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Although the capital gains tax changes brought about by the 2008 budget gave cause for much discussion in the professional press, I can’t find anything about the change whereby the settlor is no longer assessable on trust gains and I have only become aware of this as I’ve started to deal with 2009 trust tax returns.
Granted, the reduction in the tax rate to 18% suggests – on the face of it – that the tax bill will be the same whether the settlor or the trustees are paying it, but as I see it, the Treasury will be receiving more in every case because of the loss of half of the capital gains tax exemption.
I appreciate that this is not a huge amount, but all those little bundles of £864 (in 2008/09: £4,800 x 18%) must add up!
In most cases, brokers try to ensure gains come in just under the individual capital gains tax allowance, but they have all been caught out by the change and some of my little trusts now find themselves having to pay tax. Hopefully, that won’t be repeated next year and there will be greater awareness of the reduction in the exemption.
Given the extent to which the capital gains tax changes were examined at the time, I’m surprised this wasn’t highlighted. I certainly didn’t spot it.
There’s a very brief mention in the April 2009 issue of Inheritance Tax & Trusts Newsletter that ‘gains arising to settlor-interested trusts are now chargeable on the trustees’, but I have not been able to find the actual section that says this! Am I right that rather than being a ‘positive’ provision, it’s a ‘negative’ one in that it simply cancels out TCGA 1992, s 77, which dictated that the charge would be on the settlor?
I would be grateful for readers’ advice and any other implications of this change.
Query 17,486 – Changeling.
Reply from Sparta
The provisions referred to by Changeling were introduced as an anti-avoidance measure when the rate of capital gains tax for trusts was noticeably lower than that applicable to higher rate taxpayers.
The announcement of a flat rate of capital gains tax in the Chancellor’s pre-budget report speech of October 2007 undermined the rationale for those provisions and as part of the overall capital gains tax reform package the government subsequently took the opportunity to abolish TCGA 1002, s 77 to s 79.
TCGA 1992, s 77(2) said that ‘where this subsection applies, the trustees shall not be chargeable to tax in respect of the gains concerned but instead chargeable gains of an amount equal to that referred to in subsection (1)(b) above shall be treated as accruing to the settlor in the year’.
In other words, s 77 was a deeming provision. To reintegrate settlor-interested trusts within the regime applying to any other UK trust the simple phrase ‘omit sections 77 to 79’ found in FA 2008, Sch 2 para 5 was all that was required.
The Finance Bill was published on 27 March 2008. While it may be rightly argued that this gave advisers scant notice of the change, the writing was on the wall as early as 9 October 2007 and the content of the Finance Bill therefore came as little surprise.
The relatively low profile of the repeal perhaps underlines the fact that the reality of administering trusts is not just about filling in the trust return after the year end, but that there is also a demand for constant vigilance regarding legislative developments and HMRC practice together with timely and proactive advice.
Two implications follow in respect of annual exemptions.
First, where a settlor had allowable losses from the current or previous years, these could have been set these against gains attributed from the trust under s 77. The repeal denies that offset and where there are personal losses will serve to increase the amount charged to tax.
Secondly, where gains of a trust were attributed to the settlor in the past, the tax was computed with the benefit of the settlor’s personal annual exempt amount. If the settlor had no other gains in the year, then under s 77 a larger exemption is made available than would have been available to the trustees.
Following the repeal, if the settlor had made personal gains which used up the annual exemption, then repealing s 77 to s 79 allows the trustees to use their annual exemption which would otherwise have been wasted.
The change can also operate against the taxpayer as Changeling has outlined. It appears that brokers have failed to take account of the legislative change from 6 April 2008 and this is the real issue here.
If, as Changeling implies, the brokers were actively managing the portfolio to take maximum advantage of the settlor’s personal annual exemption in the 2008/09 tax year, the trustees of affected trusts may wish to consider who was responsible for the tax advice in these circumstances if not themselves.
Where the trustees of such trusts believe that they had delegated their powers in accordance with the administrative powers contained in the trust deed they may justifiably consider whether there has been a breach in the duty of care owed to them.
Reply from Lacuna
From the wording of Changeling’s query I wonder whether he was under a misapprehension about the effect of TCGA 1992, s 77 which, as he correctly surmises, was abolished with effect from 6 April 2008 by FA 2008, s 8 and Sch 2, para 5.
The repealed section operated to attribute to the settlor gains realised by the trustees only if the trust was ‘settlor-interested’ for capital gains tax purposes. In its final form, to be settlor-interested meant that the settlor, his or her spouse or civil partner or minor unmarried children needed to be potential beneficiaries.
Civil partners were added with effect from 5 December 2005 and minor unmarried children were brought in with effect from 6 April 2006. Normally, care would have been taken to ensure that a trust was not settlor-interested if only because of the potential income tax and inheritance tax problems that might otherwise have ensued and it seems odd that Changeling has so many on his books.
