Enter Your E-mail

Matthew Hutton MA, CTA (fellow), AIIT, TEP, presenter of Monthly Tax Review (MTR), highlights the distinction between increases in value and chargeable transfers in the context of settlements.

Matthew Hutton

Context

William Massey QC suggested that it may be possible for the settlor of a  pre-22 March 2006 IIP settlement to increase the value of the trust fund (as a PET) without making a chargeable transfer constituting a new relevant property settlement, eg by directly paying off a mortgage .  The subject had received extensive treatment in an article by Peter Twiddy in [2006] Private Client Business Issue 6. 

The legislation

There are particular provisions expressly dealing with certain additions to a settlement.  For example IHTA 1984, s 151(5), concerning certain pension funds or schemes, provides: ‘Where a benefit has become payable under a fund or scheme to which this section applies, and the benefit becomes comprised in a settlement made by a person other than the person entitled to the benefit, the settlement shall for the purposes of this Act be treated as made by the person so entitled.’  This treatment appears to have been predicated upon the basis that the recipient settlement was a pilot trust with only a small amount of initial capital, but need that be the case?  There are a number of provisions concerning additions where the trusts being considered fall within IHTA 1984 Part III Chapter III – which deals inter alia with relevant property trusts, accumulation and maintenance trusts, and trusts for bereaved minors.

IHTA 1984, s 44(2) caters for the possibility of separate settlements where more than one person is a settlor.  This could lead one to conclude that additions to a settlement by the same settlor cannot be separate settlements.  This would be supported by the decision in Rysaffe Trustee Company (CI) Ltd v IRC [2002] WTLR 1077. The thrust of Park J’s decision in that case [upheld by the CA] was that IHTA 1984 s43 is determinative of what is settled property and what is a settlement, but leaves to the general law the question of whether property is comprised in one settlement or several. 

There appears to be a conflict between the approach of Park J and the published stance of HMRC on additions where s 48(3) is concerned.  This provides that ‘where property comprised in a settlement is situated outside the United Kingdom -    
(a)  the property (but not a reversionary interest in the property) is excluded property unless the settlor was domiciled in the UK at the time the settlement was made.’ 

By way of illustration, a non-UK domiciled individual makes a discretionary trust and settles non-UK situs assets on 1 March 2006.  He becomes domiciled in the UK on 1 April 2006, either as a result of the deeming provisions in s 267 or under general law, and on 15 April adds more non-UK situs assets to the same settlement.  The HMRC view is that, given the s 43 definitions of ‘settlement’ and ‘settled property’, a settlement in relation to any particular asset is made when that asset is transferred to the settlement trustees to be held upon the trusts of the settlement.  On this basis, the added assets will not be excluded property within the meaning of s 48(3).  As McCutcheon puts it, this seems strange to the mind of a Chancery lawyer, who would look to the date of the deed to decide when the settlement was made. 

What a High Court judge would make of it remains to be seen – bearing in mind that the Rysaffe case involved the Revenue seeking, through the associated operations provisions, to amalgamate five general law settlements into one settlement for IHT purposes, which is the converse of the HMRC view mentioned above. 

The basis for the latter approach is that s 43(2) refers to a disposition or dispositions of property whereby the property is for the time being held in trust.  Peter Twiddy takes it that the word ‘whereby’ includes the concept ‘as a result of which’.  Whilst the term ‘settlement’ will for many lawyers conjure up a mental picture of a physical document, usually a deed or Will, which sets out the terms of a trust, IHTA 1984 uses the term in a rather more slippery way, if the HMRC approach above is correct.  Support for that interpretation can be gleaned from s 267(3)(a), which disapplies the deemed domicile provisions in s267(1) ‘in determining whether settled property which became comprised in the settlement on or before that date [9 December 1974] is excluded property.’  In the next Chapter of the Act there are particular provisions which apply only for the purposes of that Chapter.

IHTA 1984 Part III  Chapter  III

Peter Twiddy goes on to examine all of s 60 (commencement of settlement), s 64 (charge at ten year anniversary), s 67 (added property etc), s81 (property moving between settlements) and s 83 (property becoming settled on a death).  He concludes that the meaning of ‘settlement’ in that Chapter broadly equates to the Chancery lawyer’s understanding of the terms ‘trust’ or ‘settlement’.  As the provisions which lead one to that conclusion obviously do so expressly only for the purposes of that Chapter, this fact gives rise to an assumption that the term ‘settlement’ can have a different, broader, meaning for the purposes of Chapter I, excluded property, and of Chapter II, interests in possession other than those brought within Chapter III by FA 2006. 

