Parental settlements

  • Author : Amanda Edwards
  • Date : April 2011
ABOUT THE AUTHOR: Amanda Edwards TEP is an Associate at Boodle Hatfield

Attempts by parents to divert income to their minor children so that the income can be taxed at their children’s own (possibly lower) rates of income tax have long been caught by anti-avoidance provisions. These date back to 19911 and are now to be found in s629 Income Tax (Trading and Other Income Act) 2005 (ITTOIA 2005), the so-called ‘parental settlement rules’.

A parental settlement for income tax purposes may even arise inadvertently as ‘settlement’, widely defined in the income tax legislation2 to include ‘any disposition, trust, covenant, agreement, arrangement or transfer of assets’.

One particular trap lies in the making by a parent of a deed of variation in favour of minor children, as in the following example.


Joe receives a legacy of GBP250,000 under his father’s will and wants to make a deed of variation3 in favour of his two children (aged four and six), mainly for inheritance tax (IHT) purposes because he has no need of the money himself. For IHT purposes this works well as the GBP250,000 will be treated as if Joe’s father had himself made the gift into trust for his grandchildren under his will.

However, the ‘writing back’ is only effective for IHT purposes and for preventing a disposal for capital gains tax (CGT) purposes (assuming in each case that the deed of variation contains the necessary election). For income tax, this will be a parental settlement by Joe. Given the age of Joe’s children, this may not be appropriate unless the investments can be invested in low-income-yielding assets. Note that if Joe has retained an interest in the trust (e.g. because he himself can benefit or the settlement is revocable), this will be caught by the settlor-interested rules under s624 ITTOIA 2005 and will be treated as a settlor-interested trust, rather than a parental settlement.

Another scenario where a parental settlement can arise inadvertently is where shares in a family company are held by parents and also by trustees, on behalf of minor children. If the parents waive their right to dividends, it may be that the trustees’ dividend is increased. This will be an ‘arrangement’ sufficient to trigger the parental settlement rules under s629.

The various tax effects of a parental settlement are set out in more detail below.

The income arising on a parental settlement is taxable on the (parent) settlor, subject to a GBP100 per annum de minimis limit. Once the GBP100 limit is passed, the entire income is taxable on the parent at whatever rate the income would have been charged if it had actually been their income. This will cover:

  • payments of income made to each child under the trust or settlement;
  • payments of capital made to each child, to the extent that they can be matched against any available undistributed income;
  • amounts applied for the benefit of each child (where the payment is made to someone other than the child but for their benefit, for example payment of school fees).

Any income that is accumulated in the trust will not be taxed on the settlor, but it will be subject to the trust rate of income tax (50 per cent for non-dividend income and 42.5 per cent for dividend income at 2010/11 rates).

For capital gains tax (CGT), the usual rules apply and the trustees are liable for CGT on gains above the annual exempt amount (GBP5,050 in 2010/11). However, holdover relief4 is not available on the transfer into the trust.

For IHT purposes, payments into a parental settlement made after 22 March 2006 (with few exceptions) will be a lifetime chargeable transfer and IHT charges may also arise when assets exit the trust and on ten-year anniversaries.

Bare trusts for minor children

Although a bare trust is not a trust for IHT purposes, it may nonetheless give rise to a parental settlement for income tax and fall within s629(1)(b), in which case the income tax treatment outlined above will apply. This could arise from a simple parental gift made, for example, when opening a building society account in the child’s name.

There are, however, CGT advantages in using a bare trust for a minor: because the child is absolutely entitled to the assets, a bare trust is not a settlement for CGT. Any gains that arise are therefore treated as the child’s gains, to be set against his or her personal annual exemption (GBP10,100 in 2010/11).

Bare trusts created by parents for minor children may therefore have a limited use for holding low-income-producing assets, which may give rise to gains within their annual exempt amounts.

S64 Finance Act 1999
S620 ITTOIA 2005
Under section 142 Inheritance Tax Act 1984
Under S260 Taxation of Chargeable Gains Act 1992


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