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Capital Tax Review by Matthew Hutton MA, CTA (fellow), AIIT, TEP

Matthew Hutton MA, CTA (fellow), AIIT, TEP reports ongoing uncertainty regarding HMRC’s view on the effect of the Trusts of Land and Appointment of Trustees Act 1996 in respect of a popular form of tax planning.

Context

An earlier Trusts Discussion Forum posting cast doubt that main residence relief may be available to trustees on disclosing of a share in a property held typically under the will trust of the first spouse to die. Further support for the suggestion comes from both Jeremy de Souza and Gill Steel.

TLATA 1996: What on earth does it mean?

This interpretation of the Trusts of Land and Appointment of Trustees Act 1996 (TLATA 1996 s 22(1)) is not an 'obscure' one. It has been appreciated as a likelihood from an early stage and, indeed, was raised with the Revenue (and agreed by them) at the outset by the Law Society: see 'More Qs and As' by Chris Jarman, The Tax Journal, 6 February 1997, page 19.

That view was, however, not shared by all specialist property lawyers (as to which, see Gammie and de Souza's Land Taxation, page 2282/2/4, n.2),and, when asked to clarify their position by the City of Westminster and Holborn Law Society Revenue Committee recently, HMRC's Capital Taxes declined to comment either way.

This particular problem is one of a number giving rise to concern at present on whether a surviving beneficial tenant in common obtains an interest in possession in the whole property on the other's death. The first issue, which it had been hoped to solve before the Lands Tribunal in Arkwright before that case was settled [though, as I understand it, the case is still open], is the extent of the survivor's rights to possession under TLATA 1996 s 13(7). The better view is that such a right is not exclusive in the sense that the s 12 rights of the co-owners do not exist, with the result that the trustees of the property may require the survivor to pay a half-rent under s 13(6)(a).

In the event of a half-rent being charged, it is generally considered that the survivor would not have an interest in possession in the whole. But if the trustees in question do not actually charge a half-rent, then (depending upon the reason for this, e.g. the flat refusal to co-operate of the survivor in her capacity as a trustee coupled with the family's reluctance to litigate), the possibility cannot be ruled out that Capital Taxes would (if minded to take issue on the point) succeed in establishing that the survivor had obtained an interest in possession in the whole.

If, however, it is the case that the deceased's half share was settled by his Will, irrespective of whether under fixed or discretionary trusts, then on the normally accepted reading of s 22(1), the beneficiaries of the Will trust would have no s 12 rights and, as a result, s13 would not fall to be considered at all until an absolute appointment had been made out of the Will trust. It ought to follow from this that, during the subsistence of the trust, the survivor has an indefeasible right to possession under s12. In their recent letter, however, Capital Taxes did not put forward such a contention, merely saying that, in some of the larger list of scenarios raised in the letter to them, an interest in possession might arise.

The position is particularly important in the light of the abolition of the concept of interest in possession by BN25, as elaborated by the extensively amended Finance Bill currently before Parliament. This is, of course, why Capital Taxes were written to in the first place.

While the extent to which TLATA 1996 s 12 applies to a pre-1997 co-ownership structure is (by statute) a matter of documentary interpretation, it seems unlikely that the draftsman of any subsequent document would have sought to go behind the terms of such a statute. And it would, of course, be an issue for counsel (and ultimately the court) as to whether any purported disapplication of s 22(1) had been effective.

(Taxation 6.7.06 p 391, response by Jeremy de Souza in Readers’ Forum)

Further confirmation of HMRC’s analysis

In a posting on the Trusts Discussion Forum on 20.8.06 Gill Steel writes as follows:

‘The important advantage of discretionary trusts, the non-aggregation of the trust fund with the estate of a beneficiary on the beneficiary's death, was undermined before 22 March 2006 by arguments made by HMRC where the trust fund comprised an half share in the family home the whole of which continued to be occupied by the surviving spouse.

With the coming into effect of TLATA 1996 the right of each co-owner to common occupation was replaced by s12, which gives a right to occupy to a co-owner in certain circumstances. Whilst both co-owners are alive both clearly have the right to occupy the whole.

Where each spouse has a half share by way of tenancy in common and the first to die leaves his share to a discretionary trust, the situation can therefore be reached in which only the survivor has s 12 rights. HMRC argued that if the trustees had not nominated a beneficiary to occupy the property with the surviving spouse then in such circumstances only the surviving co-owner has s 12 rights.

The IHT analysis, especially for deaths on or after 22 March 2006

The question then arises as to whether IHTA 1984 s 43(2)(a) has the effect of deeming the survivor to have an interest in possession in the whole property even though, under the Will, the deceased's half was given or appropriated to a discretionary trust. The effect of that would be to bring that half into charge on the second death by virtue of s 49(1), even though the survivor had no beneficial interest in it.

Fortunately, it is not possible for new interest in possession trusts to be created after 22 March 2006 which are taxable under s 49(1). It would therefore appear (although HMRC have not yet confirmed this) that their line of argument based on TLATA 1996 s 12 is no longer likely to apply to discretionary trusts to which half shares of co-owned property have been gifted or appropriated for deaths on or after 22 March 2006.

It is conceivable that existing discretionary trusts created by Will for deaths prior to 22 March 2006 may presumably still be caught by the argument if HMRC’s view were correct.

Note that the new subsections (3) - (6) added to IHTA 1984 s 144 permit distributions to be made from discretionary trusts within two years of death and for deaths on or after 22 March 2006 these can be to an IPDI, a s71A trust or a s 71D trust. If s 144 is used care would be needed in this situation not to create an IPDI: otherwise the consequence would indeed be for the trust's share to be aggregated with the surviving co-owner's share on their death’.

(Trusts Discussion Forum posting by Gill Steel of LawSkills on 20.8.06)

Application

While HMRC’s approach to such an issue is uncertain, it cannot be assumed that they will simply accept a claim to s 225 relief ‘on the nod’ – even if they might have done so readily enough in the past. My own inclination is for this reason to avoid such structures and instead to go for something like the debt or charge route – unless of course one can constitute the nil-rate band on the first death without recourse to the family home at all: that is the ideal.

Matthew Hutton MA, CTA (fellow), AIIT, TEP

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.