Designated accounts – Introduction
Designated accounts of unit trusts and open-ended investment companies (OEICs) have, for many years, been a simple yet effective way of gifting an investment for a child or grandchild and removing the investment from the investor’s estate for inheritance tax purposes.
Moreover, if the £100 p.a. income (parental settlement) tax rule does not apply (for example in a case where a grandparent, or someone other than a parent, sets the designated account up) the investment will be taxed efficiently as all income and capital gains will be taxed as that of the designated beneficiary meaning that the child’s income tax reliefs and allowances and capital gains tax (CGT) annual exempt amount can be used.
All of this does however rely on the designed account arrangement being treated as a bare trust with the investor being the donor and initial trustee and the designated child being the beneficiary.
It is understood that HMRC will normally accept this interpretation, but this is less likely to be the case where the designated account is set up by somebody domiciled or resident in Scotland because of the more rigid rules that apply there in determining whether a trust exists from a legal standpoint.
However, it should be remembered that, for a valid trust to exist, the three certainties must be satisfied (certainty of intention, property and beneficiary). As a designated account does not involve a written trust document, donors should ensure that they demonstrate a clear intention at outset to make an outright and absolute gift of the investment for the designee’s benefit. The donor must also accept that the designated beneficiary has the right to demand access to the investments held in the designated account on attaining the age of majority (18 in England and Wales).
Should this intention not be clear, or the ‘donor’ wishes to exercise control over how and when the designee can access the investment, or, perhaps, the ‘donor’ wants flexibility to add, say, future grandchildren, the arrangement is likely to be seen as mere ‘earmarking’, meaning that the investments remain in the donor’s ownership and will be treated as the donor’s assets for tax purposes.
Even if HMRC accepts that a bare trust exists, problems can still arise on the donor’s death. At that time, there may be no additional trustee to take over the administration of the investment and it may be necessary to await the appointment of the executors or administrators of the deceased’s estate to determine who is the new trustee(s) of the designated account.
The executors or administrators will then also be dealing with the estate assets and there is a danger that the designated account investments may get mixed up with other assets in the estate. Indeed, if the estate beneficiaries and the designated account beneficiaries are different people and there is friction between them, the whole position may become very difficult for the executors or administrators.
So, what are the solutions to these potential problems? How is it possible for people to set up designated accounts and ensure that these difficulties do not arise on their death?
Well, the first thing to say is that if a donor/ investor is very concerned about these potential future problems before setting up the arrangement, they should instead consider making the investment inside an absolute trust and appointing an additional trustee(s) who would hopefully survive them.
However, not everybody wants to do this, and many will not consider there to be a problem when they set up the investment.
So, in cases where the designated account is up and running, it is suggested that the donor/ investor could consider the following actions should the need arise to “prove” the transaction in the future:
- They should register the trust under HMRC’s Trust Registration Service (TRS). The TRS now requires registration of express trusts (including absolute/ bare trusts), even where there is no tax liability. The registration of the trust is a strong indication that a valid trust exists should there be a later legal dispute.
- The investor should write a letter at the time of the gift to designated beneficiaries who are children or, in the case of grandchildren, their parents, to confirm that the arrangement has been set up for their benefit.
- The investor should leave a letter and/ or instructions with his or her will and personal papers confirming that they hold the investment as a trustee of a designated account arrangement for the absolute benefit of the named beneficiary(ies).
- As the initial trustee, the donor could also look to appoint an additional trustee(s) to provide continuity of the management of the investment in the event of his or her death or loss of mental capacity (on the basis that the incapacitated trustee can then be removed under s36 of the Trustee Act 1925). Should there be changes to trustees after the arrangement has been registered on the TRS, the trustees should remember their duty to update the details held on the Trust Register.
In these ways, the donor/ investor will do as much as he or she can, whilst alive, to demonstrate that the designated account investment is an outright and absolute gift for the benefit of the relevant beneficiary(ies) and should not be treated as an asset of the investor during his or her lifetime or their estate on death.