This is a chapter from the Bloomsbury Professional book Trusts and Estates in Scotland 2011/2012, which covers the tax aspects of UK trust law and guides you through the complexities of Scotland's unique trusts and estates regime. The book covers the tax aspects of starting, running and ending a trust and deceased estates. It is a user-friendly, practical volume, which provides professionals with a core tax annual from which they can easily find initial guidance on mainstream areas of UK tax legislation and practice, as applied in Scotland.
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5.1 CGT is payable on actual disposals, which includes a disposal by way of gift (TCGA 1992, s 1). CGT is also charged on deemed disposals, eg where within a liferent trust (which does not fall within the relevant property regime by reason of creation, on or after 22 March 2006), the liferenter dies or where, within any type of trust, one or more beneficiaries becomes absolutely entitled to the property against the trustees. This situation is discussed in more detail in 9.5–9.11.
5.2 The gain has to be calculated. In simple terms the gain is the sale proceeds less the cost of acquisition. In the case of a gift, the market value at the date of the gift is used. The same 'market value' rule applies where the trustees make a disposal, even by way of sale, to a 'connected person', eg the settlor or anyone related to him.
5.3 Base cost: if the asset was acquired before 31 March 1982, the value at 31 March 1982 will be the 'base date'.
Also allowed as a deduction from the gain are the professional and other incidental costs of acquiring and disposing of the asset.
Until April 1998 an allowance was given for the effect of inflation, namely the 'indexation allowance'. However, the indexation allowance was 'frozen' at that date from which point the relief was, in general terms, replaced by taper relief. No indexation allowance or indeed taper relief is given for disposals on or after 6 April 2008.
There are various other reliefs that are dealt with in the course of this book and these are listed at 5.4 below.
Finally, after the application of any reliefs and losses (see 5.13–5.15), a deduction is allowed for the annual exemption (see 5.36–5.39) which, for 2011/12, will vary in amount between £5,300 and (because of the rules described at 5.37–5.38) £1,060.
The rate of CGT payable by trustees since 23 June 2010 is 28%. (18% between 6 April 2009 and 22 June 2010 and 40% in 2007/08).
Principal private residence relief (see 5.25–5.27). In parallel to the relief given to individuals, trustees making a gain on the disposal of a house that has been used as the only or main residence of a beneficiary, may have the gain wholly or partly relieved. Legislation in FA 2004 introduced with effect from 10 December 2003 prevents the combination of deferral by hold-over of the gain arising on the gift of a residence into a discretionary trust and principal private residence relief for the trustees on ultimate sale by them (see 5.27 and Example 5.9).
Entrepreneurs' relief (see 5.32–5.34) introduced from 2008/09 to mitigate the effect of the withdrawal of business assets taper relief. To a large extent this represents a return to the old retirement relief which came to an end on 6 April 2003 and is confined to truly business assets (not considered in this book, though for a description see 5.34–5.36 of Trusts and Estates 2007/08).
Taper relief: Introduced in 1998, but withdrawn from 6 April 2008. It was designed to relieve the impact of CGT according to the length of time the particular asset has been owned, with very significant favour being given to business assets.
Roll-over relief (see 5.28–5.31): – This is a specific relief given to trustees who trade, whether as a body or in partnership, achieved by way of a deferral of a gain realised on the sale of one business asset into the acquisition cost of another.
Enterprise investment schemes (EIS): Allow trustees to defer a gain realised on any asset by making an investment in a qualifying EIS company, see 5.23–5.24.
Hold-over relief. The trustees of certain trusts may in some circumstances defer recognition of CGT, which would otherwise trigger, when they advance certain assets to a beneficiary. The in-built gain becomes charged to tax when the beneficiary comes to sell the asset and in other prescribed clawback situations.
5.5 CGT is triggered by a disposal or deemed disposal. The date of the disposal for CGT purposes is the date on which a binding unconditional contract is concluded (even if the sale is 'completed' in a subsequent tax year) (TCGA 1992, s 28(1)).
If the contract is conditional, the date of disposal occurs on the date the contract becomes unconditional (TCGA 1992, s 28(2)).
5.6 Any CGT falls due on 31 January following the end of the tax year in which the disposal takes place. The fact that the sale proceeds might not be paid for some time makes no difference. That said, however, there is a relief (historically called 'hardship' relief) where the whole or part of the proceeds is receivable by instalments over a period exceeding 18 months, beginning no earlier than the date of the disposal (TCGA 1992, s 280). In such a case, the taxpayer can ask for instalment relief and may agree with HMRC a plan for payment of the tax over a period not exceeding eight years and ending not later than the date of the last instalment. There is no longer any need to satisfy HMRC that payment in one sum would cause undue hardship. In practice, HMRC will agree a payment plan that ensures that the taxpayer does not have to pay in tax more than 50% of what he has received.
Tax may also be paid by instalments over a ten year period where the disposal was a gift (TCGA 1992, s 281): see 5.52 for details.
5.7 The vendor of a business may agree with the buyer that the price paid is, in part, determined by the results of the business over say, the next three years. This is colloquially known as an 'earn out'. While part of the price may be paid shortly after the contract, it will not be known for another three years or so whether any further element will become known and payable. This is a so-called Marren v Ingles [1980] 1 WLR 983, situation, named after the 1980 House of Lords case. Some valuation has to be placed on the future right and that valuation is deemed to be part of the price received on sale. In three years' time, when that right becomes quantified, there is a further disposal, which may itself give rise to a gain or a loss.
The trustees enter into a binding contract to sell Blackacre on 31 March 2011, with the contract being completed on 30 April 2011. For CGT purposes the disposal falls into tax year 2010/11.
The trustees have agreed to sell Blackacre for £100,000, payable in four equal annual instalments. The first instalment is due 30 days after the contract and the next three instalments on each anniversary of the contract. It would be open to the trustees to apply to HMRC for instalment relief.
The trustees sell a business for £500,000 plus 10% of the profits shown by audited accounts over the next three years, payable nine months after the year-end in three years' time. The right to receive the further profits is quantified at £50,000. The immediate sale proceeds are therefore £550,000 (£500,000 + £50,000). In three years and nine months' time, the amount actually payable is £75,000. Therefore, a further gain of £25,000 (£75,000 – £50,000) arises at that time.
If, for disposals on or after 10 April 2003, a loss arises on realising the further right, that loss can (subject to conditions) be set off against the original gain (TCGA 1992, s 279A).
5.8 Prior to 6 April 2007, separate residence tests applied for CGT and income tax (see 4.1–4.4) and the then CGT test did not look at the individual trustees, but rather presumed trustees (as a body of persons) to be resident and ordinarily resident in the UK unless:
the general administration of trusts was ordinarily carried on outside the UK; and
the trustees, or a majority of them, were not resident or ordinarily resident in the UK (TCGA 1992, s 69(1)).
Prior to 6 April 2007 there was also a further provision which used to help the UK professional trustee. This allowed a professional trustee even though resident in the UK, eg an Edinburgh solicitor, to be treated as non-UK resident if the settlor was not domiciled, resident or ordinarily resident in the UK. In such a case, all or the majority of the trustees were treated as non-UK resident and the general administration of the trust was treated as carried on outside the UK (even if, as a matter of fact it was carried on in Edinburgh).
The rules for residence have been revised from 2007/08 (TCGA 1992, s 69). The income tax test now described in 4.1–4.4 applies also for capital gains tax purposes and the favourable rule for UK professional trustees described above has been repealed.
5.9 The advantage of a trust being resident outside the UK is that, apart from anti-avoidance rules (see 5.58–5.60), and assuming the trustees do not realise gains from UK assets used in a UK business, the trustees do not have a liability to CGT. This is the case even in relation to the disposal of assets situated in the UK. In the 1980/1990s this ostensibly favourable position led to a considerable number of UK resident domicilaries establishing offshore trusts. The ideal asset to put into such a trust would be one showing no current gain but with a significant prospect of a substantial future gain, eg subscription shares in a private trading company. The intention would be that the trustees would sell the asset in due course, realise a significant gain and then use it in such a way as to benefit the beneficiary and his family but without advancing capital to him. It was in response to such situations that substantive anti-avoidance legislation was enacted in 1991, 1998 and 2000. The capital payments charge has been further refined in 2008/09, following the changes to taxation made for UK resident non-UK domiciled beneficiaries generally by FA 2008: see 5.59–5.60 for more detail.
5.10 Most recently, in the light of attempts to exploit the application of specific double tax treaties to procure a UK CGT advantage, F(No 2)A 2005, s 33 prevents the use of a double tax treaty to argue that trustees are not UK resident in a particular year of disposal, with effect from 16 March 2005. It appears from the High Court decision in Smallwood v HMRC [2009] STC 1222 in favour of the taxpayer that such legislation was indeed necessary.
The Harry Trust is UK resident, and is therefore taxed on its worldwide gains as they arise.
The Hector Trust is non-UK resident. It was made by a person neither UK resident nor UK domiciled who continues to be so, and therefore, the settlor charge does not apply and no-one is taxed on the trustees' gains in the UK as they arise.
However, the capital payments charge (see 5.59–5.60) will apply to the Hector Trust even though the trust was made by a non-UK domiciliary. As and when payments of capital are received by a UK resident beneficiary the 'trust gains' (or, from 2008/09, the so-called 'section 2(2) amounts') (TCGA 1992, s 87A) of the settlement will be attributed to these payments in so far as they have not been previously attributed to other capital payments (including payments outside the capital payments charge made to a non-UK domiciled beneficiary). For capital payments received up to 2007/08, the charge applied only where the UK resident beneficiary was also domiciled in the UK. From 2008/09 it matters not where the beneficiary is domiciled, though if outside the UK and the payment is received outside the UK a remittance basis may apply. (See further 5.60.)
