Grand designs: opportunities for generation-skipping

Tax law often makes it difficult for parents to benefit their minor children in a tax-efficient manner.  The chief hurdle is in the application of the “settlement” provisions, which – broadly speaking – treat minors’ income that derives from a “parental settlement” as if it were that of the parents.

But these pesky provisions have no application to “grandparental settlements”.  Thus, grandparents have the opportunity to benefit minor grandchildren in much more flexible ways without falling foul of anti-avoidance rules.

The simplest way is to give income-producing assets to grandchildren outright (or, what amounts to the same thing for tax purposes, to be held in “bare trust” for the children).  The income arising is treated as that of the grandchild and (since even the youngest infant is entitled to a personal allowance and basic rate band) is often taxed at comparatively low rates and may escape taxation altogether.

Where the gift involves disposal of a capital asset, Capital Gains Tax (CGT) must be considered: but where the asset qualifies for CGT “holdover relief” (shares in a personal trading company, for example) the gain may by joint election be deferred.  Where the grandchild lacks capacity to make the joint election, it may be made on the grandchild’s behalf by a parent.

The drawback of an outright gift or “bare trust” is that the grandchild can call for control of the asset on reaching majority.  Substantial wealth at age 18 is perhaps as likely to be a burden as a benefit; in such cases a trust for the grandchildren may be the answer.  The problem here is that unless the property gifted into trust benefits from a relief from Inheritance Tax (Business Property Relief, for example) gifts in excess of the available IHT nil-rate band (currently £325,000 for each donor, so up to £650,000 for grandparents between them) will attract a charge to IHT.

Whether the gift is to a “bare” or other trust for the grandchild, the income must be applied to the benefit of the grandchild.  But it is generally considered that this would include defraying child-related expenses that would otherwise fall upon the parents, so indirectly benefitting them.  While it would be stretching a point to suppose that the income could be used to buy the grandchild’s Pampers (other brands are available), it could be (and typically is) used to meet school fees, music lessons or any of the other myriad “optional extra” expenses that are the price of procreation.

Inventive clients sometimes ask – can I transfer income to my grandchild by taking him or her into a business partnership?  Probably not: in a seminal case, the courts held that a child’s “immaturity and inexperience” were a bar to partnership.  But there is no reason why trustees of a trust established for a child should not become partners in a business alongside grandparents, which may be a neat way of securing a substantially similar taxation result where the circumstances are appropriate.

Finally, do not forget that there is no lower age limit on benefitting from pension provision; and that even where a person has no “relevant earnings” – indeed no taxable income at all, contributions of up to £3,600 (gross) may benefit from tax relief.  Thus, a grandparent may consider making contributions to a grandchild’s pension fund of £2,880 (net) per year from birth and HMRC will add a further £720 per year to the fund by way of tax relief.  Carefully structured, it’s likely that it will be possible to avoid any IHT consequences by bringing the contributions into the relieving provisions for “normal expenditure out of income”.

Amounts in excess of £2,880 can be contributed – in principle, up to £40,000 per year – but they won’t benefit from any further “tax top-up”.  The attraction of an arrangement of this kind is that (quite apart from the initial tax relief and the tax-free growth within the fund) there is no risk of the grandchild accessing the cash at age 18 and spending it with the gay abandon and cheerful improvidence of youth.

So, that’s the money side sorted out.  Just need now to remember (or learn) how to change nappies…

For more information, please get in touch with your usual BKL contact or use our enquiry form.



Sam Inkersole

In 2022, Sam won the Taxation’s Rising Star award at the Taxation Awards in and was named in the Accountancy Age 35 Under 35.

Jon Wedge

While Jon’s client work focuses on the financial services sector, he also oversees the firm’s assurance service, as well as supporting the trainees following in his footsteps.


Elana joined us in 2017 as an ACA trainee, after graduating from Durham University where she had studied languages. She is now a manager in our assurance team.


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