Meeting Points

RALPH RAY FTII, TEP, BSc (Econ) solicitor, consultant with Wilsons of Salisbury, reports on the taxation highlights only of the STEP Sixth Annual Sussex Conference on 18 May 2001.

Time bomb trusts for capital gains tax

When A on attaining age 18 receives income from the trust, but on attaining age 25 receives the trust assets absolutely, there will be no capital gains tax holdover relief on the latter event. The hold over requires income and capital entitlement to arise at the same time.

Chris Whitehouse advised that in certain circumstances capital gains tax problems can be overcome.

The circumstances instanced above constitute an accumulation of maintenance trust until 18. For investment assets, the capital gains tax cannot be held over under section 260(2), Taxation of Chargeable Gains Act 1992 because the entitlement to income and capital do not coincide.

The speaker showed that if the individual is still under 25 (but over 18) he can assign his income entitlement into a new accumulation and maintenance trust so that the income and capital entitlements do coincide at age 25, whereupon the capital gains tax can be held over under section 260(2)(d).

Alternatively, and by way of an exercise of power of advancement under section 32, Trustee Act 1925 as extended, and if the trustees are satisfied that the exercise will be for the beneficiary's benefit, the absolute entitlement of the beneficiary at a particular age could be postponed, or the trust varied into a flexible life interest trust. Thereby the section 71, Taxation of Chargeable Gains Act 1992 time bomb can be averted.

Purchased annuities

Purchased annuities are to be distinguished from those acquired under a pension scheme. It is simply a lump sum investment which produces a return of capital as well as income. The advantage is that only the income element is taxable and then only for higher rate taxpayers, tax at 20 per cent being deductible at source. Mark Ward LLB, ATII advised that against this 'favourable' tax treatment should be considered the current relatively low yield, being offered on annuities and also one is effectively giving away one's capital to fund it. On the other hand, many investors choose to protect their capital by using some of the return of income to fund an insurance policy maturing at the end of the annuity period.

Ramsay and Westmoreland

Chris Whitehouse, barrister, Gray's Inn Square, spoke on tax planning in 2001.

Under the heading 'Schemes, shams and tax mitigation' Chris analysed the Ramsay approach following the taxpayers' victory in the House of Lords in MacNiven v Westmoreland Investments [2001] STC 237. The scheme was circular and intended to achieve a tax advantage; but there was nothing unusual in paying off indebtedness with borrowed money. Lord Hoffmann made a vital distinction between 'the legal position', and 'commercial concepts'.

Chris Whitehouse suggested that we were therefore back to the drawing board and illustrated two schemes which if correctly executed should be effective:

Example 1

A owns a country cottage pregnant with gain. He wishes to gift it to his grandson who intends to live in it as a main residence.

As an alternative to an outright gift, for which no holdover relief is available, consider a gift into a discretionary trust with the trustees licensing the use of the property initially (see Sansom v Peay [1976] STC 494) and then converting the trust into a life interest (or appropriate entitlement) for the grandson (or advancing it out to him). For a discussion of whether this works for capital gains tax, see Taxation, 11 January 2001 at pages 349 and 350.

Note in the similar scheme discussed in that issue of Taxation, the settlor was to be added as a beneficiary and might collect all or some of the proceeds of sale. That may be taking the scheme into provocative territory. Nevertheless holdover relief is available only if the property goes into a discretionary trust; then the son should not be already in occupation and should not become entitled to occupy immediately on creation of the trust.

Regardless of whether or not section 224(3), Taxation of Chargeable Gains Act 1992 applies, could the Revenue disregard the settlement for capital gains tax purposes because the settlor can be added as a beneficiary, under Furniss v Dawson? If the events happened over a period of not more than about eighteen months, there could be sufficient circularity within the meaning of Ramsay (see Taxation 11 January 2001 at page 349 for additional comment).

Example 2

In the will of a wealthy husband the widow, who is also comfortably off, is given a revocable life interest for a relatively short time, but during which the widow has to enjoy some income. The life interest is then revoked as a potentially exempt transfer and the funds pass to other family beneficiaries.

