lengthy delays, I was able to surrender the trust and get the money out which has now been paid to the beneficiaries. However, several months later, I received a surprise letter from the trust provider confirming a chargeable gain amount. It transpires that nan had set up a regular monthly withdrawal, the total of which coincidentally was almost exactly the same as the gain amount but did not exceed the 5% rule. Any of this sum that was in her savings or current account at the time of death would have been subject to IHT. I have been researching and trying to understand the tax rules around bare trusts but they are unecessarily complicated. The questions I have are:

1) Is tax due on the chargeable gain amount even though none of it was available to the beneficiaries and IHT has potentially been paid on it as savings?
2) If tax is due, who is liable? Beneficiaries or the estate?

Many thanks in advance

Matt

[AGoodman]

It sounds as though this wasn't a straightforward bare trust but probably a discounted gift trust:

https://www.mandg.com/wealth/adviser-services/tech-matters/iht-and-estate-planning/discounted-gift-trust/discounted-gift-trust

[mbs1986]

I believe you are correct, this is indeed a discounted bare trust. My questions still stand though. The various resources seem to suggest that the tax on any chargeable gains sits with the beneficiaries but it doesn't seem right that the beneficiaries should pay tax on a sum that they never received or benefitted from in any way, essentially eroding the original gift by a significant amount. I suppose that the response is nothing seems sensible or fair when it comes to taxation but it would be good to establish a trace of logic.

[AGoodman]

The tax is payable on the increase in value of the underlying bond and your nan could only ever take out the original value she put in (in 5% tranches).

On that basis, the beneficiaries should only be paying tax on a chargeable event gain of (at most) the money they receive.

i.e. nan bought the bond for £100. She took out £25 over five years, but it also grew in value by £20, leaving the bond with a value of £95. When encashed, it realises a gain of £95 - (100-25) = £20.

The beneficiaries receive £95 and an income tax liability calculated on a gain of (approximately) £20 at their marginal rate.

Given the beneficiaries' tax will always be less than the sum they are receiving (and you have distributed this to them), I'm not sure I understand your comment that they are paying tax on a sum they never received.

[mbs1986]

Thank you for the reply and sorry if I'm being a bit thick here but I don't get it. So if I take an extreme example, lets say she put in £100k and it grew by £250k over the years and she took £250k out at less than 5% over the years (appreciate this is a lot of years and a fantastic investment). The beneficiaries then receive £100k when it is surrendered but the chargeable gain is £250k and the tax on this would be say £100kish leaving the beneficiaries with nothing or potentially even out of pocket whereas if she had gifted them the original investment amount and they had themselves grown it by 250k, they would have kept the original 100k and the untaxed amount on the 250k leaving them much better off. I am therefore failing to see the tax efficiency of the scheme? Or perhaps I am misunderstanding the calculation? If you were to tell me that the deceased would be liable for the income tax on her drawings upon surrender of the trust, this would make a lot more sense to me, albeit we have already paid inheritance tax on whatever was left of it.

[AGoodman]

The originator is only able to take out up to 100% of the original premium tax free (20 years @ 5% p.a.). If the terms of the scheme allow them to take more then as soon as they exceed 5% per year, or 100% of the original premium, the originator would be taxed on the gain.

In your example it would take 50 years to take out £250k at £5k per year and the originator would be paying income tax on the gains from year 21 onwards.