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Income tax and trusts – £100 rule

This article looks at the income tax treatment of trusts created by an individual, when their unmarried minor children are beneficiaries of the trust.


Before the changes to the tax treatment of trusts for inheritance tax (IHT) purposes in the Finance Act 2006, interest in possession trusts were used instead of bare trusts for sucession and IHT planning due to the flexibility the trust offered and the fact that the interest in possession beneficiary could be changed by the trustees.

Now that new interest in possession trusts are treated the same for IHT purposes as a discretionary trust, one of the few remaining ways to create a potentially exempt transfer and use a trust is to create a bare trust.

One of the major benefits of a bare trust is that for tax purposes the trust is effectively ignored, with the liability falling on the beneficiary (or beneficiaries) at their own rates of tax and with access to their own personal allowances and reliefs (apart from ‘Parental Settlements’, see below). This would apply to income tax, capital gains tax (CGT) and IHT.

Parental Settlements

One area often overlooked is the source of the money in relation to income tax. Where assets are placed under trust from parents for minor unmarried children, if gross income exceeds £100 per annum all of the income will be taxed as if it was the parents’. This is per parent (settlor), per child. For collective investments (unit trusts and OEICs), this applies to income that is distributed as well as income that is re-invested into accumulation units. Income below the £100 limit will continue to be assessed as the child’s income and taxed accordingly.

This has applied to bare trusts since 9 March 1999 and applies whether the income is paid to the child or not. For trusts created before this date which have not had any additional funds added, the £100 rule does not apply. Where the trust is a discretionary trust, the £100 rule will only apply where income is actually distributed from the trustees to the minor beneficiary.

Example – bare trust

Paul puts £5,000 into a bare trust for his son John and invests in a high yielding bank account. After one year the bank account pays interest of £500 gross and the bank deducts 20% (£100) at source. Paul is a higher-rate taxpayer and John a non-taxpayer. Despite the capital being in trust for John, Paul has an additional 20% to pay, ie another £100. As the income is only being rolled up inside the bank account, holding a cash investment through another structure, such as a single premium investment bond, may well avoid this tax complication. Once John reaches 18, he will be absolutely entitled to the capital and income and it will be taxed as his own.

If, in the above example, the interest is distributed to John when it arises, Paul will still be liable to income tax.

However, if Paul had invested in growth assets then the trustees would be able to utilise John’s own capital gains annual exempt amount, year on year, on any capital gain made inside the trust. Using a bare trust provides certainty for the settlor regarding who will benefit from the funds under the trust. This certainty may outweigh the lack of ability to vary the arrangement.

A discretionary trust will offer additional flexibility and a wider beneficiary class and avoid this issue where the income is accumulated.

However where either type of trust is used, care must be taken where the settlor is the parent of the beneficiary and the underlying investment may produce real income.

This article is based on Skandia’s interpretation of the law and HM Revenue & Customs practice as at June 2013. We believe this interpretation is correct, but cannot guarantee it. Tax relief and the tax treatment of investment funds may change. Skandia does not accept any liability for any action taken or refrained from being taken due to the information in this or related documents.

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