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Bare trust returns Synopsis: HMRC claim that most tax returns for bare trusts are completed incorrectly. Date posted: 3.8.10 In the June 2010 Newsletter for Trusts and Estates Practitioners, HMRC Inheritance Tax and Trusts claim that, following a small review conducted within its division, they concluded that over 80% of tax returns completed for bare trusts were found not to be for bare trusts. The rules are quite simple. Trustees of bare trusts do not need to make a tax return. The trustees may pay the tax due to HMRC on behalf of a beneficiary of a bare trust but it is the beneficiary who is chargeable to tax. Where a bare trust is created there is no need to complete Form 41G (Trust) which may be required for other trusts. The beneficiaries are taxable on the trust income and gains. The beneficiaries must include trust income and gains in any tax return they are required to complete or in any Form R40 used for claiming repayment of tax. So, if the rules are so straightforward, is the problem in the understanding of what actually constitutes a bare trust? Again, the principles seem straightforward enough. A bare trust is one under which both capital and income are held for the absolute benefit of the beneficiary, normally a minor child. It is possible that problems may arise where trusts are created in wills without using specific express words such as 'absolute trust' or 'bare trust'. Problems may also arise with the interpretation of a trust where certain conditions are imposed on the entitlement of the beneficiary. These will not always point to a straightforward outcome. Even the guidance issued by HMRC in their Manual sometimes appears to be contradictory. For example, HMRC refers to a 'bare or simple trust' as one in which each beneficiary has 'an immediate and absolute entitlement to both capital and income and has the right to take actual possession of trust property'. On the other hand, HMRC also treats a trust as a bare trust even where the terms of the trust defer payment until the beneficiary reaches a particular age. Here HMRC makes a distinction between the terms of the trust that impose conditions that must be fulfilled before the beneficiaries become entitled to the trust fund, and the terms which merely defer payment until the beneficiary reaches a particular age.

Technical

This information is based on our understanding of applicable law and HMRC practice as at the date each paper was posted, and has been produced for general information only. Action should not be taken, or refrained from, based on the contents of this information alone. The rules, tax rates and regulations that apply may well change in the future. As all clients have different personal circumstances, the precise recommended course of action for each particular client can only be considered in the light of individual circumstances. Prescient Financial Intelligence Limited is authorised and regulated by the Financial Services Authority.

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The first example from the HMRC guidance is a trust under a will where the residue of the estate is left to grandchildren who are alive at the date of the death of the testatrix. However, the will directs that the funds should not be paid to the grandchildren until they respectively attain age 21 years. The question is therefore: are the beneficiaries entitled straight away or is their entitlement effectively deferred until they reach age 21? In the eyes of HMRC, all of the grandchildren who are alive when the grandmother dies are entitled to an equal share of the residue of the estate. There are no other conditions that they must fulfil before they become entitled. In HMRC's view the direction about payment does not affect the basic position and the beneficiaries have a vested interest and therefore the trust is a bare trust. On the other hand, if the will provision was 'to such of my grandchildren as survive me and attain age 21 years' the conditions for the grandchildren to benefit would be that they must survive the testatrix and that they must attain age 21 years. In this case the grandchildren do not take an immediate vested interest and will not take unless and until they attain 21. This is therefore not a bare trust. HMRC also clarifies in their guidance that even where, under an English trust, section 31 Trustee Act 1925 applies during a child's minority and therefore the trustees have discretion over the use of income for the benefit of the minor and must accumulate the balance, where the beneficiary's entitlement to income is indefeasible, the income is the beneficiary's as it arises and they will not tax the trust as a discretionary trust. Comment Understanding the nature of a trust is fundamental, not just in order to ensure correct reporting for tax purposes but, also, to ensure that the trust is administered correctly and for the right beneficiaries. As can be seen from the HMRC research, even what may appear to be a straightforward question will, in practice, often be misunderstood or misinterpreted. Clearly, the crucial question to ask with regards to the beneficiary's right under a trust is: is the trust fund indefeasibly vested in the beneficiary? If it is, the trust will be a bare trust.