The Bare Bairns

BARE TRUSTS ARE not real trusts in the usual sense because the beneficiary or beneficiaries are absolutely entitled to the income and capital of the trust fund from the beginning. The trustees hold the trust fund as mere nominees.
Such bare trusts can arise in various circumstances, such as the minority or other disability of the beneficiary; interim arrangements where a full trust (e.g. a life interest) has terminated and the trustees who are now bare trustees are making arrangements to transfer the net trust fund to the beneficiaries absolutely entitled; and joint ownership by way of 'trust'. (See also the statutory definition of bare trusts in the controlled foreign companies provisions at section 752C(7), Taxes Act 1988.)
Income tax position pre 9 March 1999
Bare trusts for a settlor's minor children resulted in an anomalous but highly advantageous income tax quirk being very much in the taxpayer's favour due to the tax legislation, particularly section 660B, Taxes Act 1988 and the then Revenue practice. These advantages were not affected by section 120, Finance Act 1998 (which introduced the uniform trust capital gains tax rate of 34 per cent) because the income was not subject to accumulation or discretion.
The applicable circumstances arose where income accrued to a minor child of a parent (say a son) under a so called bare trust whereby the infant was entitled from the outset and irrevocably to the income so generated (and probably also the capital). Thus the child had an indefeasibly vested interest in the income and usually also the capital of the trust. It was an essential feature (subject to the closed loophole referred to below) that neither the income nor the capital was paid or applied for his benefit during his minority, the relevant income being de facto accumulated and on the basis that the infant was not able to give a valid receipt. If capital rather than income was so applied, this would not be a valid argument against tax liability (apart from the closed loophole), because, under the provisions of section 660B(3), to the extent that income arose, a capital application was treated as being an income distribution.
Section 64, Finance Act 1999 has closed a loophole as from 9 March 1999 which was inadvertently added when the legislation was simplified in 1995. This allowed income accumulated within the trust, which had been treated as the minor child's income, to be extracted from the trust without triggering a tax charge – see also Re Delamere's Settlement [1984] 1 All ER 584.
Given this treatment, the trustees having no legal right to accumulate the income, any income was then treated as the minor beneficiary's income and not the parent's under section 660B, Taxes Act 1988. Assuming the child had no other assessable income, the bare trustees were able to make an income tax repayment claim, adding the sum to the trust fund held for the infant's benefit. An infant, being a taxpayer in his own right, has a personal allowance of £4,385 (2000-2001).
These bare trusts were often of a very simple nature and generally a separate bare trust was created for each child – see the precedent set out below.
There also existed many marketed savings schemes designed by the financial industry to exploit the loophole that has been closed from 9 March 1999, as explained below.
Income tax position as from 9 March 1999
From 9 March 1999 new bare trust arrangements are caught by the new provisions and therefore income arising will be taxed as that of the parent settlor under section 660B, Taxes Act 1988 whether accumulated or not (subject to the £100 statutory limit). This had been a recommendation in the Consultative Document on United Kingdom Trusts of March 1991.
This change (i.e. assessment on parent) also applies to any income arising to funds added on or after 9 March 1999 to existing trusts. Such income will be taxed as the income of the parent (again subject to the £100 limit). Trust funds in place pre 9 March 1999 continue to benefit.
Continuing tax benefits
Such bare trusts have had and continue to have important capital gains tax advantages.
Chargeable gains are treated as the infant's gains at his or her rate(s), if any. Moreover the infant will have the full individual small gain exemption (2000-2001 £7,200); trustees normally have only one half thereof.
Furthermore, such bare trusts need to be contrasted with formal trusts, such as accumulation and maintenance, interest in possession or discretionary trusts where there is a 34 per cent capital gains tax liability when the beneficiary becomes absolutely entitled, for example on attaining a specified age, on disposal of assets, or on the exercise of trustees' discretion. By contrast, in the case of a bare trust the beneficiary owns the capital from the setting up of the trust so that the attainment of any specified age or exercise of any particular discretions will not be an issue. This therefore avoids the so-called 'time bomb' trust problems that exist for formal trusts where the entitlement to capital vests at a later date from income, e.g. at age 21, or 25 or possibly in the trustees' discretion. In that event, attainment of the age or the exercise of the discretion would give rise to a capital gains tax liability on the beneficiary becoming absolutely entitled, where an entitlement to income had already vested at an earlier age, say 18.
The tax on such deemed disposals is at 34 per cent (subject to possible holdover under section 165, Taxation of Chargeable Gains Act 1992 in which case there is likely to be taper relief disadvantage as holdover stops the taper period from running).
It is possible to overcome the new rules, by having a bare trust fund consisting entirely of non-income producing assets, e.g .quoted 'capital' shares nil yield unit trusts (e.g. Far east units), unquoted shares which do not have dividends declared on them, secondhand endowment policies, zero coupon preference shares.