As is apparent from the terms of s 67(2), s 67(1) is not restricted to additions of assets, but it also includes additions to the value of property already comprised in the settlement.  The latter would include the release of a debt owed by the trust or the transfer of assets to a company owned by a trust, as a result of which the value of its shares increased.

Excluded property: confusion compounded

HMRC take the view that, going back to the possible interpretations of s 48(3), the added property was not excluded property as defined by s 6 since the beneficial owner was then domiciled in the UK.  The transfer to the trustees would have been a chargeable transfer, and so the property transferred would be added property within the meaning of s 67 if Chapter III applies.  The non-UK situs property would therefore be comprised in a settlement which commenced when the settlor was not domiciled in the UK.  Does this mean, as McCutcheon seems to suggest, that the property has been transmogrified into excluded property because of the application of s48(3), and so cannot be relevant property for the purposes of Chapter III?  This seems a rather strange result considering that the transfer of the property into trust was a chargeable transfer. 

The term settlement in s 67 appears to equate with a general law settlement – though of course it should be remembered that it need not have been made under UK law – and it commenced when property was first comprised in it.  The date of commencement is established by s60 – but only for the purposes of Chapter III – and that is therefore not of itself conclusive of ‘the time the settlement was made’, the material phrase in s48(3).  The HMRC approach, of treating the addition as a distinct ‘settlement’ does have a certain amount of logic, given that it was a chargeable transfer, but the fact remains that for the purposes of the Chapter III charging provisions, it is not a separate settlement, merely an addition.  That this is a somewhat uncomfortable state of affairs is compounded when we bear in mind that the s43(2) definition of settlement is meant to determine its meaning for the purposes of the Act.

So far as dealings with HMRC are concerned, we can take it that in practice in general additions of property or of value by the original settlor to relevant property trusts will not be separate settlements.  Where s 48(3) applies, the HMRC approach would require the trustees to ring-fence any non-excluded property addition as a discrete fund.  So an addition to pay costs, for example, of an excluded property settlement with no interest in possession would be a chargeable transfer, in the absence of an exemption such as that under s21, but the exit charge would presumably be nominal.

If it is only value which is added to property already in a settlement, as opposed to more property, is that disposition a ‘settlement’?  The definition of that term provides that the disposition has to be one ‘whereby the property is for the time being’ held on trusts of a certain nature.  If value is added by the original settlor in forgiving a debt owed to him by the trustees of a relevant property trust charged on an asset already in the trust, the ‘whereby’ test in the definition is presumably not satisfied.  We should not forget, however, that the definition in s 272 of ‘disposition’ includes a disposition effected by associated operations, as defined by s 268.  The payment of a premium on an insurance policy is, presumably, a disposition which will add value.

Favoured Interest in Possession Trusts

Immediate post-death interests (IPDI) – s 49A

Where the original settlement was effected by Will or under the laws relating to intestacy, any subsequent additions of property other than by way of instruments within s 142 will be by different settlors and will form separate (relevant property) settlements for IHT.  Where a person adds value by a disposition, again it would be difficult to show that that person has not provided funds directly or indirectly for the purpose of or in connection with the settlement.  If that cannot be established, then the person would be to an extent a settlor, and a separate relevant property settlement would exist for IHT purposes.

Transitional serial interests

The test in s 49C(2)(b) refers to ‘the property then (emphasis added) comprised in the settlement’, the time in question being immediately before 22 March 2006.  Although a TSI can exist in an inter vivos trust, it would seem that the settlor cannot add property to the settlement and have TSI treatment extended to the addition.  Is there, however, a bar to the settlor adding value?  If not, this could be particularly useful when the settled property included the shares in an unquoted company.  The property held in trust would be the shares, not the assets of the company, and so there could be scope for adding more assets.  Where a TSI trust holds a house, expenditure on it by the settlor may add substantial value without adding property.  Although HMRC may not welcome post-Budget Day dispositions by the settlor as eligible for PET treatment where they merely add value to TSI trusts, it is difficult to see how the contrary can be argued.  Added value dispositions other than by the original settlor would be more vulnerable to attack because of s44(2).

Pre-22 March 2006 interests in possession

The same thoughts as above apply, mutatis mutandis.  The HMRC approach to s 48(3) and additions may be deployed against additions of property to continuing pre-Budget Day interest in possession trusts, but would they succeed?

