Added complexities

THE RYSAFFE TRUSTEE cases were heard before Dr A N Brice sitting as Special Commissioner in August 2001. The cases concerned additions made to multiple discretionary trusts. The issues were the application of the associated operations rules, and the meaning of the term 'settled property'. The core issue was the measure of tax due on a ten-year charge.

Background

In February and March 1984, Richard Utley made five separate discretionary settlements, and his brother John Utley made five further discretionary trusts. Each was expressed to be governed by Hong Kong law, and the initial trustee was a trust company resident in Hong Kong. The initial settled property was £10. Each trust was virtually identical. The settlors, both of whom were United Kingdom domiciled, returned the engrossed trust instruments to their solicitors undated, who inserted different dates in each case. The trustees executed all the deeds on 27 March 1984.

The brothers were the principal shareholders in an investment company called Richard Utley Ltd. The company owned a valuable subsidiary called Eurotube. On 3 May 1984, the articles of the company were altered so as, it was purported, to increase the share capital by a bonus issue of a large number of deferred shares. Essentially these shares had very limited immediate rights initially, although after 12 years they would then rank pari passu with the ordinary shares.

The problem was that there were insufficient reserves, with the result that the bonus issue was invalid. In order to remedy the position, the brothers were advised to convert part of the existing ordinary shares into deferred shares, and each added an equal number of shares to each settlement they had established.

The parent company sold its subsidiary Eurotube for £4.4 million in 1992 after the extraction of some commercial property assets. Its principal activity thereafter was as a property holding company.

In May 1996, the period of 12 years expired, and all the deferral shares then ranked pari passu with the ordinary shares and were redesignated as ordinary shares. The appeal concerned the first ten-year anniversary charge which occurred in 1994. Peter Twiddy, assistant director of Inland Revenue (Capital Taxes), argued that the entire capital value of the trusts created by each settlor should be aggregated for the purposes of calculating the ten-year charge. David Ewart, counsel for the taxpayers, sought to keep each trust separate and distinct.

The tax plan

Although it is not absolutely crystal clear, it seems likely that the brothers' advisers were seeking to take advantage of what is now section 67, Inheritance Tax Act 1984 which is concerned with property added to discretionary trusts. The general effect of the provision is that where a settlor has made any chargeable transfers since creating the settlement, his cumulative total of transfers prior to the date of any addition could be substituted for his pre-settlement cumulative total if it was greater. This would be for the purpose of calculating the rate of inheritance tax on the succeeding ten-year anniversary charge. In order to achieve a degree of fairness, the 'additions' rules generally disregard other additions made to discretionary trusts on the same day.

This led to the development of something called the 'added property route' which sought to take advantage of these rules through having significant additions made to multiple discretionary trusts on the same day, where each of the settlements had themselves been established on different days. The idea was not to mitigate the inheritance tax on putting the value into the discretionary trusts. The aim was to establish a number of settlements with nil rate bands.

It is also assumed that there was a second key element here. The first ten-year anniversary would take place prior to the conversion of the deferred shares at year 12. Provided that the individual trust holdings could be kept separate, it should have been possible to achieve a significant valuation discount in respect of the deferred shares through the fragmented ownership. This would further limit the inheritance tax charge.

It is assumed that these two elements, namely maximising the availability of nil rate bands available, and the valuation discounts on the deferred shares on the ten-year charge, were behind the planning here. There may also have been a further intention to get value into offshore trusts at a time when they were effective deferral vehicles for capital gains tax purposes.

Arguments raised

The arguments were based upon three main issues. The first two involved the application of the associated operations rule, under both of its limbs. The final argument dealt with a much more fundamental point involving the definition of settled property. En route, the Special Commissioner made an interesting, albeit not surprising, aside as regards the date that each trust was considered to have commenced.