5.11 It is unlikely, in the context of the present legislative climate, that trustees of a UK trust or indeed the family behind the trust will consider making the trust non-UK resident. If they do, however:
there must be power in the trust for a successor body of non-UK resident trustees to be appointed;
that new body would be appointed as trustees and the existing UK trustees would retire in the normal way.
that act of appointment of non-UK resident trustees would cause a deemed disposal and re-acquisition by the UK resident trustees of the assets in the trust at that time (TCGA 1992, s 80). Any resulting CGT would be a liability of the retiring UK trustees (and they should therefore retain sufficient funds to pay the tax as well as to satisfy any other liabilities, eg professional costs); and
any gains held over by a settlor on putting assets into a trust within (broadly) the previous six years will become immediately assessable on the UK trustees and, if not paid within 12 months, on the settlor (TCGA 1992, s 168).
Outgoing UK resident trustees should also be aware of a possible liability for CGT, even where other UK Trustees took over in the first instance (TCGA 1992, s 82).
The fact that the trustees would become non-UK resident would open up the possibility of the settlor charge and/or the capital payments charge. However:
the settlor charge would apply only in relation to any tax year if the settlor was during that tax year alive and resident and domiciled in the UK;
the capital payments charge would apply only if capital payments were made to a beneficiary resident and domiciled in the UK or (from 2008/09) to a UK resident beneficiary wherever domiciled. (See 5.59–5.60 for further detail.)
Considerations of changing the governing law and also issues of future administration (including cost) should also be borne in mind.
Exporting the residence of a UK resident trust is not a step to be taken lightly. Probably, since 1998, rather more non-UK resident trusts have been brought back to the UK than UK resident trusts exported. However, depending on the nature of the assets and indeed the circumstances of the principal family, eg if one or a number of beneficiaries were to become non-UK resident and domiciled, it might be a step worth taking.
Example 5.5—Exporting a trust The Harry Trust has been UK resident for many years. Harry, having married a Scottish girl and brought up his children in the UK, has now reached retirement age. All his children have left home and are living in various parts of the world, none of them in the UK. He and his wife decide to retire permanently to Switzerland. |
The trust has not made huge gains over the years, though if certain investments recently made do 'come good', it might become quite valuable. Harry wishes to move the residence of the trust to a tax haven jurisdiction and his co-trustees are happy to do so. He is prepared to 'bite the bullet' by accepting the 28% tax charge (effective from 23 June 2010 onwards) on in-built gains on exporting the trust. The settlor charge will have no application for the future as Harry, the settlor, will become resident and domiciled outside the UK. Nor indeed will the capital payments charge have any impact, as all the beneficiaries have long since abandoned their Scottish domiciles of origin and have made their permanent homes, and tax residence, elsewhere. |
5.12 In principle, a gain realised on the disposal of any asset (see Example 5.13 at 5.55 for the method of calculation) is chargeable. That said, there are certain exempt assets such as sterling cash and indeed certain exemptions, such as main residence relief (see 5.25–5.27).
Focus Losses must be claimed and, for 2010/11 onwards, that claim must be made within four years from the end of the year of realisation. |
5.13 A loss realised on disposal will be allowable if the disposal of that asset at a gain would have been taxable (TCGA 1992, s 16). Allowable losses realised in the same year as a taxable gain must be deducted from those gains in computing the taxable amount for the year (even if the effect is to 'waste' the annual exemption). By contrast, losses in a given year, which are not used, for example, because there are no gains to offset against them, may be carried forward to a later year. Such brought forward losses need not 'waste' the annual exemption and the taxpayer trustees need only utilise so much of the losses as are necessary to bring the gains down to the annual exemption threshold. Any losses remaining can then be carried forward further.
Losses must be claimed, and within the permitted timeframe. For years prior to 2010/2011, a claim needed to be made within five years and ten months after the year in which it arose, in principle by recording it in the capital gains self-assessment pages (see 5.54). This time limit was reduced to four years, following FA 2008, Sch 39 from 1 April 2010 (The Finance Act 2008 Schedule 39 (Appointed Day, Transitional Provisions and Savings) Order 2009 SI 2009/403).
5.14 Trustees, as also individuals and executors are potentially affected by an anti-avoidance rule introduced with effect from 6 December 2006 (TCGA 1992, s 16A inserted by FA 2007, s 27(3)). A loss is not an allowable loss if it accrues 'directly or indirectly in consequence of, or otherwise in connection with, any arrangements [which includes any agreement, understanding, scheme, transaction or series of transactions (whether or not legally enforceable)], and the main purpose, or one of the main purposes, of the arrangements is to secure a tax advantage'.
The expression 'tax advantage' is defined to mean: relief or increased relief from tax, repayment or increased repayment of tax, the avoidance or reduction of a charge to tax or an assessment to tax, or the avoidance of a possible assessment tax; and 'tax' means CGT, corporation tax or income tax.
