Patrick Harney and Nicola Simmons explain the US UTMA account and how it should be treated for UK tax and trust law purposes, for STEP Journal.
What is the issue?
Whether a US Uniform Transfers to Minors Act account (UTMA) is a ‘bare trust’ rather than a ‘settlement’ for UK trust and tax law purposes.
What does it mean for me?
Whether an UTMA is a settlement or a bare trust has implications for its tax treatment in the UK for the settlor, trustees and, in some cases, beneficiaries. Its classification is determined by laws and principles in both the UK and the US, and the terms of the specific UTMA.
What can I take away?
Subject to the laws of the applicable US state providing the legislation, UTMAs can be structured so as to be treated as bare trusts under English and Welsh law, even with the age of majority being 21 rather than 18. This can, in turn, limit the UK tax and reporting obligations for the relevant parties.
Governed by the Uniform Transfers to Minors Act, an UTMA account (referred to herein as an UTMA) allows an appointed custodian to manage any gifts paid into a minor’s UTMA until they become of legal age for the purposes of the UTMA in question (which is typically 18 or 21 years old). Until such time, an UTMA also shields the minor from certain US tax consequences on the gifts. An UTMA is not a formal trust but the custodian has a trustee‑like role.
An UTMA is a creature of US state law. In determining how English and Welsh law and UK tax law characterise foreign arrangements, it is necessary to effectively ‘shoehorn’ each arrangement into a category that Her Majesty’s Revenue and Customs (HMRC) is familiar with. Typically, one would therefore examine the legal characteristics of the arrangement in order to determine whom to tax and how. In characterising any foreign arrangement for UK tax purposes, it will have to be treated as a company, partnership, trust or co‑ownership arrangement. If a trust, it must be either a ‘bare trust’ or a ‘settlement’.
An UTMA is a trust‑like arrangement, so the choice is between a bare trust and a settlement. This choice has significant implications for the UK tax treatment for the settlor, trustees and beneficiaries. It may also impact trust registration requirements.
So, is an UTMA a settlement or a bare trust?
Section 43(2) of the Inheritance Tax Act 1984 (the 1984 Act) provides that a settlement, for UK inheritance tax (IHT) purposes, is a disposition of property where any one of three conditions is satisfied. The property is:
- held on trust for persons in succession; or
- held by trustees on trust to accumulate income; or
- charged or burdened with the payment of an annuity.
The second limb will be the focus of this article.
A bare trust is a fiduciary arrangement where a trustee holds title to assets for the benefit of someone (a beneficiary) who is absolutely entitled to those assets as against the trustee, or would be so entitled but for being an infant or under a disability. Under English and Welsh law, a ‘bare trust’ for an infant can include an arrangement whereby the custodian (i.e., a bare trustee) holds assets on the child’s behalf until they are 18. During their minority, the custodian may withhold and/or accumulate income for the minor’s benefit using the statutory power to accumulate under s.31 of the Trustee Act 1925.
On first reading, this power might appear to satisfy the second limb above, so as to constitute a settlement for UK IHT purposes. The s.31 power can be excluded, but doing so can remove administrative flexibility. Thankfully, in correspondence between HMRC, STEP and the Chartered Institute of Taxation from 2008 (the Correspondence), HMRC explicitly confirmed its view on this to the contrary, as follows:
‘… where assets are held on [a bare trust] for a minor, the assets so held will not be settled property within the meaning of [section 43] and … this will be the case whether or not the provisions of [section 31] have been excluded.’
So, is a typical UTMA a bare trust?
Given the disparity of age of entitlement between the UK concept of a bare trust for minors (18) and US UTMAs (21 in Colorado, for example), one needs to consider whether the custodian having control over the assets and power to accumulate income while the beneficiary is aged between 18 and 21 could potentially tilt an UTMA into ‘settlement’ territory under the UK rules.
For example, in the case of an UTMA that is created under the laws of Colorado, the authors understand that (broadly) under ss.11‑50‑113 and 11‑50‑114 of the Uniform Transfers to Minors Act:
- The statute does not specifically grant a custodian the power to accumulate income; a custodian is simply granted the more general power to manage and invest the UTMA’s assets. That power is administrative in the sense that assets can only be accumulated for the UTMA’s beneficiary, but distributive in the sense that the custodian can choose to distribute or accumulate income until the child is 21.
- When the beneficiary reaches age 21, the custodianship automatically terminates and the custodian must transfer the assets to the beneficiary. The custodian does not have any discretion on this point.
This summary of the position under Colorado law suggests that a Colorado UTMA should be characterised as a bare trust for English and Welsh law and UK tax purposes, in line with the approach taken by HMRC in the Correspondence.
Charlie lives in the US and is a settlor and potential beneficiary of a US trust that she has funded with US annual exclusion gifts. That trust holds US assets. Charlie’s minor children are the primary beneficiaries. Charlie’s parents were domiciled in the UK and Charlie was born in the UK. Charlie will shortly be returning to the UK.
On those facts, one would expect that Charlie is a ‘formerly domiciled resident’, meaning she would become deemed domiciled in the UK for:
- UK income tax and capital gains tax purposes upon becoming UK tax resident; and
- UK IHT purposes from her second year as a returning UK resident.
In terms of Charlie’s US trust, this would mean that:
- The trust would become a relevant property trust for UK IHT purposes from that second year, meaning the trustees would be liable to IHT in respect of all the funds settled by Charlie at up to 6 per cent:
- when distributions are made from the trust; and
- on the trust’s ten‑year anniversaries.
- Further, the assets Charlie settled into the trust would be subject to the ‘gift with reservation of benefit’ (GRB) rules for IHT purposes, and therefore subject to 40 per cent IHT on Charlie’s death.
In order that the trust’s assets can pass to Charlie’s children tax efficiently, Charlie might want to ask the trustees to consider transferring her contributions to the trust into UTMAs for each of her children (with Charlie and any spouse excluded from benefit) before she becomes UK resident. This is potentially advantageous for Charlie, provided that the UTMA in question is treated as a bare trust for UK tax and trust law purposes as, in that case, the children will be treated as having received a gift from an excluded property trust and the GRB issue should fall away.
Conversely, if the UTMA was instead treated as a settlement for IHT purposes, this proposal would be treated as a transfer between trusts under s.81 of the 1984 Act. In that case, the assets would be treated as remaining in the first trust for the purposes of the relevant property trust IHT rules.
It should also be noted that, although the relevant beneficiary is under 18, Charlie would still be taxed on UTMA income under s.629 of the Income Tax (Trading and Other Income) Act 2005.
In this example, it is crucial that the UTMA is treated as a bare trust. Its treatment as a bare trust also has more mundane benefits for UK‑domiciled and UK‑resident US persons who wish to create such accounts for their minor children.
In the authors’ experience, in many US states (including Colorado) it is possible to treat an UTMA as a bare trust for the minor for UK tax purposes, notwithstanding the custodian’s power to accumulate income beyond age 18.