Even when s 77 applied, the trustees were primarily responsible for making returns of the chargeable gains and allowable losses accruing to them: see HMRC’s Capital Gains Manual at CG34850.
If the brokers were routinely triggering gains just under the individuals’ exemptions they must have assumed that the settlors were not realising any gains personally.
Notwithstanding the repeal of s 77, capital gains tax holdover relief remains precluded on a transfer to a settlor-interested settlement by virtue of TCGA 1992, s 169B.
Reply from Hodgy
Changeling is correct that the legislation has been changed and that capital gains made by settlor-interested trusts will be assessed on the trustees with effect from 2008/09.
The change was introduced in FA 2008 which repealed TCGA 1992, s 77. If you repeal the section which provides that gains made by a settlor-interested trust are to be taxed on the settlor, such gains will be assessed on the trustees, as they are the persons making the disposal.
The specific provision is contained in FA 2008, Sch 2 para 5 where it reads ‘omit sections 77 to 79 (charge on settlor with interest in settlement)’.
I would agree that the change does not appear to be well-publicised. I knew about the change, but could not recall whether I had heard it on a course or from some other source of information.
I looked through the 2008 budget notes and the notes from the 2007 pre-budget report without seeing any reference to this change. I realised where I had read about the change when looking at my annotated copy of FA 2008 – sent to me every year by the Chartered Institute of Taxation – as it does mention the repeal of TCGA 1992, s 77 to s 79.
It goes on to give the reason for the repeal being that as the rate of capital gains tax is not to be linked to the rate of income tax paid by a taxpayer from 2008/09, s 77 to s 79 were said to have become redundant.
I would agree with Changeling that for some trust clients, they could end up paying capital gains tax unexpectedly. However, for other clients, a charge to capital gains tax may now be avoided or certainly reduced.
This can occur if the settlor commonly uses his annual exemption on the disposal of assets in his own name, such that gains made by a settlor-interested trust set up by that individual will now have the benefit of half of an annual exemption.
If, as Changeling suspects, many people have not been aware of this change in the legislation, hopefully his query and the replies will help to publicise it more widely.
Reply from Digby Bew
FA 2008, Sch 2 is entitled ‘Capital Gains Tax Reforms ... Rate: consequentials’, and Sch 2 para 5 repeals TCGA 1992, s 77 to s 79 with effect from 6 April 2008. Thus the repeal of s 77 to s 79 is a direct consequence of the introduction in FA 2008 of a simplified single capital gains tax rate of 18% for both individuals and trustees.
Sections 77 to 79 were, of course, the provisions which, prior to 6 April 2008, taxed the gains of a settlor-interested trust on the settlor by treating the gains of such trusts as forming the highest part of the amount on which the settlor was chargeable to capital gains tax, taxed therefore at his highest personal rate of tax.
The consequence of the repeal of that ‘code’ is twofold: namely, to change in the way in which the losses of such trusts are relieved; and the availability, from 6 April 2008, of the trust annual exemption for such trusts.
As to losses, prior to 6 April 2008, the gains deemed to accrue to the settlor of a settlor-interested trust were reduced in the first place by the trust’s allowable losses; the settlor could then use any personal losses, to the extent that these had not already been used against personal gains, to reduce the trust gains, but surplus trust losses could not be used against the settlor’s personal gains.
Taper relief was then given by reference to the trustees’ period of ownership. The settlor was assessed to tax on the tapered gains after loss relief and entitled to claim from the trustees reimbursement of the tax paid.
As disposals by settlor-interested trusts from 6 April 2008 are no longer taxed on the settlor, trust gains and losses accrue only to the trustees and are taxed at 18%; surplus personal losses of the settlor can no longer be set against trust gains.
The other change is in terms of the availability of an annual exempt amount to the trustees of a settlor-interested trust from 6 April 2008. Prior to 6 April 2008, the s 77 to s 79 code applied if certain conditions were satisfied.
One of those conditions was that the trustees would, after making deductions for losses, but taking no account of the annual exemption, be chargeable to tax for the year in respect of those gains.
However, no annual exempt amount was available to the trustees of a settlor-interested trust as such since the annual exemption is only available against a ‘taxable amount’ being the amount on which the trustees are chargeable to capital gains tax (TCGA 1992, s 3(5)); having met the s 77 to s 79 conditions, the relative gains were attributed to, and taxed on, the settlor so that the trustees had no ‘taxable amount’ for these purposes.
From 6 April 2008, the gains of a settlor-interested trust are taxed on the trust to which, accordingly, an annual exempt amount is available at one-half of an individual’s annual exempt amount.
Far from being ‘half empty’, Changeling’s cup is now ‘half full’.