HMRC published revised guidance on the new rules on 19 July 2007, but it is not always easy to appreciate why one type of transaction is said to be unaffected whereas another not entirely dissimilar one is caught. Careful study should be made of the various examples supplied. Extreme caution is required in both effecting and reporting any transaction which may be affected by the new rule.
Focus Connected party losses are ring-fenced and not available for general offset. |
5.15 If the trustees realise a loss by making a disposal to a 'connected person', eg the settlor, or a relative of the settlor, they cannot offset that loss generally against trust gains (TCGA 1992, s 18(3)). The loss must be carried forward for use only against a future gain that arises from the trustees disposing of another asset to that same connected person.
5.16 Generally speaking, each asset must be treated separately for CGT purposes. Up to April 1998, however, there was a 'pooling' system for shares. Under this, each block of shares of the same class in the same company, held in the same capacity (viz as trustees as opposed to personal ownership) was regarded as a single asset, which would increase with purchases and decrease with sales. Immediately before each transaction the appropriate amount of indexation allowance (for inflation) was added to the pool.
This system changed under the taper relief regime which was introduced on 6 April 1998 and repealed on 5 April 2008. This regime, as its name indicated pivoted on the ownership period and thus required the identification of each asset to which the appropriate taper percentage could then be applied. At the same time, the 'anti bed-and-breakfast' rule was introduced, whereby (broadly) share acquisitions are matched with identical shares in the same company disposed of within the previous 30 days. (This 30-day rule is disapplied where the person acquiring the shares is not UK resident: this is a measure introduced by FA 2006, s 74 from 22 March 2006, following an avoidance technique successfully applied by taxpayer trustees in 2005 in a case called Hicks v Davies [2005] STC 850.) Shares disposed of between 1998/99 and 2007/08 were identified with acquisitions in the following order:
shares acquired on the same day.
shares acquired within the following 30 days.
shares acquired since 5 April 1998 on a FIFO basis.
pooled shares held at 5 April 1998.
pooled of shares held at 31 March 1982.
The trustees own 1,000 shares in XYZ plc, which have been acquired at various times. They disposed of 500 shares on 1 February 2008 (and repurchased 50 shares nine days later). The shares sold are identified with the following purchases:
50 shares acquired on 10 February 2008 (point (ii) above);
300 shares acquired on 1 September 2004 (point (iii) above);
150 shares held in the pool at 5 April 1998 (point (iv) above).
Note: The balance of 500 pooled shares may in fact have had a greater base cost using indexation and re-basing at 31 March 1982 than in comparison with those that were sold in February 2008 and will have commanded a higher taper percentage having been held for longer, but the trustees must still follow the strict identification rules.
5.17 With the reform of CGT from 2008/09 which repealed the taper relief regime and in its place introduced a much less complex system the rules for share identification return broadly to the pooling system which prevailed up to 5 April 1998 (as described in the first paragraph at 5.16). However, the matching rules described at (i) namely same day dealing and (ii) dealing within thirty days at 5.16 continue to apply.
5.18 To compute the gain, the base (or acquisition) cost of the asset is required. This will normally be the original cost of the asset or, if the asset was acquired by the trustees by way of a gift, the market value when the asset entered the settlement or where holdover relief has been employed, the adjusted value incorporating the held over gain. If, however, the trustees have owned the relevant asset since before 31 March 1982, then for disposals made after 5 April 2008 it will be the 31 March 1982 value.
5.19 Typically with trusts it may happen that the base cost has not been formally agreed with HMRC. Property may have been put into a settlement, especially if a liferent or an accumulation and maintenance settlement, which is a potentially exempt transfer for IHT and therefore is assumed to be exempt, and any gain was held over for CGT. The hold over of a gain does not require the formal agreement of valuation with HMRC. All the relevant election (on help sheet HS 295) requires is a statement that a gain does arise on disposal; see 3.5–3.7.
5.20 Consider the asset is now sold, perhaps relatively early in the tax year, say, on 1 May. On the face of it, it will not be until after the following 5 April when completing the Trust self-assessment return that the trustees will report the gain and will need to place an estimate figure on the base cost in order to establish the gain on which they must pay tax on the following 31 January. HMRC agreement of a gain may take some time and assist this conundrum, HMRC have introduced a process called a post-transaction valuation check explained in leaflet CG 34. What CG 34 does, once the asset concerned has been sold, is to start the valuation process running with, in the case of land, the district valuer, or with shares, the shares valuation division. The form requires the applicant trustees to supply a CGT computation based on the valuation figure that the trustees offer. They should provide any comparables and itemise any reliefs due or to be claimed. HMRC warn that any inaccuracy in the responses on form CG 34 may invalidate a valuation agreed on the basis of it. It is therefore a procedure to be adopted with care.
