This article looks at the tax consequences of establishing a designated account in conjunction with a Collective Investment Account (CIA).
Parents and grandparents (as well as other relatives and friends) often want to give money or assets to their children or grandchildren. Where a ‘gift’ is being made to a child, it’s important to consider why the investment is being made and what type of investment would be most appropriate.
If the investment needs to be for the long term, a collective investment may be suitable, as it allows investors to spread the investment risk for even a small sum.
Collective investments are usually considered alongside other investments such as a Junior ISA or bank deposit savings accounts.
The collective cannot be set up in the child's name, so the individual making the ‘gift’ must apply for it and hold it in their own name, but for the ultimate benefit of the child.
Depending on how this is achieved will affect the tax consequences for both the child and the adult donor.
If the investment is for the benefit of one or more individuals, the CIA can be set up under a designated account in one of two ways. The basis of taxation will be determined by whichever method is selected. The two options are as follows:
1. Irrevocable basis
The irrevocable basis is chosen where the individual wishes to gift the investment to a child. Where the gift is to more than one child, each child will receive an equal share of the investment. By setting up the CIA under an irrevocable designated account, the investor creates an absolute trust in favour of the child (beneficiary). This means the individual who sets up the account cannot access the funds for their own benefit or indeed change who will receive the funds. Furthermore, when the child reaches the age of 18, he/she becomes legally entitled to their share of the funds.
Inheritance tax – the investor is making a potentially exempt transfer (gift). The gift may already be exempt if it falls within the annual exemption, or if it qualifies as normal expenditure out of income. If it is not exempt, it will fall out of the estate completely after seven years and taper relief may reduce the amount liable to inheritance tax on the death of the investor within seven years.
Capital gains tax – the beneficiary will be liable to any capital gain realised and will be able to use their full available annual exemption. This applies even if the account has been set up by the child’s parent.
Income tax – if the account has been created by anyone other than a parent of the child beneficiary, any income tax liability will fall on the child and again he/she will be able to use all of their available personal allowance. However, if the account was created by a parent for a minor unmarried child and the amount of gross income generated exceeds £100 per tax year, the parent will be assessed on the total income, not just the amount that exceeds £100. This treatment also applies to nominal distributions for accumulation units where the income is accumulated inside the fund. The application of this £100 ‘disregard’ limit is on a ‘per investor/per child’ basis. Therefore, if both parents invested for the benefit of two children, the overall income limit would be £400 in any tax year before the parents are assessed on the income. If the income in any tax year is less than £100 it will be assessed on the child.
2. Revocable basis
If the account is set up under a revocable basis, no trust is created. Consequently no gift has been made and all income tax and capital gains tax liabilities remain with the investor. The investment remains inside their estate for inheritance tax purposes. This means that they can access the funds at any time and redirect as they see fit, including to themselves.
Where sizeable gifts are being made, the tax rules on income and capital gains not only affect the beneficiary, but also the individual making the gift. Where an irrevocable designation is made from a child beneficiary’s parent, it makes sense to invest in capital-appreciating assets rather than income-producing assets to avoid the parent being unintentionally assessed on the income. Given the introduction of the loss of personal allowances for incomes over £100,000, the impact is potentially wider than just the designated account itself.