Date the settlements commenced

The Special Commissioner noted that there was no evidence of the dates when the initial settled property of £10 was paid to the trustees, thereby constituting the settlements. Pragmatically, it was assumed that the initial property became comprised in all five settlements on the same date. As a result, the dates that appeared in the deeds were ignored. This aspect was not fatal to the scheme, although it could have been had significant sums been involved, which would have eroded the nil rate band of each settlement. This is because each settlement was now related within section 62, Inheritance Tax Act 1984, as they had been established on the same day. This meant that in calculating the tax due on any ten-year anniversary, it would be necessary to take into account the value of any property held by them immediately after having been established. Here this aspect did not appear to matter unduly as the sums used to establish the trusts were relatively modest.

Section 268(1)(b), Inheritance Tax Act 1984

Section 268 sets out the associated operations rules. These need to be taken into account in determining whether a disposition results in a charge to tax. The main argument centred around section 268(1)(b), which says:

'(b) any two operations of which one is effected with reference to the other, or with a view to enabling the other to be effected or facilitating its being effected, and any further operation having a like relation to any of those two, and so on.'

David Ewart for the taxpayers argued that the term 'reference' should be construed in accordance with its meaning in The Shorter Oxford Dictionary: 'in or with reference to' or 'with respect or regard to; with a view to, according to'. He argued that such a meaning would not apply because the precise course of events as actually occurred were not contemplated from inception. Some emphasis was placed on the issue of the deferred shares that were subsequently found to be void. This was an attractive argument, which did not appear to influence the Special Commissioner.

Peter Twiddy argued as regards each settlor separately, that each one operation facilitated the other dispositions. The overall intention, he argued, had always been to transfer the shares. The first attempt had failed, the second succeeded, and was still associated. Through adopting a 'wider view' argument, Mr Twiddy sought to link the creation of the settlements and the later addition of the deferred shares. This approach found favour with the Special Commissioner who held that the creation of each settlement was effected with a view to enabling or facilitating the subsequent transfer of the deferred shares to the trustees. As a result, the creation of each settlement (with the payment of the sum of £10) and the subsequent transfer of the deferred shares were held to be associated operations.

The next issue was then to establish whether the transfers to all five settlements were themselves associated operations 'effected by reference to each other'. The Special Commissioner concluded this to be the case.

Section 268(1)(a), Inheritance Tax Act 1984

Having concluded that section 268(1)(b) applied, it was not strictly necessary for the Special Commissioner to consider the other limb of section 268. These observations here were purely obiter, and to a certain extent they might be considered to be controversial.

The terms of section 268(1)(a) apply to:

'(a) operations which affect the same property, or one of which affects some property and the other or others of which affect property which represents, whether directly or indirectly, that property, or income arising from that property, or any property representing accumulations of any such income.'

Essentially, Peter Twiddy argued that one original holding of shares in an unquoted company amounted to 'the same property'. He argued that such shares could provide voting powers which carried with them voting control or the ability to pass special resolutions. He presupposed that a holder would be unlikely to want to fragment his holdings. In this instance he argued that 'the only reason for the proposed fragmentation was to get tax advantage and that was what the legislation was designed to counter'.

David Ewart argued that each 'share was a separate piece of property' as each had a vote and was entitled to share in a dividend and in capital.

The argument advanced for the Revenue appears to introduce a motive element which seems at variance with the statutory test applied here. This is an undesirable argument, in that section 268(1)(a) appears to operate an objective criteria in linking up operations. Why should the motive of the parties have any relevance here?

Arguing that shares in an unquoted company could be a single asset appears equally mistaken. No authorities were cited by either party. The net effect of the Revenue's argument would materially extend the ambit of the associated operations rule in a highly undesirable manner. It could lead to some strange results. The formation of settlements which were otherwise completely separate and distinct would be treated as associated operations simply because a controlling shareholder decided to settle shares for the benefit of different members or even branches of his family. The question would then arise as to the value of shares appointed to different beneficiaries.

The Special Commissioner, with great hesitation, said that 'it does seem that the five parcels of deferred shares transferred to the trustees were "the same property" because they were all initially part of the same holding by the same owner of the same type of shares in the same company'. A distinction was made between a gift of private shares of the same class, and cash. The Special Commissioner felt unwilling to accept that the associated operations rules could extend to cash from the same bank account, because of the odd results that could arise as a result. However, this very same concern unfortunately did not deter her from considering the possibility that 'the same property' argument could extend to private company shares. This distinction is difficult to sustain, and it is respectfully suggested that the better view was expressed by counsel for the taxpayer.