Interestingly, HMRC Trusts have advised generally that, under self-assessment, CG 34 should be submitted in all cases where the base cost is uncertain, with the appropriate reference made on the self-assessment return. The intention behind this is to avoid or mitigate the possibility of a subsequent liability to interest or to penalties.
Example 5.7—Illustrative computation On 1 August 2010 the trustees sold for £500,000 land that was transferred to the settlement just under four years ago and which throughout their period of ownership they have used for farming. The value had been recently enhanced by a change in planning policy by the local authority which enabled the trustees to obtain planning permission for residential development. What, however, is the gain? The trust is a discretionary trust and when four years ago the land was transferred into trust, it was so transferred under a hold-over election. The settlor himself had acquired the land on the death of his late wife (spouse exempt for IHT) six years ago. In his view the land was then worth £10,000 and increasing to say £25,000 when put into the settlement. Because of the holdover election, the value on settlement is of course irrelevant for CGT purposes, although it was material for IHT as having been a chargeable transfer, albeit within the nil rate band. It was in fact that value of £25,000, less the current and previous year's annual exemptions of £3,000, which the settlor returned on form IHT 100. What matters now is an agreement of value on the death of the late wife which will in turn determine the base cost under the holdover relief claim. The trustees would, of course like this value to be as much as possible, in order to mitigate the gain but there does not seem to be much prospect of that. They have, however, found a valuer who is prepared to value the land at £20,000 which, if accepted, would save CGT of £2,800 (28% of the additional £10,000 above the settlor's estimate of date of death value). The trustees proceed with the CG 34 procedure and compute the gain as follows:  |
Focus Gains of a settlor-interested trust ceased to be assessed on the settlor from 2008/09. |
5.21 These anti-avoidance rules follow the income tax regime discussed in 4.24–4.25. The CGT rules were introduced in 1988, and while originally there was a separate code, this has now been generally aligned with the income tax provisions, although the legislation is not exactly the same. Both sets of rules apply whenever the settlement was made.
For disposals before 6 April 2008, the settlor will be treated by TCGA 1992, s 77 as if the gains of the trustees were his gains in any situation where:
trust property or 'derived property' will or may benefit the settlor or his spouse. The expression 'derived property' means income from the property or any other property directly or indirectly representing the proceeds of the sale of that property; or
there is a benefit for the settlor or his spouse that is derived directly or indirectly from the settlement property or derived property.
The rules do not apply if the spouse can benefit only after the settlor has died.
Note that, while, from 2008/09, the gains of a settlor-interested trust are assessed on the trustees and no longer on the settlor, the concept of a 'settlor-interested trust' remains. It is material for purposes of hold-over relief: a gain arising on a transfer into a settlor-interested trust cannot be held over (see 3.5).
5.22 The effect of the rules up to and including 2007/08 was as follows:
The net trust gains of the year, after deducting trustees' losses for that and earlier years, are treated as gains of the settlor.
The annual exemption applicable will, of course, be that of the settlor and not of the trustees.
The relevant rate of tax will depend upon the settlor's other income and gains and could therefore be as high as 40%, or as low as 10% – as against the trustees' rate of 40%.
Before FA 2002 the settlor could not reduce trust gains assessed on him by use of personal losses. However, as from 2003/04, a settlor's personal losses in excess of personal gains can be offset against trust gains assessed on him. (Further, he had the right to elect for this treatment in any of tax years 2000/01, 2001/02 and 2002/03.)
If a settlor-interested trust has unrelieved losses for a particular year, these cannot be transferred to the settlor for use against his personal gains, but must be carried forward to offset subsequent gains made by the trustees.
The settlor can recover from the trustees the tax assessed on him, though not in compensation for the forced use of his annual exemption or losses against trust gains.
If a settlement has sub-settlements or separate funds, and the settlor or spouse can benefit under one but not under others, the whole of the trust gains will be assessed on him and not only those gains that are funds that are 'settlor-interested'. However, see 5.40–5.43 for the 'sub-fund' election from 2006/07.
From 2006/07 a settlement will also be 'settlor-interested' if during the tax year any of the settlor's minor unmarried children, not in a civil partnership, can benefit (TCGA 1992, s 77(2A) added by FA 2006).
5.23 In the context of 'sheltering' or deferring gains from CGT, other than on business assets, almost the only opportunity for individuals, trustees and executors is presented by EIS. The present regime dates from 1998 and derives from the old reinvestment relief regime.
EIS effectively contains two separate codes:
Deferral of CGT; thus the gain that would otherwise trigger CGT is effectively 'rolled into' a qualifying subscription in EIS shares and 'comes home to roost' only when those EIS shares are disposed of or on the death of the liferenter where the trust is non-relevant property (thus a pre 22 March 2006 interest or TS1 or IPDI).
An exemption from both income tax and CGT in respect of the EIS shares, for which the rules are far more stringent, but which in any case is not available for trustees.
The regime for both deferral and exemption is extremely complex. The relevant company must carry on a qualifying trade and the shares subscribed should be newly issued. From 2006/07, the assets of the company must not exceed £7m before the issue of shares, and £8m immediately afterwards (ICTA 1988, s 293(6A) amended by FA 2006). The company must carry on a 'qualifying trade'; from which certain 'low-risk' activities are excluded, eg farming and market gardening, operating or managing hotels and nursing homes, among others.
For deferral there is no limit on the proportion of the company owned (whereas in the case of exemption for individuals it must not exceed 30% taking other associated shareholdings into account).
To defer a gain on EIS investment, subscription must be made within 12 months before, or three years after, the disposal.
An EIS claim is made by completing and submitting to HMRC form EIS 3 issued by the company. The claim must be made before 31 January following five years after the end of the tax year in which the gain arose.
Deferral relief into venture capital trusts is not available for trustees.
5.24 The relief is extended to the following trusts:
Discretionary trust: all the beneficiaries must be individuals.
Interest in possession trust (to include post FA 2006 trust reforms): relief is given if any of the beneficiaries are individuals, although if there are non-individual beneficiaries, pro rata relief is obtained according to the proportion of the individual interests in possession borne to all the interests in possession. While individuals include charities, interests in possession do not include interests for a fixed term.
Assuming the trustees have realised the gain it is the trustees who must make the qualifying EIS investment.
On 1st January 2011 the trustees sold some shares realising a taxable gain of £10,000 and against this they may set the annual exemption of £5,050 leaving a gain of £4,950 in charge to tax. It is open to them to make a qualifying reinvestment under EIS of £4,950 at any time before 1 January 2014. The shares must be new shares in a qualifying trading company and the trustees must ensure that the anti-avoidance rules do not claw back the relief.
The CGT on the disposal would normally have to be paid on 31 January 2012. The trustees can pay the tax, subsequently make the investment and claim a refund of tax plus repayment supplement. Alternatively, the trustees can claim in their self-assessment that they will make the EIS investment and only if the investment is not made will they have to pay the CGT due plus interest from 31 January 2012.
5.25 The legislation extends to trustees the familiar and valuable principal private residence relief given to individuals. Although contained in just eight sections of the Act (TCGA 1992, ss 222–226B) the relief is extremely complex and, to be understood, must be read in the context of a number of decided cases and HMRC statements and concessions. The general principle for trustees under s 225 is that:
the trustees sell a dwelling-house (viz a house or flat);
during all or part of their period of ownership, the dwelling-house has been occupied by a beneficiary as his only or main residence;
the beneficiary has been entitled to occupy under the terms of the settlement;
if the beneficiary has more than one residence, the trustees and the beneficiary jointly can elect that the trust property (or indeed the beneficially owned property) shall be treated as the main residence for purposes of the relief. Accordingly, it is not open for an individual for any period of time to be accruing relief on a property that he and/or his spouse owns and occupies at the same time as relief is being given on a property within a trust which he occupies. That said, the last 36 months rule (discussed at 5.26) can, in appropriate circumstances, give relief on two properties concurrently occupied by the same individual, which can operate where the one property is owned outright and the other is owned by trustees. Similarly with the first 12 months rule.
One of the interesting factors about s 225 is that there is no pro rata test. This means that, whether the trust is discretionary or interest in possession in form and whether there are a number of beneficiaries, occupation by just one of them will secure the relief for the whole of the gain arising on disposal.
5.26 There is an interesting statutory 'concession' in s 223(1). Relief is given automatically for the last 36 months of ownership (assuming that the property is not then used for business purposes) even if the beneficiary is not in occupation during that period, providing that at some time the main residence relief applied ie the property has been used as the main or principal residence of the beneficiary during the trust ownership.
Similarly, there is a non-statutory concession where for the first 12 months of ownership (or sometimes longer up to a further 12 months) the beneficiary cannot live in the house, either because of essential renovations or because the house is being built or reconstructed (HMRC extra-statutory concession D49). There are also further concessions, which give certain permitted periods of absence, some of which were given statutory effect in 2009.
5.27 An anti-avoidance rule was introduced on 10 December 2003, to counter an arrangement that had become common (see paragraph 2 of Example 5.11), which combined hold-over relief and principal private residence relief. Now, broadly speaking, for transfers into a discretionary trust and since 22 March 2006, most lifetime interest in possession trusts within the relevant property regime, on or after 10 December 2003 a choice must be made between hold-over relief for the settlor on entry and principal private residence relief for the trustees on subsequent disposal. Under transitional rules, in a case where a property was already in a trust as at 10 December 2003, a subsequent sale by the trustees can attract principal private residence relief only for periods up to 9 December 2003.