Reply from Scorpio
I agree that there was very little attention directed at the change in the capital gains tax position of self-settled trusts, which were effective from 6 April 2008.
There is only a brief mention of the changes in the budget summaries and the FA 2008 reports and commentaries, and I agree that there may well have been unexpected capital gains tax liabilities arising for the year 2008/09 for some of these trusts.
Most of the trusts that I deal with had net losses on 2008/09 share transactions so the impact of these changes must wait another year.
The reason why very little is available on this subject is because the changes were buried within a major reform of the capital gains tax regime, which was dealt with in FA 2008.
The legislation introducing the reform is contained within FA 2008, s 8 but the part of the legislation that Changeling is looking for is contained in FA 2008, Sch 2 para 5.
As Changeling has suggested, all this does is to take out TCGA 1992, s 77 to s 79 from the legislation. As there is very minimal wording in FA 2008 covering these changes and because they have been introduced at the same time as significant other changes, little attention has been paid to them.
The changes were not flagged up within the legislation with a heading of any description and were contained in the small print.
It was thought that as the rate of tax applied to capital gains for individuals and to trusts has been brought into line at a flat 18%, there is no requirement to continue to assess gains from these trusts on the settlor.
Prior to 5 April 2008, the rate of tax depended upon the tax rates of the individual and part of the gains could be taxed at 20%. TCGA 1992, s 77 was originally introduced as an anti-avoidance measure at a time when presumably the capital gains tax rates for trusts were lower than the capital gains tax rates for individuals.
Changeling has identified one of the effects of this legislation whereby the trust will only now have a trust exemption available. As to whether the changes have a positive or negative impact that is a matter of opinion.
In my cases involving self-settled trusts, the individuals also have individual portfolios of shares and I am looking at this as a positive change as there is an extra trust annual exemption available to play with each year in the future. There are also some capital losses being brought forward to utilise in these cases.
Reply from Doc
FA 2008, s 8 and Sch 2 introduced the reforms to capital gains tax. One of the changes was to repeal TCGA 1992, s 77 to s 79, which assessed the settlor of a settlor-interested trust with any gains made by that trust. The normal rules therefore apply from 6 April 2008 with the trustees receiving an annual exemption and the excess gains taxed at 18%. This gets a brief mention in HMRC’s Capital Gains Manual at CG34700.
It should be noted that there is no change to the income tax rules and settlors continue to be assessed on the trust income.
Although Changeling considers this part of the capital gains tax reform to be a tax increase, my experience is the opposite.
If the settlor has investments in their own name they now have the capital gains tax exemption available in full and it is no longer used in part by the trust gains, which are relieved against their own exemption.
Reply from Gardener
This change was indeed hidden away, and arose in the way that Changeling supposes – the repeal of the provision in TCGA 1992, s 77 that assessed trust gains on the settlor of a settlor-interested UK trust.
It is a rare example of a provision being repealed when the reason for it has gone; often such rules hang around in the law for years or for ever.
Someone must have remembered that the reason the provision was introduced in 1988 was the possibility that capital gains tax could be charged at a lower rate in an interest in possession trust than for an individual settlor, so there would be a tax advantage in ‘parking’ an asset in a settlor-interested trust while it was disposed of and receiving the net proceeds back afterwards.
Now that everyone pays at 18%, supposedly ‘it makes no difference’.
However, as Changeling has noticed, it makes a considerable difference in at least three ways: the lower annual exemption available to the trustees; the incidence of the liability to pay the tax; and the availability of other reliefs.
The lower annual exemption for the trustees at least means that an extra annual exemption is available – part of the point of the 1988 change was to deny that as well.
However, investment managers may have realised gains of £9,600 in the trust for 2008/09, leading to a payment of capital gains tax, rather than the more beneficial £4,800 in the trust and £9,600 separately for the individual.
The incidence of the liability is important, particularly where the trust is being wound up. I was planning to wind up a settlor-interested trust in December 2007, mainly because the income tax changes to such trusts had made my life much more complicated from 6 April 2007 onwards.
The announcement of the capital gains tax rate cut meant that it was advisable to wait until 6 April 2008. Fortunately, I noticed the repeal of s 77 in time to obtain an indemnity from the settlor/beneficiary – he will pay the tax when it falls due on 31 January 2010. Otherwise, I would have distributed all the assets and would still have had the tax liability, which was not previously the case with a settlor-interested trust.
Thirdly, the change can be a good or a bad thing if there are other capital gains tax reliefs available. If the trustees have losses, they can now use them against these gains. The use of the settlor’s personal capital gains tax reliefs (losses, reinvestment relief, etc.) against gains attributed from settlements was never straightforward, so perhaps this effect is not detrimental.
I wonder how many 2008/09 tax returns have been or will be submitted on the basis that nothing has changed – as Changeling writes, it was not a change that was highlighted at any point.
