Income tax and CGT efficiency of a will trust for a testator's minor children

On PLC it states that a bare trust for the testator’s minor children is tax efficient, for income tax and CGT purposes, compared to other will trusts for minors as income tax and CGT apply at the beneficiary’s marginal rates. How can there be any actual tax advantage as when the beneficiaries receive the income from the trust they are entitled to a tax credit if the tax paid was above their marginal rate or a tax refund if it was below their marginal rate. Therefore, the total net tax payment to HMRC will be the same as if the income was taxed at their marginal rates.

The bare trust, which must disapply s31 TA 1925, works automatically for income tax without the need to make distributions and get the timing right. It also does not involve actual distributions which the minor has access to prima facie, without trying to add on the legally murky sophistry of distributing to the parent and then arguing that the minor doesn’t have access if the minor wants to challenge the arrangement.

Actual distributions of income to the child where a parent is the settlor can be taxed on the parent, see TSEM 4300-4310. HMRC’s view is that:
"Bare Trusts

ITTOIA/S629 applies to treat the income belonging to the child as that of the parent for tax purposes whether or not it is paid to the child". As far as I know the question whether the trustees’ right to withhold payment from a minor who cannot give a valid recept amounts to income being “paid to or for the benefit” of the minor within s629 (1) ITTOIA 2005 has never been tested. A non-bare trust for a minor by a parent settlor allows income to be retained as income in the tax pool, subject to income tax, and to then be paid out to the minor, gradually if need be, to avoid tax or generate refunds.

CGT doesn’t work like that. Trustees of “settled property” are liable to pay the tax on gains at their rates whereas in a bare trust the minor’s own rates will apply. s31 does not apply to gains and because a minor is absolutely entitled if he would be but for his minority an age condition up to 18 can be attached. As he cannot make a will other than a privileged will a gift over can also be included to avoid intestacy if he dies before 18 (but not a higher age as that would make the trust settled property for CGT). Gains are not taxable on a parent settlor of a UK resident settlement.

Jack Harper

Thanks for the answer, Jack. As it is a will trust I am proceeding on the basis that s.629 is not relevant. Regarding their being a benefit to the income being taxed automatically, could that not be a downside as one might want to choose the year one pays the income to the beneficiary to reduce tax or secure tax refunds?

The usual expectation is that a minor will have no or no significant taxable income until he or she ceases education. Not invariably; one of my university contemporaries worked on building sites throughout his stay, which was remarkably long given that. The level and possible fluctuations of the minor’s income is a relevant factor and may be very difficult to judge when a will is made, perhaps many years before death and even the birth of the relevant minor. The non-bare trust does allow more flexibility at the price of the cash flow cost of tax at 45% paid ahead of distributions and refunds. There might be additional cost if the trustees have to hire a professional to manage this operation because they are not able to do it personally, again which may be difficult to predict at the time of making the Will.

Jack Harper

Thank you Jack, this now makes a great deal more sense to me.