Trust losses

Section 75, Finance Act 1999 inserted new subsections into section 71, Taxation of Chargeable Gains Act 1992 (availability of losses on beneficiary becoming absolutely entitled). The position is now as follows :

Finance Act 2000 contained further restrictions designed to prevent other trust loss schemes. For example, assume that the Jokey Trust has unused realised capital losses. Bill purchases an interest in the trust, adds assets to the trust which are pregnant with gain (claiming holdover) and those assets were sold by the trustees thereby utilising the losses. From 21 March 2000 this has been stopped. However, Chris Whitehouse pointed out that there is nothing to stop an original beneficiary from utilising the losses in this way.

Income draw-down: consequences as regards death benefits

The issue of income draw-down from pension funds was discussed by the Association of British Insurers in its memorandum of 10 June 1999. If the deceased has taken income withdrawal and leaves no survivor (spouse or financial dependant), the lump sum will normally be payable at the trustees' discretion. Section 648, Taxes Act 1988 applies an income tax charge at 35 per cent. However, there should be no inheritance tax liability unless the Capital Taxes Office can show that the deceased failed to take an annuity or reduced his income withdrawals with a view to benefiting others within section 3(3).

Mark Ward said that the position is more complicated if a spouse or a financial dependant survives. A lump sum taken by a spouse will be subject to a 35 per cent income tax charge. However, if the surviving spouse does not take an annuity but continues with the income withdrawal and dies within the two-year period, the Revenue may make a claim either under section 5(2) or under section 3(3), Inheritance Tax Act 1984. Here therefore there is potential for double taxation in the form of both 35 per cent income tax on the lump sum and 40 per cent inheritance tax on the balance. Further clarification is awaited.

Meanwhile, consider the inheritance tax treatment of the lump sum once income withdrawals have started. Perhaps the member should be advised to assign the lump sum death benefit to a separate discretionary trust at a time when he is in good health.

Personal pensions and IHT 200

In the context of completing supplementary page D6 to the Form IHT 200, question 2 on supplementary page D6 asks 'Was a lump sum payable under a pension scheme or a personal pension policy as a result of the deceased's death?'. It may be a straightforward matter to ascertain this, especially if the question can be answered in the negative, because any death benefits have been written under irrevocable trusts. However, the notes to D6 explain that the lump sum will form part of the deceased's estate if it is payable to the estate or if the deceased could have bound the trustees of the pension scheme to make a particular payment. Here the practitioner will have to review the pension provider's scheme rules governing the distribution of the lump sum death benefit, as well as obtaining a copy of any letter of wishes, direction or nomination made by the deceased.

Question 3 of D6 asks whether the deceased, within two years of his death, disposed of any benefits or made any changes to the benefits to which he was entitled under the personal pension. Mark Ward said that this goes back to a letter from the Capital Taxes Office to the Association of British Insurers of 5 June 1991 included in the Tax Bulletin of February 1992). The issue is whether the Revenue could make a claim under section 3(3), Inheritance Taxes Act 1984 (omission to exercise a right). The Revenue said that it would not take the point generally, but if for example the deceased was in very ill health and at that time took out a new policy and assigned the death benefit into trust, or assigned the death benefit of an existing policy on trust, or paid further contributions to a policy where the death benefit had previously been assigned, or deferred the date for taking his retirement benefit, the point might apply. Even so, the Revenue would not take the point where the death benefit was paid to the spouse or dependants or where the member survived two years or more after making such arrangements. Therefore the practitioner will need to investigate the position in relation to any personal pension in the two years prior to the death. Where there have been any dispositions or changes, the deceased's doctor should confirm the state of health and what the deceased knew of it at the relevant date.

Enterprise zones

An investor may purchase a building in an enterprise zone but as this may be a very substantial investment, there is the alternative of investing through an enterprise zone trust. In the latter case, a unit trust scheme is created and a number of investors subscribe, each being entitled as a tenant in common to a pro rata share of rents received and in the underlying property. It is usual for an investor in an enterprise zone to fund the investment with borrowings and also to rent out the property. An individual should be able to obtain tax relief for interest paid on borrowings, provided that the property is let and it qualifies interest relief under normal rules.

Issue: 3817 / Categories: