Meeting Points

RALPH RAY FTII, TEP, BSc(Econ), solicitor, consultant with Wilsons, Salisbury reports a Key Haven conference, 'Tax planning for high net worth individuals' which took place on 9 November 2001.

Gift to discretionary settlement subject to a reservation of benefit

With regard to the operation of inheritance tax excluded property rules on the death of a settlor who was non-domiciled when that settlement was created, the Revenue has, until now, agreed with the settled property solution, said James Kessler, barrister. Law Society's Gazette, 1986, page 3728 provides:

Question: G, a non-domiciliary, gifts excluded property into a discretionary settlement under which he is in the class of beneficiaries. G dies domiciled in the United Kingdom. Are the 'excluded property' assets in the settlement treated as part of G's estate?

Answer from the Controller, Capital Taxes Office: Here it seems to me that the settled property would be 'property subject to a reservation' in relation to the settlor. Accordingly, it would fall within section 102(3), Finance Act 1986 to be treated as property to which he was beneficially entitled immediately before his death. The effect would be to lock the property into the settlor's estate within the meaning of section 5(1), Inheritance Tax Act 1984 which is subject to the exception for 'excluded property'. It would follow that in the case of settled property, relief for foreign assets could continue to be available under section 48(3).

The same point is made in the Capital Taxes Office Advanced Instruction Manual at D8. Astonishingly, the Revenue has said informally that it is reconsidering its position on this point. It was understood that if it changed its view, no tax would be sought where taxpayers have relied on the previous view. How will that work in practice? The text of the manual was changed (without a public announcement) about October 2001. The last sentence now reads: 'Any cases where this is the situation must be referred to the litigation team'. It is considered that if the Revenue does change its mind, it will eventually be defeated in the courts. It seems to James that taxpayers can no longer rely on the 'official' statement of the Revenue view.

The foreign domiciliary and his home

Stephen Brandon QC said that even if a person is within the ambit of section 145(1), Taxes Act 1988 in respect of the occupation of property owned by a company, one has to ask two questions: first, is there any sum 'made good' to those at whose costs the accommodation is provided and, the more fundamental question: at whose cost is the accommodation provided? If it is not the employer 'at whose cost' the accommodation is provided, but the (alleged) employee, section 145 cannot apply. Success on the latter point also takes the case out of section 146.

It is crucial to remember that in R v Allen [1999] STC 846, the allegation was that the company made (undisclosed) profits from its trading. It used its profits in, among other things, buying a villa for Mr Allen to use. In every sense, the company provided the villa to Mr Allen.

Future planning must clearly seek to avoid a Revenue argument. The following might, therefore, be considered:

• insurance (sometimes the cheapest route);
• use of settlement;
• creation of separate interests in property;
• options.

Moving the property, in an existing structure, can only be done if it is certain that the company is not resident in the United Kingdom.

Loan to trust arrangements

James Kessler described loan to trust arrangements whereby a settlor loans funds interest free to a trust, the trustees invest the funds and repay the loan in instalments, giving the settlor tax-free income. The object is that growth of the trustees' investments is outside his or her estate.

James Kessler said that it has been held that so long as the loan is outstanding, the settlor has an interest in the trust, so is within section 660A, Taxes Act 1988 (settlement income taxable on the settlor) and section 77, Taxation of Chargeable Gains Act 1992 (chargeable gains of settlement taxable on the settlor): see Watchel v Commissioners of Inland Revenue 46 TC 543 in which the settlor deposited a sum with a bank as security for a loan made to the settlement. These problems are avoided in principle by the use of a policy of assurance. This also offers the possibility of five per cent annual withdrawals to repay the loan.

As regards inheritance tax, an interest-free loan repayable on demand is not a disposal by way of gift. But James Kessler said to beware of paragraph 5 of Schedule 20 to the Finance Act 1986 which can probably be avoided by using a bare trust.

Film schemes

Andrew Thornhill QC said that just as with the capital allowance régime (where film master negative qualified as plant) under Mrs Thatcher (which led to Ensign Tankers (Leasing) Ltd v Stokes [1992] STC 226), the Revenue has been slow to approve film schemes designed to take advantage of the income tax relief available under section 113, Finance Act 2000. Usually this is because there is a lack of symmetry between incurring expenditure and receiving the income.

Straightforward purchase and lease back schemes have been approved. The income flow is usually bank guaranteed, which can cause Ramsay problems with 'circularity' of cash flow. If this point can be satisfactorily handled, these schemes are satisfactory with the 40 per cent taxpayer usually having to find about 19 per cent of the investment and being able to borrow the balance and service the loan out of income.

If relief is spread back, there is an awkward trap in section 42(2) of, and Schedule 1B to, the Taxes Management Act 1970. Although the relief is given by repaying tax quantified by reference to the previous year, the claim is a current year one. So the tax has to be paid for the previous year in full, unreduced by the claim and the claim reduces the liability for the current tax year.

Flat schemes

Little attention has so far been given to the legislation granting allowances on flat conversions or renovations, said Andrew Thornhill QC. This was introduced by section 67, Finance Act 2001.

The important features are that the allowances are 100 per cent. They work very like industrial building allowances, but no event after seven years gives rise to a balancing charge.

It is thought that these allowances will be attractive provided that the investor does not have to spend capital on acquiring a major interest in the shop with flats above. The ideal course is as follows:

• Taxpayer (T) takes underlease of upper floors at market rent reflecting current value for, say, 14 years.
• T spends money improving the premises and grants sub-underleases for the residue of 14 years. Indications are that over 14 years T would receive sufficient income to recover his capital investment and cover interest costs (if he borrowed to finance the expenditure).

At some stage, the rent review will take into account tenant's improvements. So the retailer tenant will want the premises back so that he can use the occupation rent to pay his review. The allowance conditions are detailed (section 490 et seq, Capital Allowances Act 2001) but essentially simple.

Avoiding the inheritance tax gifts with reservation rule

James Kessler said that the inheritance tax gift with reservation rule does not apply to any gift which qualifies for the inheritance tax spouse exemption: see section 102(5)(a), Finance Act 1986. A suitable proposal to take advantage of this exclusion is that H should make a gift to a settlement, on the following terms:

• W would be entitled to the income of the trust fund for, say, 12 months;
• subject to that, the trust fund would be held on trust to pay the income revocably to, say, the children, H and W being capable of benefiting from appointments out of the capital.

The trust fund may consist principally of a policy of assurance or a family residence, i.e. assets outside income tax and capital gains tax and their anti-avoidance provisions. However, it would be best (though not perhaps strictly essential) if H also gave to the trust some additional funds, cash or shares, which produced a little income. Income should arise both during the initial period (12 months) and subsequently.

Gift to non domiciled spouse

James Kessler gave a note of warning where a United Kingdom domiciled spouse makes a gift to a foreign domiciled spouse. In such cases, the spouse exemption is restricted to £55,000, so that a gift over that limit will be within the scope of the gifts with reservation rules, unless some other exemption is in point. James noted that the reservation of benefit rules sometimes work harshly in the mixed situation. Suppose:

• H (United Kingdom domiciled) makes a gift to W (foreign domiciled);
• the gift does not qualify for the inheritance tax spouse (or any other) exemption so the gift with reservation rule applies;
• H continues to enjoy benefits from the property.

On the death of H, the property forms part of his estate. It is not excluded property (even though W is not United Kingdom domiciled). So H will be subject to inheritance tax on the property on his death. By contrast, suppose H had kept the property until his death, and by the time of his death W had become United Kingdom domiciled or deemed domiciled. In such a case, there need be no inheritance tax on the death of H if W survives him, since the spouse exemption would apply. The spouse exemption is arguably available when the gift with reservation of benefit rules apply, if the property is still in the spouse's estate at the time of death, but the Revenue may not accept this.

Going non-resident

Kevin Prosser QC looked at the position when a United Kingdom resident leaves the United Kingdom for just one tax year. In Reed v Clark [1985] STC 323, Dave Clark left the United Kingdom for the whole of the tax year, not setting foot in the United Kingdom at all. He did not give up his United Kingdom home. He spent the whole year in Los Angeles. While there he carried on his music business.

It was held that he was not resident and not ordinarily resident in the year. A person's occasional residence is to be contrasted with his usual or ordinary residence; ordinary residence has the meaning given in R v Barnet London Borough Council ex parte Nilish Shah [1983] 2 WLR 16, so that a 'settled purpose' does not require an intention to stay indefinitely. The judge said that:

'A year is long enough for a person's purpose of living where he does to be capable of having a sufficient degree of continuity for it to be properly described as settled... In this case there was a distinct break in the pattern of the taxpayer's life which lasted (as from the outset he intended) for just over a year.... For that year Los Angeles was his headquarters. He did not visit this country at all. On the whole I do not think that he can be said to have left the United Kingdom for the purpose only of occasional residence abroad.'

Tax avoidance after Westmoreland

As with most Ramsay cases, said Michael Furness QC, MacNiven v Westmoreland Investments [2001] 2 WLR 277 is largely about emphasis. It undoubtedly stresses the primacy of technical legal language, and makes clear the onus on the Revenue to show why a scheme which takes advantage of technical legal concepts should be struck down on Ramsay grounds. But Lord Hoffmann offers some assistance to the Revenue in the area of commercial concepts.