Example 5.9—'Washing the gain' – in the past The settlor of a discretionary trust made on 1 January 1993 owns a second property, which is used by the family as an occasional holiday home. The house is now worth £200,000 within which there is a gain of over £100,000. The grandchildren beneficiaries of the discretionary trust are aged 20, 18 and 16. |
The settlor could have transferred the house to the trust, say on 9 December 2002, within his nil rate band for IHT purposes, holding over the gain under TCGA 1992, s 260. The trustees would then be treated as acquiring the house at the date of settlement, for the settlor's original base cost. The trustees would exercise their power in the trust deed to allow the eldest grandchild to occupy it as a residence from year to year, given that he also lives elsewhere. It is important that his occupation is more than occasional. The trustees and the beneficiary irrevocably elected within the two-year period that the trust property is treated as the beneficiary's principal private residence. The house would then be sold one year later, on 9 December 2003, at a gain of £150,000, all of which is exempt under s 225. If the house should instead be sold on 9 December 2010, the anti-avoidance rule described in 5.27 would come into operation. Only one eighth of the gain would be exempt under s 225 (9 December 2002 to 9 December 2003). The remaining seven eighths (10 December 2003 to 9 December 2010) would be taxable (and, specifically, could not benefit from the last 36 months of ownership rule described in 5.26). If, since 10 December 2003, such a settlor is considering CGT mitigation possibilities for the house, the combination of hold-over relief into a discretionary trust and principal private residence relief within the trust is no longer open to him. Up to 22 March 2006, it would have been possible to achieve much the same result through a combination of s 165 hold-over (for business assets, including 'furnished holiday accommodation' at that time) and s 225 relief. Suppose the husband owned a holiday home, which he gave to his wife on a no-gain, no-loss basis under TCGA 1992, s 58, she would then let the property as qualifying furnished holiday accommodation (within the meaning of ITTOIA 2005, s 322 and following) after which she would give the property to an interest in possession trust for the children, excluding herself and her husband as beneficiaries. The gain would be held over under s 165. The trustees would allow one or more children to occupy the property as their only or main residence pursuant to powers in the settlement and on sale by the trustees the whole of the gain would be 'washed out' under s 225. Unfortunately, however, any new interest in possession settlement on or after 22 March 2006 falls within the 'chargeable transfer' regime and so any hold-over would be under s 260 rather than under s 165 (TCGA 1992, s 165(3)(d)). And of course the combination of s 260 hold-over and s 225 relief for the trustees has been precluded since 10 December 2003. Only if, within such an example, the grandparents were prepared for the property to become owned outright by the grandchildren, might the suggestion still be |
effective. Section 165 hold-over would apply on the gift by grandmother to the grandchildren, who would then occupy and sell with the benefit of relief under s 223. And even this suggestion will not work following 5 April 2011, unless the grandmother is able to establish the existence of a trade under general income tax principles given the reform to the deemed trading treatment of furnished holiday accommodation. |
5.28 The colloquially known roll-over relief is formally called 'relief on replacement of business assets' (TCGA 1992, ss 151–158). This allows a trader to defer CGT, triggered by a gain on a business asset, by reinvesting the proceeds into the acquisition of a new asset used for the business. Complete relief depends on the investment of the total sale proceeds (net of incidental costs) into the new asset, though partial relief may be claimed. A new asset must (subject to extension by HMRC) be acquired within 12 months before, or three years after, disposal of the old asset.
5.29 The relief applies only to trades, ie not to property investment. However, certain non-trades, eg the occupation of woodlands on a commercial basis and (before 2010/11: see example 5.9 at 5.27, final paragraph) furnished holiday lettings, are treated as trades for this purpose.
5.30 The old and the new assets must fall within certain specified qualifying categories including land and buildings, goodwill and certain quotas, though the old and the new assets do not have to fall within the same category, nor do the trades have to be the same.
Focus Roll-over relief is extended to trustees but will only be in point if the trade and the asset are both in trustee ownership. |
5.31 The claim to relief may be made on a 'protective' basis, that is, even when the new asset has not been acquired, ie by stating an intention that the taxpayer will acquire the new asset within the qualifying time. When that time expires he can either confirm the claim on the basis that the new asset has been acquired, or simply withdraw it, in which case tax will fall due, plus interest in the normal way.
A trustee is a taxpayer like any other for the purposes of roll-over relief. The important thing is obviously that trustees carry on the trade whether as sole traders or in partnership. For this purpose they could be limited partners. However, both the trade and asset must be in the same ownership to secure the relief.
The trustees are limited partners in a limited farming partnership. They have a one-third share in the capital of the firm. Among the assets is a barn, which has, throughout its ownership, been used for storing farm machinery and farm stocks. The barn is on the edge of the village and the partners have obtained planning permission for residential conversion. The barn is sold for £200,000, realising a gain of £180,000. The trustees, together with the other partners, will therefore have to pay CGT on the gain.
However, in the following three years, the partnership spends £205,000:
as to £100,000, to acquire a further 40 acres;
as to £30,000, extending the grain store; and
as to £65,000, buying milk quotas; plus
£10,000 on professional fees and disbursements.
The whole of the gain can, therefore, effectively be rolled over, subject to a claim.
