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What is a bare trust?
A bare trust is the simplest form of trust. It is basically a nominee agreement.
Essentially, the bare trustee holds legal ownership on behalf of the beneficiary absolutely. The beneficiary has an immediate and absolute right to both the trust capital and the income received by the trust from that capital.
A person who creates a bare trust know that the assets they have set aside for the beneficiary will go directly to them. The Trustees have no discretion and the beneficiaries cannot be changed.
The most common use of a bare trusts is to hold assets on behalf of minors. For example, a minor cannot hold land or shares. As such, the bare trustee will hold the assets on bare trust until the beneficiary reaches age 18.
At this point, the beneficiary can demand that the Trustees hand over the assets. So be warned!
Note, recent tax case law has confirmed that a bare trust does not need to be created by written agreement.
As stated above, the assets of the bare trust are held by the bare trustee on behalf of the beneficiary who is absolutely entitled to the income and capital of the assets.
As such, the income and any capital gains are directly taxed on the beneficiary. They will need to put this income on their personal tax returns under the normal self-assessment rules. Note, there is no need to fill in the trust pages on the tax return.
An exception to this might be where the parents have transferred income-producing assets on to bare trust for minor children.
Although trustees can pay income tax on behalf of a beneficiary, it is still the beneficiary who is liable for the tax.
Capital Gains Tax is payable on the gains on assets held on bare trust. Who is liable for paying tax?
The analysis is the same as that set out above. The assets and the gain belong to the beneficiary of the bare trust and he or she will therefore be liable to tax.
He or she will get the benefit of the Annual Exemption and, potentially, other CGT reliefs that may be in point. Any gains will be subject to the usual rates of CGT.
Again, the beneficiary must declare any chargeable gains on their personal Self-Assessment tax return.
Essentially, a transfer of an asset on to bare trust is the same as an outright gift to a person. However, rather than transferring the legal ownership to the done, the donor has transferred it to a third party (or may be acting as bare trustee themselves).
As such, for Inheritance Tax purposes, assets placed in a bare trust are treated as Potentially Exempt Transfers. This means that if one survives the gift by 7 years then one is home and hosed and there is no tax. However, if you die within 7 years then the gift is added back to your estate. There is some consolation if one dies between 3 – 7 years in that the tax payable is ‘tapered’.
Otherwise, the beneficiary is the beneficial owner of the asset and it will be dealt with in their estate.
Again, one should check the availability of any reliefs that might be applicable to either the donor or the beneficiary depending on the circumstances.
If you have any queries about the taxation of bare trusts, or trusts in general, then please get in touch.