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 final article in this series focuses on two of the main occasions on which a CGT charge arises in relation to settlements (all references are to TCGA 1992 unless otherwise stated).
Transfer of property upon creation of a trust, or a further disposal into an existing trust
The settlor and trustees are 'connected persons' when the trust is created (s 286(3)(a)). The initial settlement of property and any further transfers into trust therefore constitute disposals at market value, notwithstanding that the settlor might retain an interest in the trust as a trustee or beneficiary (s 70). Gains arising on disposals into trust can be the subject of claims for relief from CGT-
Relief for gifts of business assets (s 165)A claim may be made by the settlor alone in respect of gifts or disposals of 'business assets' (as defined in s 165(2) and Sch 7) at undervalue to UK resident or ordinarily resident trustees. However, the claim will result in a potential loss of any taper relief otherwise available to the settlor, and reduces the base cost of the asset in the hands of the trustees by the held-over gain.
Example 1In March 1996, Royle bought 90 ordinary shares in A Ltd for 10,000, representing 30% of the voting rights in a trading company. On 1 May 1999, when the shares were worth £100,000, Royle settled the shares on an accumulation and maintenance trust for his minor, unmarried grandchildren. Royle makes a claim under s 165 in respect of the gift.
(a) Held over gain
Market value - May 1999
Less: Cost - March 1996
Less: Indexation (to April 1998)
£10,000 x 0.073
(b) Trustees' base cost of shares
Market value of shares
Less: held over gain
Note - Despite the fact that the shares are a business asset for taper relief purposes (para 6(2) Sch A1), the 15% taper relief which has accrued to Royle (7.5% for one complete year of ownership after 5 April 1998, plus 7.5% in respect of the 'bonus year' for acquisitions before 17 March 1998) is effectively wasted.
The trustees' taper relief 'clock' commences from their acquisition date of May 1999.
Transfers on which inheritance tax is immediately chargeable (s 260)A further unilateral claim for relief is available for transfers of value which are immediately chargeable for inheritance tax purposes. A disposal of any asset to a discretionary trust resident or ordinarily resident in the UK therefore qualifies for relief, even if no tax is actually payable (such as a gift to a 'nil rate band' discretionary trust).
However, it should be noted that any gain held over (whether under s 165 or s 260) from the initial transfer of assets to the trustees is not 'washed out' upon the death of a beneficiary with an interest in possession (see s 74 below).
Retirement relief (s 164)Due to the gradual phasing out of retirement relief from 6 April 1999, the use of life interest settlements by eligible individuals to crystallise entitlement to retirement relief has become a familiar CGT planning technique. A material disposal of business assets to the trustees is deemed to take place at market value, which 'triggers' the settlor's entitlement to relief (s 164(3)). To the extent that the resulting gain is not fully covered by retirement relief, a claim for the excess gain to be held-over may be possible under s 165 (note that retirement relief is mandatory, and therefore takes precedence over gift relief claims).
On a beneficiary becoming absolutely entitled to the settled property (s 71)
When a beneficiary becomes absolutely entitled to settled property as against the trustees (for example, upon reaching a specified age or at the trustees' discretion), the trustees are deemed to dispose of that property and immediately re-acquire it at market value. Thereafter, the trustees may continue to hold the asset as nominees or bare trustees, until sold or actually transferred to the beneficiary. A subsequent disposal by the trustees in this capacity is treated as a disposal by the beneficiary (s 60(1)).
Although no inheritance tax may be chargeable when the beneficiary of an accumulation and maintenance trust becomes absolutely entitled to settled property (or an interest in possession in it) by a specified age not exceeding 25, hold over relief is available under s 260 on any gain arising (IHTA 1984 s 71(4)).
However, a 'trap' exists for the unwary. It is common for entitlement to income to vest in the beneficiary at an earlier age (for example, at age 18) than capital. When the trust property is subsequently appointed to the beneficiary at age 25 or earlier, an interest in possession exists, and a hold over claim under s 260 for accumulation and maintenance trusts does therefore not apply (s 260(2)(d)).
Example 2The beneficiaries of the Weaver accumulation and maintenance trust (Nicholas, Andrew and Sarah) become entitled under the terms of the trust deed to a share of the trust income at age 21, and are absolutely entitled to trust property upon reaching the age of 25.
The entitlement of the beneficiaries to an interest in the trust income at age 21 is not a disposal by the trustees for CGT purposes. However, the trust effectively changes in nature to an interest in possession trust at that point. This means that, upon becoming entitled to trust property at age 25, a hold over claim under s 260 cannot be made by the beneficiary and trustees (although a s 165 hold over claim may instead be possible in respect of qualifying assets).
If the gain arising is held over, any taper relief on that gain to which the trustees would otherwise be entitled is effectively forfeited. The taper relief clock in relation to the property re-commences in the hands of the beneficiary, following his or her deemed acquisition from the trustees.