Westmoreland is one of those cases which, in retrospect, would have been significant if the Revenue had won it but, in the event, is likely to mean little change to the Revenue's approach. The Revenue has never successfully applied Ramsay in the higher courts to concepts other than commercial concepts. A good example of a failed attempt to apply Ramsay to a technical concept is Piggott v Staines [1995] STC 114, another case involving a dividend. So far as commercial concepts are concerned, the case carries on where McGuckian left off in emphasising the need for a broad purposive approach, and placing less emphasis on fulfilling requirements laid down in earlier cases before Ramsay can be invoked, at any event where the circumstances differ from the earlier case.

In its natural habitat - the world of gains and losses, income and capital, and commercial (i.e. loosely defined) concepts generally - Ramsay appears to be alive and well.

Taper relief and takeovers

According to the Revenue (see Capital Gains Tax Manual at paragraph 53425), although Richard Bramwell QC expressed doubts as to the interpretation, for a debenture or loan note to be eligible for continuing business assets taper relief, it must also be a debt on a security.

This seems to entail that the security should be capable of being held as an investment and realised at a profit.

These conditions are, to some extent, interrelated, but it is important that both should be satisfied. For example, a debt may be regarded as a good investment. But if it cannot be realised at a profit, it cannot be a debt on a security.

Capital Gains Tax Manual at paragraph 53426: 'Held as an investment': For a debt to be held as an investment it should either: carry a commercial rate of interest; or carry a premium on repayment, equivalent to the interest which would have been paid; or be issued at a discount, so that repayment at face value again reflects the interest which would have been paid on the debt.

Where these criteria are not met and the return on the investment is clearly uncommercial, debt on a security status should not be accepted.

Capital Gains Tax Manual at paragraph 53427: 'Realised at a profit': Whether a debt can be realised at a profit will depend, in part, on the premium, or rate of interest which the debt carries. But even if a debt carries an attractive rate of interest, it may not be regarded as a worthwhile investment by a potential purchaser. For example, the terms of the loan may enable the borrower to repay the debt early. A potential purchaser would need to consider whether the loan would last long enough to cover the costs of acquisition, and obtain a worthwhile return on the investment.

Just a ferry trip away

Kevin Prosser QC recommended that the United Kingdom/Belgium double tax agreement should be considered as a strategy to avoid capital gains tax. Article 13 (Capital Gains) provides:

'(4) Gain from the alienation of any property other than that referred to in paragraphs (1) to (3) (e.g. immovable property, business property) shall be taxable only in the contracting state of which the alienator is a resident.'

Thus gains accruing on the alienation of property by an alienator who is a resident of Belgium are not liable to United Kingdom capital gains tax. Kevin considers that there are two alternative routes:

• to be not resident and not ordinarily resident in the United Kingdom, and be a Belgian resident for Belgian tax purposes (tie-breaker clause in the treaty not then relevant); or
• continue to be United Kingdom resident and/or ordinarily resident and be a Belgian resident and satisfy the tie-breaker clause.

What is involved in being a Belgian resident? One year's absence may suffice to be not resident and not ordinarily resident in the United Kingdom, but longer may be required to be resident in Belgium.

The treaty will not apply to all gains; for instance it will not apply where the individual is not the alienator and a different gain of equal amount is treated as accruing to the individual, as under sections 86 and 87, Taxation of Chargeable Gains Act 1992. Kevin suggested selling a trust interest to a non-resident while being treaty non-resident as a way round section 87. Note that for stamp duty purposes, the sale must be outside the territorial scope.

Turning capital into income

There is no income tax equivalent of section 10A, Taxation of Chargeable Gains Act 1992, said Kevin Prosser QC. Therefore temporary non-residence is fine for income tax purposes. So, instead of liquidating Offco and triggering a capital gains tax gain on disposal of the shares, extract the value in income form by way of dividend while temporarily non-resident. The country of temporary residence must be a tax haven. However, it must be considered whether the dividend is subject to capital gains tax under any of the following sections of the Taxation of Chargeable Gains Act 1992:

(a) Section 22 - disposal where capital sums derived from assets.

(b) Section 24 - disposal where assets become of negligible value.

(c) Section 30 - value shifting: charge on tax-free benefits.

(d) Section 122 - capital distribution in respect of shares.

It will be crucial to establish that section 37 of the Act applies (consideration chargeable to tax on income).

It might be better to make Offco United Kingdom resident first, so that the dividend is taxable income under Schedule F although not taxable at the higher rate (section 128, Finance Act 1995) and with a credit for tax paid at any other rate.

Consider section 703, Taxes Act 1988 (transactions in securities): and whether there is a tax advantage in the circumstances of the case.

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