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Mark McLaughlin CTA (Fellow) ATT TEP outlines outlines some recent developments for taxpayers and advisers involving trusts.

Mark McLaughlin

Introduction

The tax world invariably seems to move at a rapid pace. The following is a selection of recent developments for practitioners involved with trust work.

Trust residence

Trustees are generally treated as a single person for capital gains tax (CGT) purposes (TCGA 1992, s 69(1)). Finance Act 2006 introduced new rules to determine whether trusts are resident in the UK or offshore, where there are both resident and non-resident trustees. Those rules only took effect from 6 April 2007. Trustees are resident in the UK from that date if all of the trustees are UK resident, or if the following conditions are satisfied (s 69(2)):

• at least one trustee is UK resident; and
• a settlor was resident, ordinarily resident or domiciled in the UK at the ‘relavant time’ (i.e. broadly when the settlement was made, or immediately before the settlor’s death if the settlement was made by Will, intestacy or otherwise).

Before 6 April 2007, trustees were broadly treated as resident and ordinarily resident in the UK unless two conditions were satisfied:

• all or a majority of trustees are not resident or not ordinarily resident in the UK; and
• the general administration of the trust is ordinarily carried on outside the UK.

Thus a UK resident trust before 6 April 2007 may have inadvertently become an offshore trust from that date (e.g. by one of the trustees not being resident in the UK and the settlor not meeting the above UK residence or domicile requirements when making the settlement). Previously, a majority of trustees needed to be non-resident and the general administration of the trust carried on abroad. This can have potentially serious repercussions, including a deemed disposal of trust assets for CGT purposes upon ceasing to be UK resident (TCGA 1992, s 80). Separate rules for determining trust residency apply for income tax purposes, although the wording and effect of that legislation is broadly the same (ITA 2007, ss 475-476).

Settlor-interested trusts    

If the trustees of a settlor-interested discretionary trust make an income distribution to a beneficiary other than the settlor, the beneficiary is treated as having paid tax at 40%. However, the tax credit is notional and non-repayable. This treatment applies for 2006/07 and later years (ITTOIA 2005, s 685A). HMRC have issued a new version of form R185(Trust Income) for trustees to record discretionary payments to beneficiaries other than the settlor. Discretionary payments from non settlor-interested trusts are not affected (Business Brief 20/07).

Trust distributions

Certain capital receipts by trustees are treated as income in their hands, and are liable at ‘special trust rates’ (i.e. the rate applicable to trusts of 40 per cent, or the dividend trust rate of 32.5 per cent). This includes the receipt from a company which is buying back its own shares from the trustees.

The tax treatment of such a disposal by trustees was called into question following changes to ICTA 1988, s 686A (‘Receipts to be treated as income to which section 686 applies’) made in FA 2006. The original legislation in s 686A provided that what was taxable was only the distribution element, excluding the original subscription price for the shares. However, the effect of an omission in the wording of the FA 2006 amendments was to treat the whole payment to the trustees (i.e. including the original subscription price) as being taxable, rather than just the distribution element. The circumstances in which capital gains treatment applied were not distinguished either.

This omission is to be corrected in Finance Act 2007, by ensuring that ‘qualifying distributions’ are liable to income tax (i.e. only the ‘profit’ element, excluding the original subscription price). The amendment has effect from 6 April 2006. Following the introduction of Income Tax Act 2007, the correct position is also stated in ITA 2007, s 482 (‘Types of amount to be charged at special rates for trustees’) as amended. A ‘qualifying distribution’ covers most types of distribution (ICTA 1988, s 14(2)). However, a company purchase of own shares which satisfies the conditions for capital treatment is specifically excluded from the meaning of ‘distribution’ (ICTA 1988, s 219(1)). Hence a capital payment under trust law, and for tax purposes on a company purchase of own shares within ICTA 1988, s 219, should not be subject to income tax as a distribution. Trustees should therefore be able to continue claiming taper relief and the annual exemption as appropriate where the conditions for CGT treatment are satisfied (ICTA1988, ss 219-229).

Bare trusts for minors

HM Revenue & Customs (HMRC) have recently confirmed to professional bodies that if assets are held on trust for a minor absolutely, the trust will not be treated as a settlement for inheritance tax (IHT) purposes (i.e. within IHTA 1984, s 43(2)). This applies even if the trust deed gives the trustees discretion under the Trustee Act 1925, s 31 to apply trust income for the maintenance, education or benefit of that minor beneficiary.

Previously, it had been feared that transfers to a bare trust for a minor would be an immediately chargeable transfer for IHT purposes and subject to the relevant property regime as for discretionary trusts. However, transfers to bare trusts for minors will continue to be potentially exempt as before, and outright appointments from the trust will not trigger an ‘exit’ charge. Whilst in many cases it may seem unwise to place substantial sums of money into a bare trust for a minor, there are circumstances in which HMRC’s confirmation of the IHT treatment will be welcomed, such as where the Court awards damages for the personal injury of the minor.

Trust management expenses

The deduction of management expenses in calculating the income chargeable to tax for the trustees of a discretionary trust has previously been the cause of some uncertainty among many trustees and advisers. However, the recent case Trustees of the Peter Clay Discretionary Trust v Revenue & Customs Comrs (2007) SpC 595 offers some guidance. In that case, the trustees claimed certain expenses (i.e. trustees’ fees, investment management fees, bank charges, custodian fees and professional fees for accountancy services), some of which contained elements of both income and capital. The Special Commissioners held that in principle that a proportion of all the expenses, apart from the investment management fees, was attributable to income and properly chargeable to income for the purposes of ICTA 1988, s 686(2AA) (now ITA 2007, s 484). In addition, the Commissioners held that the accruals basis was a proper way of allocating trust management expenses to particular tax years, as opposed to when such expenses were incurred and paid.

Whilst the decision will clearly be welcomed by most trustees and professional advisers, in appropriate cases they will be required to apply their judgement in apportioning trust management expenses between income and capital. This could be the ‘trigger’ for enquiries by HMRC and possible disagreements over the correct proportions to be used. Full disclosure of the expenses apportioned and the basis of apportionment will be necessary in such cases, to reduce the possibility of a subsequent ‘discovery’ by HMRC outside the normal enquiry window.