Claims under both s 165 and s 260 upon property leaving the trust are made jointly rather than unilaterally. Relief under s 165 is available to the trustees for:
- Agricultural property (s 165(5) and Part I Sch 7);
- An asset used for the trade, profession or vocation of the trustees or a beneficiary with an interest in possession in it immediately prior to disposal; or
- The unlisted shares or securities of a trading company, or the holding company of a trading group, in which at least 25% of the voting rights are exercisable by the trustees (para 2 Sch 7).
Where certain conditions are satisfied (see Statement of Practice 8/92), the Inland Revenue will accept claims for relief under s 165 (or s 260) without requiring a computation of the held over gain in respect of the asset transferred. In practice, Help Sheet IR 295 enables claims for hold over relief and requests to defer formal agreement of asset values to be made together.
Extra Statutory Concession D10
In appropriate circumstances, a specific part of the trust assets may be separately identified with the termination of an interest in possession. An advantage of this concession is where a trust has both resident and non-resident beneficiaries. It enables a claim under s 165 to hold over gains arising on specific assets appropriated to UK resident beneficiaries, where the trust's assets are being appropriated to mixed resident beneficiaries in general. Note that the relief is not available where the transferee is not resident or ordinarily resident in the UK (s 166).
Other occasions of charge
There are certain additional occasions of charge, and exceptions from liability:
- a chargeable gain potentially arises on a sale of trust assets by the trustees;
- however, no chargeable gain arises on the termination of an interest in possession, upon the death of the beneficiary. The trustees are deemed to dispose and re-acquire the settled property at market value, but no chargeable gain arises (ie there is a tax-free uplift) (s 72);
- in addition, no chargeable gain arises on the deemed disposal by the trustees where a beneficiary becomes absolutely entitled to settled property on the death of a person entitled to an interest in possession. The base cost of the settled property for the new beneficiary is the property's market value at the date of death (s 73(1)).
Example 3In June 1995, Morrison set up an interest in possession trust in favour of Cooke for life, with remainder to Kennedy absolutely. The market value of the assets transferred at that time was £75,000. Cooke died in August 1999, when the market value of the trust assets had increased to £125,000.
No chargeable gain accrues on Cooke's death (s 73(1)), and Kennedy is deemed to acquire the trust assets at an uplifted value of £125,000.
Example 4The facts are the same as in Example 3, except that Morrison has claimed to hold over a gain of £10,000 arising on the initial transfer of assets into the trust. The base cost of the assets in the hands of the trustees is therefore £65,000 (ie £75,000 - £10,000)
On Cooke's death, the trustees' gain (before indexation allowance and taper relief) amounts to £60,000 (ie £125,000 - £65,000), but is restricted to the held over gain of £10,000, subject to a potential further holdover relief claim.
- however, where a holdover claim was made on the original disposal of the property to the trustees, the deemed disposal by the trustees on the death of an individual with an interest in possession crystallises the held-over gain (s 74), subject to a possible further holdover claim by the trustees, if appropriate;
- a lifetime termination of an interest in possession in trust property, following which the trustees continue to hold the underlying asset, does not involve a deemed disposal by the trustees (contrast this with the situation where the same or another beneficiary becomes absolutely entitled following that termination (see s 71)).
- the disposal of an interest in settled property by a beneficiary does not generally give rise to a chargeable gain (s76), unless:
a) it was purchased for money or money's worth; or
b) at any time the settlement interest was (or property contained within it was derived from) an offshore trust, in relation to disposals from 6 March 1998.
- as mentioned previously, a further CGT charge can arise on the emigration of a settlement.
Statement of Practice 7/84
The exercise of the trustees' power of appointment or advancement over settled property to a separate trust is not considered to give rise to a deemed disposal under s 71(1), unless the trustees have express or implied authority to subject the property to a different settlement. Even if this is the case, a deemed disposal does not necessarily arise where, for example, the appointment is revocable, or the trust property might revert to the original trust at some point in the future. Similarly, a deemed disposal is unlikely to arise if the original trustees retain duties over the appointed assets in that capacity (see Bond v Pickford  STC 517, CA).
Recent CGT changes - trust losses
Provisions enacted in FA 1999 s 75 restrict the transfer of unused capital losses from trusts to beneficiaries. This legislation was introduced to stop anti-avoidance schemes involving the purchase of trust losses, but it actually affects any beneficiaries to which s 71(2) previously applied. Losses arising on the actual disposal of assets by trustees will no longer be transferred to beneficiaries, upon their becoming absolutely entitled to trust property on or after 16 June 1999. In addition, where trust property standing at a loss is transferred to a beneficiary who becomes absolutely entitled, the deemed loss arising on that occasion may only be transferred to the extent that the trustees cannot set it against gains arising to them in the same tax year. Any loss that is transferred to the beneficiary may only be offset against a subsequent gain arising on the same asset (and in the case of land, any asset derived from it). The loss may not be offset against other capital gains arising to the beneficiary.