Investors' Chronicle Tax & Pensions Clinic: Our reader wonders how a 'bare trust' is treated for tax purposes
Partner, Simon Malkiel, and Legal Director, Nicole Aubin-Parvu, answer a query from a reader in Investors' Chronicle's Tax and Pensions Clinic. This article was written by Leonora Walters and first published in Investors' Chronicle on 17 July 2023.
"My father passed away in 1981 and left a fund for his daughter [my sister] in his will. The will required that all the income from this fund should be distributed to her, making it an interest in possession trust (IIP), and that when she died the capital sum should be distributed to her children. My sister has now also passed away.
I believe the capital sum is added to the value of her estate for inheritance tax (IHT) purposes, but is not liable for capital gains tax (CGT) because the costs of acquisition are taken as the value at the date of her death. As executor, I have submitted the IHT400 forms, and [due to the residence nil-rate band] there is no IHT to pay.
As trustee, I am preparing the SA900 tax return for the will trust for 2022-23 and I can enter the date that the trust ends and why. I understand that the will trust, i.e. the IIP, becomes a 'bare trust' at the time the will trust ends. I have registered a corresponding bare trust, although that may not be required as it may be a Schedule 3A trust. The SA905 supplementary form allows for declaration of the disposal of assets and capital gains, and declaration of the death of the persons with interest in possession trusts and those becoming absolutely entitled. But there seems to be no mention of the uplift of the cost of the assets to market value.
I phoned HM Revenue & Customs (HMRC) to try to find out what reporting is required and the call handler said that CGT was due. I referred to section CG36540 of the HMRC CGT manual and the call handler agreed that it suggests a cost uplift is available. However, he didn't know the answer and consulted two other enquiry sections, neither of which could give an answer either. The call handler said that he would escalate the query but I have yet to hear anything from HMRC.
Simple will trusts setting up an interest in possession can’t be that uncommon so I am surprised at the situation. Can you shed light on this?"
Nicole Aubin-Parvu and Simon Malkiel at Howard Kennedy, say:
If a testator or settlor made a will or set up a trust before 22 March 2006, giving another individual – the life tenant – the right to the income of the trust fund (an IIP), the life tenant is treated for IHT purposes as if the trust property was part of their estate. When the life tenant dies, the trust property is taxed to IHT in the same way as their personal estate. This is the position for the trust set up by your father for your sister.
Since 22 March 2006, the IHT rules for trusts have changed significantly so that most life interest trusts created since that date are not subject to the IHT treatment set out above. The underlying trust fund is not taxed to IHT as if it was part of the life tenant's estate at their death. Instead, it is subject to a different IHT taxing regime involving a charge to tax every 10 years and on capital distributions.
Some post-22 March 2006 trusts are still subject to the old rules, including ones that give rise to an ‘immediate post-death interest’ (IPDI) – essentially, trusts coming into effect under a will or intestacy where a beneficiary has the right to the income of the trust fund. The life tenant under an IPDI is also treated as owning the trust property for IHT purposes, so it is subject to IHT on their death. In the case of your sister, the IHT treatment would have been the same even if the trust had come into effect on or after 22 March 2006.
For CGT purposes, when an individual dies, the assets of which they were "competent to dispose" – essentially their own property – are deemed to have been acquired by their personal representatives at market value, but not to have been disposed of by the deceased on their death – section 62 Taxation of Chargeable Gains Act 1992 (TCGA). The result of this legal fiction is referred to as the "tax-free uplift on death", and means that there is no CGT charge on their estate.
The CGT rules that apply on the death of a life tenant of a trust created prior to 22 March 2006 or qualifying as an IPDI that is taxed to IHT under the "old" rules, are different to those that apply to a deceased person's own assets, but achieve the same effect. Essentially, if the trust ends so that someone, in this case your sister's children, becomes absolutely entitled to the trust assets, section 71(1) TCGA provides that the trustees are deemed to have disposed of the assets of the trust fund and immediately reacquired them for consideration equal to their market value. Again, the effect of this is that there is no CGT liability on the life tenant's death.
In this situation, there is no requirement to complete form SA905. This is explained on page TCN2 of the notes to SA905 on Trust and Estate Capital Gains, as follows:
"Fill in the Trust and Estate Capital Gains pages [SA905] if any of the following apply:
• The trust or estate disposed of chargeable assets in the year to 5 April 2023 worth more than £49,200... In working out whether the assets you disposed of were worth more than £49,200, ignore [...] any asset that the trustees are deemed to dispose of without a chargeable gain on the termination of a life interest in possession on the death of the person entitled to that interest [...]"
You should, however, complete form SA900 Trust and Estate Tax Return and, in particular, question 21 which asks:
"If you are a trustee and the trust was terminated in the year to 5 April 2023 please enter in box 21.4 the date of termination and, in the 'Additional information' box, box 21.9, the reason for termination."
Trusts that should be registered on HMRC's Trust Registration Service
You wondered whether the bare trust, which was created following the death of your sister and ended her life interest, is registrable on HMRC's Trust Registration Service or exempt under Schedule 3A.
In 2017, anti-money-laundering regulations were brought in that required UK and non-UK trusts that are liable to certain UK taxes to register on HMRC's Trust Registration Service. This obligation was extended in 2020 to include all UK express trusts, unless they fall within a specific exception, and certain non-UK express trusts. The deadline for registering non-taxable express trusts set up before 4 June 2022 was 1 September 2022, and any trust set up subsequently must be registered within 90 days of creation.
If your sister died on or after 6 October 2020, which we assume is the case, her trust should have been registered by 1 September 2022, unless it was taxable and already registered under the 2017 regulations.
Until the trustees are able to distribute the trust property to your sister's children they hold it on bare trust for them. However, this trust does not have to be registered on the Trust Registration Service because it is not an "express" trust. As HMRC explains in its manual at TRSM10030, it was not deliberately created by anyone. Instead, it arises by operation of law to cover the period until the property can be distributed.
You mention that the bare trust may not be registrable as a Schedule 3A trust. However, Schedule 3A excepts certain express trusts from the requirement to register. Trusts that are not express trusts were not covered by these regulations at all.