Bare trusts and wills
Where a minor is to be entitled to income and/or capital under a will, the use of a bare trust can continue to have substantial income tax and capital gains tax advantages. The assessment to income tax on the parent will not arise under section 660B, Taxes Act 1988 as amended because, by definition, the parent testator is dead. If a bare trust has been set up under the will, the income and gains are those of the minor child. Contrast such a bare trust bequest with a will trust where there is a minor beneficiary entitled to a gift contingently on attaining 18 or at a later age. As the beneficiary only has a contingent interest in the income before the age of 18 two main disadvantages result.
First, up to the age of 18 the trustees must pay the 12 per cent income tax surcharge which applies in most cases but in the case of dividends the rate can be 15 per cent.
Secondly, there would be no possibility of repayment claims for the beneficiary, except insofar as the income is paid or applied for the beneficiary's maintenance, education or benefit.
A compromise solution may be to give the beneficiary only a vested interest in the income as soon as it arises, ie on the death of the testator, with the result that, although he only has a contingent interest in the capital, the income will be regarded as his and consequently the trustees will only be taxed at 20 per cent or 22 per cent and repayment claims may be made on behalf of the beneficiary, whether or not the income is de facto accumulated or paid for his maintenance, education or benefit. Consider the further advantage of giving the beneficiary an immediate interest in the capital. The capital gains tax time bomb problems referred to above are thereby also avoided.
There is an inheritance tax danger if the beneficiary dies before obtaining a vested interest in capital with income entitlement meanwhile; this involves termination of an interest in possession and consequently inheritance tax liability (but this could be insured against).
Bare trusts in a will may also be unacceptable for family reasons.
Non-parental trusts
Bare trusts set up by grandparents (or persons other than parents) will not suffer from the anti-avoidance legislation. The income of unmarried minors of the bare trust will be the grandchild's with his own personal allowance.
As regards inheritance tax there is no liability on the trustees as the beneficial ownership is entirely that of the beneficiary. This is subject to sections 199(1)(c) (lifetime) and 200(1)(c) (on death), Inheritance Tax Act 1984 whereby the trustees can be accountable or liable for the tax as the property is vested in them.
Precedent
THIS DEED is made the day of 2000 BETWEEN of ('the Settlor') of the one part and of ('the Bare Trustees' which expression shall where the context so admits include the Bare Trustees or Bare Trustee for the time being of this Bare Trust) of the other part.
WHEREAS:
The Settlor wishes to transfer the property specified in the Schedule hereto and any additions thereto as he shall from time to time make ('the Property') to the Bare Trustees TO HOLD the same UPON TRUST for the Settlor's grandchild ('the Infant') born on absolutely.
NOW THIS DEED IRREVOCABLY WITNESSES as follows:-
1. The Settlor HEREBY DECLARES that he [will] [hereby] transfer[s] the Property to the Bare Trustees TO HOLD the same UPON TRUST for the Infant absolutely.
2. The Bare Trustees HEREBY AGREE that they will at the request and cost of the Infant transfer the property to such person or persons at such time or times and in such manner or otherwise deal with the same as the Infant shall direct or appoint provided that the Infant shall not then be under any disability.
3. 3.* Section 31 of the Trustee Act 1925 shall be excluded from applying to this Settlement and the Infant shall be absolutely entitled to any income arising from the Property.
4. The standard provisions of the Society of Trust and Estate Practitioners (1st Edition) shall apply with the deletion of paragraph 5 PROVIDED that these provisions shall not have effect so as to conflict with any of the terms of this Bare Trust particularly (but without prejudice to the generality of this PROVISO) as regards Clause 1.
5. IT IS CERTIFIED that this instrument falls within Category L in the Schedule to the Stamp Duty (Exempt Instruments) Regulations 1987.
IN WITNESS whereof the parties hereto have signed this instrument as their Deed the day and year first before written.
THE SCHEDULE
SIGNED and delivered as a DEED
by [the Settlor] in the presence of:
SIGNED and delivered as a DEED
by [Trustee] in the presence of:
SIGNED and delivered as a DEED
by [Trustee] in the presence of:
NOTE re Clause 3 (section 31, Trustee Act 1925).
Some practitioners take the view that section 31 need/should not be excluded for the following main reasons:-
? The section applies to property held for any person for any interest whatsoever vested or contingent (including an absolute interest).
? Section 69, Trustee Act 1925 provides in effect that the provisions of section 31 apply so far as not inconsistent with those of the trust instrument.
In the case of a bare trust therefore section 31 ceases to be limitational and assumes the character of a mere administrative authority – not dispositive.
NEVERTHELESS in the case of a bare trust the writer prefers on balance to exclude section 31 the income belong as of right to the beneficiary.

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