Parents often feel inclined to be generous to their children and like to set aside money for their future.
The income tax treatment of such generosity may have taken many by surprise.
It would seem logical that once the gift is made that any income arising on the gift would be treated as the income of the child. However the tax rules do not work in this way and treat the income as still belonging to the parent.
Since 1991 the tax rules have provided a trap for the unwitting parent.
The rules have a wide application and do not just apply to the more complicated trust arrangements that some may wish to arrange. They will catch all sorts of “arrangements” which can be interpreted as being a “parental settlement” including the simple transfer of cash into a deposit account for a child.
Any income on a gift under £100 will be ignored under the “de minimis“ ( to small to be significant in plain English) rule and so at current interest rates there may be nothing to worry about in many cases.
However, there is one situation which occurs quite frequently should be considered carefully: a Deed of Variation.
A Deed of Variation is often used in a situation where you may have inherited money and wish to redirect it to a minor child (i.e. one under 18)
A Deed of Variation may work well in other tax areas, but be careful in this instance; if the correct procedure is adopted, the tax rules do not work for income tax purposes.
This means that the gift is still treated as being made by the original recipient, you the parent and is therefore trapped by the tax rules
The tax rules apply in the following manner-
1.The income arising is taxable on the parent (once it exceeds the £100 threshold) at whatever rate the income would have been charged at if it had actually been their income
2. Any payments of capital will be caught as well in circumstances where there is income available to distribute.
There is also another alternative which parents often consider; a bare trust.
A Bare Trust, although not strictly treated as trusts for most tax purposes, they are nevertheless subject to the income tax rules outlined above.
However, as they have more favourable treatment for capital gains tax purposes they can be attractive provided the parent realises that the children have the right to ask for the asset; as it is strictly theirs from the outset.
As always individual circumstances change, and the above is a general guide only.