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Capital Tax Review by Mark McLaughlin ATII TEP

Matthew Hutton MA, CTA (fellow), AIIT, TEP, author of Capital Tax Review, comments on the recent decision in Judge and another v HMRC.

Context

This is the first case heard on the application of the traditional HMRC argument based on SP 10/79 that a surviving spouse occupying the matrimonial home as a beneficiary under her late husband’s discretionary Will Trust has an interest in possession under that trust. Interestingly, in this case, the widow did not also have a half share as tenant-in-common.

Judge and another v HMRC: the facts

Mr Walden died in 2000 leaving under his Will all his interest in property at 30 Perrymead Street London upon trust for sale (with the consent of his wife in writing during her lifetime). The Will declared that the trustees should during Mrs Walden’s lifetime permit her the use and enjoyment of the property ‘for such period or periods as they shall in their absolute discretion think fit’, Mrs Walden paying the outgoings. Mrs Walden died in 2003.

HMRC issued a notice of determination that on Mrs Walden’s death she had enjoyed an interest in possession in Perrymead Street under Mr Walden’s Will.

The trustee of Mr Walden’s Will was Commercial Union Trustees Ltd. Interestingly, no IHT was paid on Mr Walden’s death on the grounds in particular that the gift of Perrymead Street (valued at £625,000) attracted the spouse exemption, on the footing that Mrs Walden had an interest in possession therein!

The decision (SpC): Dr Nuala Brice
Because Mrs Walden did not have the right as against the trustees to occupy Perrymead Street for any period, since the trustees had an absolute discretion as to whether or not they would permit her to exercise that right, Mrs Walden did not have an interest in possession.

The nature of an interest in possession

Dr Brice quoted with approval the dictum of Viscount Dilhorne in Pearson v IRC [1980] STC 318 at 323 ‘… for there to be an interest in possession, there must be a present right to the present enjoyment of something …’.

Mrs Walden would not have a right as against the trustees if the trustees had a discretion as to whether or not they would permit her to exercise that right.

Can a right of occupation be an interest in possession?

It is clear from the 1998 High Court decision in Lloyds Private Banking that a right of occupation can be an interest in possession. However, that case also makes it clear that a proper construction of the Will is crucial to the issue as to whether an interest in possession has been created.

What legal principles should be applied to the construction of Mr Walden’s Will?

The normal principles of construction which apply to Wills also applied to the construction of Clause 3 (below). Agreeing with Peter Twiddy for HMRC, Dr Brice concluded from AJA 1982 s21 that, if the language used in the Will is ambiguous, extrinsic evidence may be admitted to assist in its interpretation. However, she doubted whether the jurisdiction of the Special Commissioners includes the power to rectify a deed or Will, but the Special Commissioners should give effect to the intention of the testator as expressed in the terms of the whole of the Will.

The construction of Clause 3 of Mr Walden’s Will

Both parties agreed that the wording of clause 3 was defective and that, at the very least, the word ‘sale’ should be included after the word ‘until’. With that amendment, and with the deletion of the words which were not in dispute, the clause reads:

‘I GIVE free of tax … to my Trustees ALL THAT my interest in the property known as and situate at 30 Perrymead Street, London SW6 … UPON TRUST with the consent in writing of my Wife during her lifetime to sell the same with full power to postpone sale for so long as they shall in their absolute discretion think fit and to hold the net proceeds of sale and other monies applicable as capital and the net rents and profits until [sale] upon the trusts and with and subject to the powers and provisions of my Residuary Fund (as hereinafter defined) as an accretion thereto AND I DECLARE my Trustees during the lifetime of my Wife to permit her to have the use and enjoyment of the said property for such period or periods as they shall in their absolute discretion think fit pending postponement of sale she paying the rates of taxes and other outgoings …’.

The words ‘free of tax’ were held to have no significance. As to the words following ‘UPON TRUST’ and before ‘I DECLARE’, they made it clear that Mrs Walden had no right to the income of Perrymead sale pending sale.

Regardless of the fact that the words following ‘I DECLARE’ did not make grammatical sense, the succeeding words ‘for such period or periods as they shall in their absolute discretion think fit’ were unambiguous and provided that the trustees were given a discretion (but not a duty) to allow Mrs Walden to occupy. There was no contradiction of intention between the first part of Clause 3 (evidencing the intention that Mrs Walden, during her lifetime, could unilaterally postpone the sale of Perrymead Street, but that for so long as the property was not sold the net rents and profits were to be held on the terms of the discretionary trust) and the second part of the Clause (giving the trustees discretion as to whether she could reside in Perrymead Street and, if so, for how long).

Dr Brice concluded that, on her reading of Clause 3, Mrs Walden did not have the right to occupy Perrymead Street. The appeal succeeded.

The extrinsic evidence

Mr Twiddy sought to rely on extrinsic evidence to the effect that the trustees had drafted Mr Walden’s Will and that, as trustees, they had always been of the view, right from the start, that the Will had given Mrs Walden an interest in possession and that she could occupy Perrymead Street for her life. Specifically, Mr Twiddy argued that the words ‘for such period or periods as they shall in their absolute discretion think fit’ should be rewritten to read ‘for such period or periods as [she] shall in [her] absolute discretion think fit’. However, Dr Brice considered that it was not possible to rewrite part of Clause 3 in the way suggested by Mr Twiddy. Rather, the Clause should be interpreted as far as possible to give effect to the words actually used, which she had done.

(Judge and Another v HMRC [2005] UK SpC 506, 5.10.05)

Comment

Presumably HMRC are now proceeding to collect IHT following Mr Walden’s death (in particular, being within the last six years).

On the face of it, this decision now makes it easier to achieve the double benefit of avoiding an interest in possession for IHT purposes while securing main residence relief for the trustees under s225 (described over 10 years ago by Richard Oerton, then of Birchams, as ‘a trick known only to members of the magic circle’). For s225 relief, all that is necessary is to show that there is occupation of the trust property by a beneficiary who is entitled to do so under the terms of the trust. While the discretionary trust analysis precludes the possibility of a CGT-free uplift to market value on the death of the beneficiary, there would of course be complete relief under s225 either on a sale within three years thereafter or indeed on a disposal without a sale to a child of the deceased, whether absolutely or on the terms of a separate trust. However, do remember the exit charge on coming out of the discretionary trust regime!

January 2006

Matthew Hutton

More Information

The above article has been taken from Matthew Hutton’s Capital Tax Review, a quarterly update for professional advisers of private clients. For more information, visit http://www.taxationweb.co.uk/books/capital_tax_review.php.

About the Author

Matthew Hutton is a non-practising solicitor (admitted 1979), who has specialised in tax for over 25 years. Having run his own consultancy (latterly through Matthew Hutton Ltd) until 30th September 2000, he now devotes his professional time to writing and lecturing.