Taxation Practitioner by Mark McLaughlin ATII TEPContinuing the series of articles on the tax implications of UK trusts. The capital gains tax treatment of such trusts is covered, including the implications of various events and anti-avoidance provisions.The first articles in this series ('Trust me!' (parts 1 & 2), see Taxation Practitioner August 1999, p 26 and September 1999, p 26) dealt with income tax implications concerning UK resident trusts and settlements. This article looks at capital gains tax (CGT) issues affecting them (all references are to TCGA 1992 unless otherwise stated).
Liability to CGT
'Settled property' is simply defined in statute as any property held in trust, other than property to which s 60 (nominees and bare trustees) applies (s 68).
Bare trusts - where bare trustees hold assets for beneficiaries who are absolutely entitled (or would be so entitled but for being a minor or a disabled person), then for CGT purposes:
- transactions between them are disregarded; and
- acts of a bare trustee are treated as those of the beneficiary for whom he acts.
The trustees are treated as a single and continuing body of persons, distinct from the persons who may from time to time be trustees. Chargeable gains and CGT liabilities therefore generally attach to that body, and not to a trustee in an individual capacity (s 65(2)). Whilst the retirement of one UK resident trustee in favour of another does not itself give rise to a chargeable disposal, a CGT charge can be imposed when the trustees become neither UK resident nor ordinarily resident (s 80(1)).
In the case of mixed residence trustees, the trust is treated as not UK resident and ordinarily resident where:
- a majority of trustees are non-resident or not ordinarily resident in the UK and the general administration of the trust is ordinarily carried on outside the UK; or
- the trustees include a 'professional trustee' (ie a person whose business includes managing trusts) and the settlor was not domiciled, resident or ordinarily resident in the UK when funds were provided to the trust and a majority of trustees are considered to be non-UK resident.
For these purposes, UK professional trustees may be treated as non-resident. Hence the general administration of the trust is treated as carried on outside the UK (s 69(2), even if carried on here (Revenue Manual CG33384).
Example 1The Bernstein family trust was set up by Alex, who is domiciled, resident and ordinarily resident in Israel. The Trustees are Alex, Bart (his brother, who resides in the UK) and Carl, a partner in a UK-based trust management services partnership. The trust's business and annual trustee meetings are conducted at Carl's business premises. Two of the three trustees are actually UK resident. However, as a professional trustee, Carl is treated as non-UK resident, and the trust's general administration is treated as carried on outside the UK. Accordingly, the majority of trustees are regarded as non-UK resident.
CGT rate and the annual exemption
The chargeable gains of both interest in possession and non-interest in possession trusts are liable to CGT at the rate applicable to trusts (currently 34 per cent) by virtue of TA 1988 s 686(1), with effect from 6 April 1998 (s 4(1AA)). Prior to that date, interest in possession trusts were liable to CGT at a rate equivalent to the basic rate of income tax.
The trustees' entitlement to the annual exemption is generally equivalent to one-half of the exempt amount for individuals (para 2 Sch 1). For 1999-2000, the trustees' exemption therefore amounts to £3,550. Settlements in a tax year made by the same settlor after 6 June 1978 other than 'excluded settlements' (broadly non-resident, charitable or certain retirement benefits scheme trusts) are restricted to an exemption equivalent to the greater of:
1) £3550 divided by the number of such settlements; and
2) one-tenth of the exempt amount for individuals (ie £7,100 x 1/10 = £710 per settlement).
Example 2In May 1985, Bell made a group of six settlements, one for each of his grandchildren. Bell is not the settlor of any other trust. For the tax year 1999-00, the trustees of each settlement are entitled to an annual exemption of £710, being the greater of:
|(a)||£3,550||= £592; and (b)||£7,100||= £710|
However, trustees of settlements for mentally disabled persons and those in receipt of certain allowances (para 1(6) Sch 1) are entitled to the £7,100 exemption available to an individual. However, this is once again subject to possible restriction for 'group' trusts with a common settlor (paras 3-5 Sch 1).
Taper relief for trustees
From 6 April 1998, taper relief replaces indexation allowance (which is 'frozen' at April 1998) for trustees. The taper relief legislation contains provisions to determine whether disposals of trust property qualify for the 'business asset' rate of taper relief, depending upon whether the trust property in question constitutes shares or securities in a 'qualifying company', or other types of asset:
Shares or securities held by the trustees in a qualifying company (para 5 Sch A1)A company is a 'qualifying company' for these purposes if:
a) it is a trading company or holding company of a trading group; and
b) the trustees can exercise at least 25% of the voting rights; or
c) an 'eligible beneficiary' (broadly being an individual with an interest in possession) can exercise at least 5% of the voting rights and is a full-time working officer or employee.
Other assets (para 6 Sch A1)An asset will be a 'business asset' if it is used wholly or partly:
a) for a trade or profession carried on by the trustees, or an eligible beneficiary as a sole trader or in partnership; or
b) for the qualifying company of the trustees or eligible beneficiary, or a trading company member of a trading group in which the holding company is the trustees' or eligible beneficiary's qualifying company; or
c) in the full-time office or employment of an eligible beneficiary with a trading company, or a trading employer with whom he is required to devote substantially the whole of his time.
Anti-avoidance: 'settlor interested' trusts
In order to prevent the exploitation of lower CGT rates for trusts compared with those applicable to individuals, specific anti-avoidance rules apply in relation to settlements in which the settlor has an interest. These provisions prevent arrangements by which a wealthy individual could transfer an asset to settlement trustees (holding over the gain); the trustees later sell the asset and pay 34% CGT (as opposed to 40% otherwise payable by the individual) and advance the proceeds to the settlor.
The anti-avoidance provisions (ss 77-79) apply to capital gains of settlements in which the settlor or spouse has an interest, where the settlor and the trustees are resident or ordinarily resident during the tax year. A settlor or spouse broadly has an interest if any settlement income or property is capable of being applied for their benefit, or where they enjoy a benefit derived from the trust income or property. There are specific exclusions from the scope of the settlor charge in certain circumstances (s 77 (3)-(6)), such as the tax year of the settlor's death.
Where these provisions do apply, the trustees' net chargeable gains (after losses and taper relief, but before the trustees' annual CGT exemption) are chargeable on the settlor at his/her own CGT rate. The settlor may claim his/her own annual exemption (if available), but may not deduct taper relief or allowable losses, as the 'attributed gain' is receivable from the trustees 'net' of any losses and taper relief. However, the CGT liability arising on the settlor as a result of these provisions may subsequently be recovered from the trustees (s 78).
Next month, the final article in this series will examine the two most common occasions of charge to CGT - the transfer of property into trust, and a beneficiary becoming absolutely entitled to the settled property.