What is a Bare Trust?
A bare trust is one where the person who benefits from it (referred to as the beneficiary) has an immediate and absolute right to the assets that are transferred to the trust and any income generated by them.
The assets transferred into a bare trust are known as “trust property” or the “trust fund”. The trust fund is held in the name of the trustee, who may (but doesn’t have to) be the person who sets the bare trust up. Usually, there are two trustees involved; often the person setting up the trust and one other.
A person setting up a bare trust can be certain that the assets they set aside for the beneficiary will go to that person because once the trust has been created, the beneficiary cannot be changed.
As the beneficiary has an immediate and absolute right to the trust fund, the trustees have no discretion over the trust fund and must simply follow the (lawful) instructions of the beneficiary in relation to it. The beneficiary can therefore instruct the trustees to transfer the trust fund into his name at any time. Until then however, the trust fund will remain in the name of the trustees. On the death of the beneficiary, the trust fund will form part of his estate and will be distributed according to the terms of his will, or by the laws of intestacy if there is no will.
A bare trust is usually evidenced by a trust deed which will set out the parties involved (i.e. the person setting the trust up, the trustees and the beneficiary) and what assets are being transferred into it. The trust deed is signed by the person setting the trust up and the trustees, but not by the beneficiary.
A transfers £1,000 to himself and B on a bare trust for C. In this scenario, A and B are the trustees and C is the beneficiary. The money is held by A and B (preferably in a separate account from their own personal accounts) until C instructs them to transfer it to him. In the meantime, C will be entitled to any interest earned on the money and he can instruct A and B to invest the money however C chooses.
The trust fund is treated as if the beneficiary owns it, so the beneficiary is liable for any income tax on income received by the trust, such as interest on a bank account.
The beneficiary needs to account for any income tax in his self assessment income tax return by including the bare trust income as his personal income, so he does not have to complete the Trusts supplementary pages of the tax return.
Although the beneficiary is responsible for paying the tax, it may be paid for him by the trustees out of the trust fund.
Capital gains tax
Capital gains tax is a tax on the gain (profit) made above a certain level on the sale or gift of assets such as shares, land or buildings. It is charged on gains that exceed the “annual personal exempt amount” in any one tax year.
For a bare trust, capital gains tax is charged on the beneficiary as if the trust did not exist (as with income tax) so the beneficiary will have to declare any chargeable gains made by the trustees on the disposal of assets held in the trust in his personal self assessment tax return.
If the person setting up the trust does so by giving assets to the trust (as opposed to cash), he may incur a capital gains tax liability if the value of the assets at that time has risen by more than the annual exempt amount since the time when he acquired the assets.
For inheritance tax purposes, the setting up of a bare trust is the same as making an outright gift to someone. The gift is called a “potentially exempt transfer” which means that inheritance tax will usually only be payable if the person setting the trust up dies within 7 years of doing so and the amount transferred into the trust exceeds his available “nil rate band”. In such a scenario, the beneficiary will be responsible for any inheritance tax due in respect of the bare trust.
On the death of the beneficiary, the trust fund will form part of his estate for inheritance tax purposes so, depending on the amount involved and who inherits, it may be subject to tax at 40% at that point.
If you are interested in setting up a bare trust or you would like further information, please contact our Wills, Trusts & Probate team on 023 9238 8021.