Legal vs beneficial ownership: the difference (and how to spot it)

Alan Pink considers a legal concept regarding property ownership that has become very topical recently and the all-important tax implications.

T he difference between legal and beneficial ownership of property (or indeed any asset) is both age-old and highly topical currently. We need to begin, though, by defining some terms. 

In the context of real property (that is, land and buildings) legal ownership, at least in the United Kingdom, refers usually to the person whose name is registered as the owner on the land registry. Most often in practice, the legal owner of property and the beneficial owner are one and the same. Typically, in the case of Mr and Mrs Smith who live at 23 Acacia Avenue, this house and its accompanying garden will be registered in their names and will also belong to them beneficially. But that isn’t always the case by any means. 

Let’s take an example of the alternative situation. An office building at XX Cheapside, London, EC3, is owned by Supreme Investments Limited, a company registered in Panama. This company is in turn administered by shadowy company agents with a ‘brass plate’ address in St Peter Port, Guernsey. If you like, this is the opposite extreme of the situation of Mr and Mrs Smith in Acacia Avenue, and it is likely that (if you were able to get hold of a copy of the accounts of the Panama company)  it would show no assets at all in its balance sheet. How is this possible?

The answer is that the property, in our hypothetical situation, is owned by the Panama company as nominee or ‘bare trustee’ for someone else – perhaps a member of some Middle Eastern royal family. In essence, the situation is the same as you would find if you hold a portfolio of quoted shares, say, through your local bank. The share portfolio is registered, on the plc’s share register, as being owned by Barclays Bank Nominees Limited (or something like that). But Barclays Bank Nominees Limited is not the ‘true’ owner of the shares. You are. So, you receive dividends on the shares, which are paid to you directly rather than being paid to the nominee company, and you have the absolute right at any time to order the nominee company to sell the shares or transfer them to someone else.

Some confusion has been known to be caused by the use of the word ‘trust’ in the phrase ‘bare trust’. Normally, a trust is an arrangement where the legally registered owner of an asset is holding it for the benefit of others but has some kind of discretion or judgement to exercise over how the asset, or income derived from it, is dealt with. 

In a bare trust, the bare trustee has no discretion whatsoever, and this is crucially important for tax purposes. Where the trustee has no discretion, the tax effect is usually different from the situation where the trustee does have discretion. So, it’s perhaps unfortunate that the word ‘trust’ is used in the context of nomineeships and bare trust, because that tends to lead to confusion with situations where the trust is, so to speak, fully clothed.

The tax rules clearly recognise the existence of bare trusts, and indeed the capital gains tax (CGT) rules define what a bare trust is (TCGA 1992, s 60). This definition includes the phrase that another person is ‘absolutely entitled to direct how [the asset] shall be dealt with’. Furthermore, it is explicitly stated in the CGT rules that any transactions in that asset are effectively treated as being made by the beneficial owner (the person for whose benefit the asset is held) rather than by the bare trustee – except in cases where you merely have a change from one registered owner to another without any change in the beneficial ownership. Such a transfer as this is a non-event for tax purposes. 

There is a parallel rule in the stamp duty land tax (SDLT), and equivalents, legislation, which ‘looks through’ legal ownership to the ‘true’ or beneficial owner underlying the arrangement, and taxes that person, or a person acquiring from them, without reference to the registered ownership by the bare trustee.

One important reason for setting up a bare trust arrangement is that the true ownership is invisible. This invisibility is no doubt compromised, now, under regulations which require disclosure of the true beneficial owner in certain circumstances; however, as a general rule, these tend to apply to ownership of shares rather than property. So, if, for some reason, you don’t want someone else to know that you own a property, a bare trust could be the answer. However, this isn’t intended to be legal advice, and you should check this point carefully with a suitably qualified lawyer if it is a key part of your plan.

Some lawyers, in my experience, tend to say that, where there is a bare trust over property, this needs to be noted appropriately by an entry in the land registry, thus defeating any attempt to use a bare trust for confidentiality. However, in my experience, others seem quite relaxed about this.

Let’s move on to a couple of situations where bare trusts are often of vital importance in tax planning. 

Stephen owns a large portfolio of residential properties, some of which are subject to mortgages. He took these mortgages out some years ago, and they are at what are now seen as ridiculously favourable interest rates. All the same, the so-called ‘section 24’ or ‘Osborne tax’ changes, under which interest relief will soon be fully disallowed for higher rate income tax purposes, are hitting him hard. So, he goes to a firm of tax advisers, who suggest to him that he should incorporate his portfolio in a limited company, because limited companies are not affected by the disallowance. 

Whether this advice is good advice in fact is a big subject that is a bit off our beat here, but let’s suppose that Stephen takes the advice, subject to one vitally important point. The various banks with whom he has mortgages will not agree, in practice, to transfer those mortgages, along with the properties, to a new company. They will insist (if they agree to lend at all) on issuing new loans, with new and less advantageous terms, and on charging reasonably hefty valuation and arrangement fees at the same time. 

So, what Stephen does, on the advice of these promoters of the arrangement, is execute deeds of bare trust under which the legal ownership of the property continues to be held by him, but on behalf of the new company. The important point to note is that, from a tax point of view, this is exactly the same as if he had transferred the properties to the company, with the tax benefits (we hope) that follow on from that (please note - the legalities of this are something we cannot comment on – you should always seek advice from the lawyer drawing up the trust deeds.)

Old Mrs Grundy has decided that she wants to transfer her house into the names of her three children (to ‘save them trouble when I’m gone’). The children aren’t averse to the idea, but one of them takes advice from an accountant who points out the tax disadvantages of doing this. For a start, the gift of the property will not be effective in any way to reduce the inheritance tax on Mrs Grundy’s death. Because the whole idea is that she will continue to live in the property, this is a ‘gift with reservation of benefit’, and the property will continue to be treated as if it was owned by her for inheritance tax purposes. 

This is probably an inevitable part of the situation in Mrs Grundy’s case. But there’s also a positive disadvantage in making the gift to the children, in that they no longer live in the house. Therefore, any ultimate sale of the property, perhaps after Mrs Grundy has died, will be fully chargeable to capital gains tax. 

The same practical solution (of the property being registered in the children’s’ names) can be achieved without this CGT disadvantage by putting in place a deed of trust to the effect that they are only legal owners but not beneficial owners – with the beneficial owner still being Mrs Grundy herself.