Was the property held on trust?

The final piece in the statutory jigsaw puzzle was to establish that the associated operations amounted to dispositions which resulted in the property being held on trust.

Reliance was placed here on Macpherson v Commissioners of Inland Revenue [1988] STC 362 and Reynaud [1999] STC (SCD) 185. The Special Commissioner favoured the arguments raised by the Revenue. She quoted with approval Lord Jauncey's observation in the Macpherson case that:

'it is clear that the intention to confer gratuitous benefit qualifies both transactions and associated operations. If an associated operation is not intended to confer such a benefit it is not relevant for the purposes of the subsection. That is not to say that it must necessarily per se confer a benefit, but it must form a part of or contribute to a scheme which does confer such a benefit.'

A similar approach was adopted by the Special Commissioners in Reynaud, and was cited by Dr Brice. In this case, Dr Brice identified as associated operations the establishment of the five settlements and subsequent additions of the deferred shares. However, she interpreted the word 'settlement' in section 64, Inheritance Tax Act 1984 by reference to the term as defined by section 43(2):

'"Settlement" means any disposition [including a disposition effected by associated operations] or dispositions … whereby the property is for the time being … held in trust …'

In applying this definition, she concluded that all the associated operations and all the trusts could be tied together under the umbrella of a 'single settlement'. It is not clear what counter-argument was raised for the taxpayer. It is likely that such an approach was going too far. It is not clear that the administrative provisions in the inheritance tax legislation, such as liability for unpaid tax, could operate fairly in this type of situation.

An alternative argument was raised by the Revenue that all five settlements were in fact one settlement in section 43(2) in any event. Dr Brice commented on this alternative argument. It did not form the ratio of the decision, as she preferred to rely on the associated operations rule to link all the trusts together into a single settlement.

However, she concluded that all of the five trusts in each case did in fact constitute a single settlement in any event. In doing so, she seemed to place emphasis on the term 'disposition' rather than the word 'trust':

'Bearing in mind that each settlement was identical, with the same settlor, the same trustee, the same type of trust property, the same beneficiaries, and the same commencement date, that each was a disposition, and that each one was effected by reference to the other, it would appear possible to conclude that there was one settlement within the meaning of section 43(2).'

This was very much the approach of Peter Twiddy. He also argued that there were dispositions here and a scheme or plan to show they were linked purposively. David Ewart, for the taxpayer, argued that each settlement had to be considered separately as they were separate settlements under trust law. This represents a 'traditional' argument in this type of case, and one for which the writer has a great deal of sympathy. This is because in section 43(2) there are two key words. The term 'disposition' has an extended meaning under the inheritance tax rules. But the term 'trust' used there does not, and should take its normal natural meaning. David Ewart raised a further argument that if the Special Commissioner found in favour of the single settlement argument, it could have wider implications. It could affect the incidence and limitation of liability under sections 201 and 204, Inheritance Tax Act 1984 as among the various trusts. Dr Brice concluded that this would not cause any difficulties because all five settlements in each case were identical. However, this would seem to beg the wider question as to whether the existing inheritance tax framework could accommodate such an argument. Its failure to do so would suggest that the argument favoured by the Special Commissioner was too extreme.

It is unfortunate in this case that the terms of each trust were apparently 'identical', but this should not lend credence to the Revenue's view. There will be other cases, in other situations, where such a view would be entirely inappropriate.

At the time of writing it is unclear whether The Rysaffe Trustee case will be taken to appeal. It is a case which touches upon a number of key issues, and provides an interesting gloss on the Macpherson case as well as the more recent decision in Reynaud. Some aspects might be considered to be controversial. We will have to wait and see if there is likely to be any further guidance on these topics from higher courts in due course.

Issue: 3838 / Categories: Comment & Analysis , Rysaffe , Inheritance Tax , Trusts