5.32 To compensate traders for the repeal of business assets taper relief from 2008/09, FA 2008, Sch 3 introduced entrepreneurs' relief (TCGA 1992, ss 169H–169S). In broad terms, this relief reintroduces the provisions of retirement relief (for a brief description of which, see the 2007/08 edition of this book at 5.32–5.34). For the period 6 April 2008 to 22 June 2010, gains qualifying for entrepreneurs' relief were reduced by 4/9ths, and taxed at a uniform tax rate of 18% to produce an effective tax rate for entrepreneurs' relief of 10%. Post 22 June 2010, the eligible gains are simply taxed at a stand-alone rate of 10%.
The lifetime limit for entrepreneur gains has been subject to successive increases since its first introduction on 6 April 2008. The position is as follows:
2008/09 and 2009/10 |
£1,000,000 |
6 April 2010 to 22 June 2010 |
£2,000,000 |
23 June 2010 to 5 April 2011 |
£5,000,000 |
2011/12 |
£10,000,000 |
5.33 The relief is available on the following disposals:
all or part of a trading business carried on by an individual whether alone or in partnership;
a disposal of assets used for a business which has come to an end, within three years after cessation;
a disposal of shares in or securities of a company where the individual was an officer or employee and had a minimum of 5% of the ordinary voting share capital of the company;
under an 'associated disposal' where there is a material disposal of business assets (whether in a partnership or in shares of a company) as part of a withdrawal by the individual from participation in the business of the partnership or the company.
Generally speaking, the conditions must be satisfied for a period of 12 months either ending with the disposal or in certain cases ending at a time which falls within three years after the disposal.
There is no minimum age or indeed minimum/maximum working time requirement for an officer or employee of a company.
Focus Entrepreneurs' relief may be claimed by trustees of an interest in possession trust where the underlying life tenant both meets the qualification and agrees to the usage. |
5.34 Whilst trustees are not eligible to claim entrepreneurs' relief in their own right, they may nonetheless 'piggy back' on the beneficiary's qualification thus gains realised by trustees can attract entrepreneurs' relief (TCGA 1992, s 169J). There must be an interest in possession (not including a fixed term) in the whole of the settled property or in part which contains the settlement business assets of which the trustees dispose. Those assets may be either shares or securities of a company or assets used for purposes of a business. Where the disposal is of shares of a company it must be the 'personal company' of the qualifying beneficiary who must also be an officer or employee. That is, the 5% minimum voting shareholding must already be held by the individual not by the trustees; there is no minimum requirement for the trustees' holding. Where it is a business of which the trustees dispose, the business must be carried on by the beneficiary, whether alone or in partnership. Otherwise, the rules applying to disposals by an individual are applied to trustees.
Section 1690 contains further provisions in the case where more than one beneficiary has an interest in the relevant settled property. An apportionment is made by reference to the proportional entitlement of the qualifying beneficiary to the income of the relevant settled property. Where the relief is to be claimed by the trustees, s 169M provides that there is a joint claim by the trustees and the qualifying beneficiary, which ensures that his lifetime maximum of qualifying gains is not exceeded.
5.35 Taper relief was introduced for disposals on or after 6 April 1998 (TCGA 1992, Sch A1) and was withdrawn from 2008/09. Details of the relief can be found at 5.37 to 5.42 of the 2008/09 edition of Trusts and Estates.
5.36 The annual exemption, ie within which gains will be tax free, is £5,300 for most trusts for 2011/12 (£5,050 for 2010/11). This is one-half of the individual's exemption. The individual's exemption is available to the trustees of a settlement for certain disabled persons.
5.37 An anti-avoidance rule operates in circumstances where the same settlor has made more than one 'qualifying settlement' since 6 June 1978. This is to prevent a person making a number of settlements, each benefiting from the £5,300 annual exemption (2011/12). If there is more than one qualifying settlement in a group, the annual exemption is divided between them, up to a maximum of five. That is, the annual exemption for a trust for 2011/12 can never be less than £1,060 (£5,300 ÷ 5 or £10,600 ÷ 10).
5.38 The expression does not include charitable trusts, or trust death benefits of registered pension schemes (which are among 'excluded settlements' defined in TCGA 1992, Sch 1 para 2 (7)(b)(ii). Otherwise, the expression will include almost every type of settlement, even settlements that do not realise a gain. This means that there could be a total of five qualifying settlements, only one of which is making a gain in the tax year, but it gets the benefit of an annual exemption of only £1,060, ie in 2011/12, and £4,240 of annual exemption is wasted, forfeiting £1,187 in tax potentially saved and now payable.
5.39 This rule needs to be watched very carefully, since under self-assessment it is up to the trustees to claim the right amount of annual exemption. If for some years they have always claimed the maximum exemption, but it is then established that after a period of time that they should have claimed only, say, the minimum amount, issues of interest and penalties will arise, not to mention the consumption of professional and administrative time.
The problem is that it may be difficult for the trustees to discover the existence of qualifying settlements in any case. