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Matthew Hutton MA, CTA (fellow), AIIT, TEP highlights a potential Inheritance Tax problem involving bare trusts.

Context

It appears that HMRC are not going to produce guidance specifically dedicated to Schedule 20, Finance Act 2006, but rather are going to feed additional material into the existing IHT Manual.  This is a pity.

Bare trusts for minors: HMRC’s answer to Question 33

HMRC’s response to Question 33 remains of concern.  In a letter to STEP/CIOT on 8 December 2006, HMRC indicated that Question 33 in the joint letter by STEP and ClOT sent to HMRC on 7 September 2006 requested confirmation that the application of Trustee Act 1925, s 31 to assets held on a bare trust for a minor would not result in the assets being settled property within the meaning of IHTA 1984, s 43.

In a letter dated 8 December 2006, HMRC indicated that:

‘where s 31(2) Trustee Act 1925 applies:

• a trust of this type cannot be a bare trust, on the basis that the trustees will have active duties to perform; and
  
• It is arguable that it would be a ‘trust to accumulate the whole or part of any income’ within s 43(2) IHTA.’

In addition, the view was expressed that the position would be the same even if the statutory power had been excluded, since the incapacity of the minor would mean that the trustees would have to accumulate surplus income de facto, or as part of the due administration of the trust.

On 20 December 2006, a strong response was made to HMRC, the outcome of which remains to be seen.  The basis of HMRC’s views seems to be that the trustees of such a trust have ‘active duties’, regardless of whether Trustee Act 1925, s 31 applies.

Clearly, if HMRC do finally confirm their view that such a trust is a substantive settlement for IHT purposes, there will be strong opposition from the professional bodies.  Certainly, HMRC have always accepted that such a bare trust is not ‘settled property’ for CGT purposes – though of course the definitions of ‘settled property’ for CGT and ‘settlement‘ for IHT are different. 

CIOT’s website now carries a revised version of the exchange, with the following important note after HMRC’s answer to Question 33.  ‘Practitioners should note that HMRC are considering whether any property held for a minor can be held on a bare trust or whether all property held for minors must necessarily constitute settled property EVEN IF s31 is excluded.  Separate representations and discussions are taking place on this between CIOT/STEP and HMRC but until further clarification is obtained, clients should consider the position carefully when transferring any assets to minor children unless they are certain that they wish such assets to be settled property with all the inheritance tax consequences this will involve.’

The importance of excluding Section 31

Death is generally a good CGT planning opportunity (!), with its CGT free uplift to market value.  Do remember, however, that death does not necessarily bring complete freedom from IHT.  There could for example be the recapture of previously held-over gains under TCGA 1992, s 74(2), subject however to the possibility of further hold-over, whether under s165 as business assets or s 260 as the occasion of a chargeable transfer for IHT.  Generally therefore it will only be where a UK domiciled spouse inherits non-business assets that there’s going to be an actual CGT liability. 

But what happens when a trust ends inter vivos?  It will generally be important to ensure the possibility of hold-over for CGT purposes.  And this is of course one respect in which there is a significant difference between an IPDI (no hold-over, though generally a PET if a person becomes absolutely entitled, except where this is the beneficiary, when there will be no IHT implications) and absolute entitlement under a s 71D trust (with hold-over, albeit subject to an s 71E charge to IHT at a rate between 0% and 4.2%).

Assume that a testator generally wishes to provide for capital to go to his children at age 25.  But, depending on the ages of his children at the date of his death there may be significant tax differences.  Suppose on death the testator’s children are as follows: Amelia aged 20, Bertie aged 17 and Caroline aged 14.  If they are given a right to income with capital at 25, Amelia will in any event have an IPDI.  The same will be true for Bertie: under new s 144(6) there is a reading back for trusts if they would, had they been established by the Will, have resulted in either an IPDI or s 71A or s 71D applying to the property.  In such case, s 144(4) provides that IHTA 1984 has effect as if the Will had provided that on the death the property should be held as it is held after the event (ie even if, for Bertie, s 31 is not excluded).  Whether Caroline has a IPDI will depend on whether s 31 is excluded.  If it is, she will have an IPDI.  If it is not, then Caroline at least would be entitled only under an s 71D trust, with the prospect of IHT charges arising on exit applicable to the period between her attaining age 18 and the date of absolute entitlement – but with the ability to hold over any gain. 

This is a drafting point.  On the basis that the testator will want to treat each of his children equally, s 31 should perhaps be excluded for all.

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