Malcolm Finney examines the mis-conception that children don’t pay tax.
A ‘minor’ is an individual who is below age 18, commonly described as a ‘child’.
A child is liable to the same taxes as an adult; thus a baby, one day old, may have a potential tax liability!
A child is entitled to a personal allowance (£9,440 for the tax year 2013/14).
However, because a child is unable to carry out certain transactions in their own name an adult may need to be involved. This involvement typically uses the concept of a bare trust.
Income tax:
Example 1 - Sam, the baby
Sam is one week old. He is the first grandchild of Tom and Tina.
Tina would like to give a sum of money to Sam, but Sam is unable himself to open a bank account.
Tina therefore opens the bank account in her own name but ‘as bare trustee for Sam’. This means the money in the account once deposited immediately belongs to Sam. Tina cannot take it back. She deposits £5,000 in the account.
In the tax year 2013/14 interest of £150 is credited to the account.
The £150 interest belongs to Sam; it is his income which is in principle taxable but in fact is offset by his personal allowance of £9,440 (and hence no net tax liability).
Capital gains tax:
Capital gains tax (CGT) is also payable by Sam.
Example 2 - Sam and CGT
Two years after the gift of £5,000 by Tina, she withdraws the £5,000 and purchases some shares on behalf of Sam which she sells six years later for £14,000, making a capital gain of £9,000. Tina deposits the £14,000 back into the bank account as the share proceeds belong to Sam.
Sam is in principle subject to a CGT charge on the £9,000 gain, but only after taking into account his annual exempt amount (£10,900 for the tax year 2013/14).
Inheritance tax:
If Sam happened to die whilst a minor his estate would in principle be liable to inheritance tax (IHT) (Note - as a minor Sam cannot execute a will).
Example 3 - Sam and death
Sam’s grandparent, Tom, dies when Sam is ten years old and leaves Sam £350,000.
Unfortunately, two years later Sam dies. On his death, Sam’s assets amount to £350,000 plus the £14,000 in Example 2 ie £364,000.
His estate has an IHT liability of 40% of £364,000 less the nil rate band of £325,000 ie £15,600.
A trap: Parental gifts
In the above examples, it is Sam’s grandparents who are making the gifts to a grandchild. Where it is the parent affecting the gifts the tax position is slightly different.
Although the CGT and IHT consequences are the same as those set out above, this is not the case with respect to income tax. Where a parent makes a gift to a child any income which arises from that gift is subject to income tax, not on the part of the child, but on the parent who made the gift.
Example 4 - Sam and a parental gift
Sam’s dad, Bert, owns some shares on which dividends are paid. He transfers the shares to Sam.
In the following tax year, Sam receives £300 dividend income on the shares.
Although the dividend income belongs to Sam, and not to his dad, it is his dad who has to pay any income tax on the dividends (although he can reclaim the tax paid from Sam).
There is, however, a de-minimis exception under which if the aggregate income of the child on a parental gift(s) is £100 or less for a tax year the income tax liability is that of the child and not that of the parent.
Practical Tip:
If a parent is liable to income tax at the higher (40%) or additional (45%) rate of income tax it is better to gift an asset to a son/daughter which may show capital growth rather than one which generates income.