S, a settlor, had created an interest in possession trust with £1 million of assets for his daughter in 1990, and ordained by Will that a nil-rate band legacy was to be held by the trustees of that 1990 settlement as an addition to the settled fund, the residue being spouse exempt.  Was that clause in the Will sufficient to satisfy condition 1 contained in s 49A(2) namely ‘… the settlement was effected by will or under the law relating to intestacy’?  If it was not, as a Chancery lawyer would argue, then S has not created an IPDI and the addition would fall within the relevant property regime.  On the death of the daughter, the funds representing the addition would not be aggregated with the other settled property for the purposes of the 40% charge on the daughter’s death.  If the daughter outlived the settlor by 30 years, the additions may well have suffered, say, three levies of 6% on the excess over the nil-rate band.  That is a lot less IHT overall than would have been paid in similar circumstances under the pre-2006 rules. 

In a 2006 Budget press release, HMRC said that additions to existing trusts would be treated as transfers to new settlements.  A justification for this approach can be derived from the definition of ‘settlement’ in s 43(2).  That term is directed towards the disposition or dispositions of property as a result of which the property is for the time being held in trust etc.  In the above example it is the deceased’s Will which is the disposition of property in a particular direction – towards the trustees of an existing settlement – with the consequence that the property became held in trust.  The HMRC interpretation can be criticised on the grounds that it amalgamates the effect of two separate instruments, the previous settlement and the Will, and seeks to give pre-eminence to the latter.  If, on the other hand, the settlor had simply written out a cheque and given it to the trustees of a pre-existing settlement, then would HMRC seek to regard the clearing of the cheque as a ‘settlement’?  Perhaps the department would set out its rationale and the interaction of its approach with s67, particularly where both the original trust and the death of the settlor whose Will added further property occurred after 21 March 2006.

Will trusts

For those of a more nervous disposition, an alternative approach would be for the Will of S to create a limited period relevant property trust (with the hope in a letter of wishes that the trustees would pay particular attention to his daughter’s needs), to outlast the period of two years from his death, so as to steer clear of the reading back provisions in s144, and then after two years the property would be held on interest in possession trusts for the daughter.  Peter assumes that the new s 144(3)(c) is not subject to the so-called Frankland trap, as the ‘event’ in this provision is not predicated upon there being a charge under s65, unlike the old s 144(1)(a).)  This Will trust would clearly be a settlement separate from that made in 1990.

Computational issues

There are some tax computational complications to be borne in mind where there has been an addition to settlements.  Amongst these, the value of property in the settlement which was not originally related property and has not since become such is taken into account when computing the effective rate for the decennial charge.  So, in the example above, the value of the property settled on interest in possession trusts would be taken into account in that way when computing the rate of tax charged under s64 on the fund added by Will – on the assumption that this had been an addition and did not constitute a separate settlement.  Furthermore, the aggregate of the chargeable transfers made by the settlor in the seven years preceding the addition would, if greater, be substituted for the aggregate of those transfers made in the seven years preceding the commencement of the settlement, again to establish the rate of tax (s67).

By way of a footnote, additions to any settlements to pay fees or costs may well attract s 21 exemption and may be separate settlements, but the practical consequence is simply that trust records must show a full trace of receipt and exit so that there are no long-term consequences of such additions.

([2006] Private Client Business Issue 6 p 336, article by Peter Twiddy of Bircham Dyson Bell LLP)

About Monthly Tax Review (MTR)

MTR is a 90 minute monthly training course, held in London, Ipswich and Norwich – as well as a reference work.  Each Issue records the most significant tax developments over a wide range of subjects (see below) during the previous month, containing 30 to 40 items.  The aim is not necessarily to take the place of the journals, but rather to provide an easily digestible summary of them and, through the six-monthly Indexes, to build up, over the years, a useful reference work. 

Who should come to MTR? Does it attract CPD?

MTR is designed not primarily for the person who spends 100% of his/her time on tax, but rather for the practitioner (whether private client or company/commercial) for whom tax issues form part of his/her practice.  Attendance at MTR qualifies for 1.5 CPD hours for members of the Law Society, for 1.5 CPD points for accountants (if MTR is considered relevant to the delegate’s practice) and (subject to the individual’s self-certification) should also count towards training requirements for the CIOT.  For STEP purposes, MTR qualifies for CPD in principle, on the grounds that at least 50% of the content is trust and estate related.  
 
How is MTR circulated?

The Notes are emailed to each delegate in the week before the presentations (and thus can easily be circulated around the office), with a follow-up page or two of practical points arising during the various sessions (whether in London, Ipswich or Norwich).

How do I find out more?

For further details, and for those whose firms unable to make the monthly seminars but wishing to order MTR as 'Notes Only' (at £180 per annum for the 12 issues, invoiced six-monthly in advance), visit http://www.taxationweb.co.uk/taxevents/monthly_tax_review.php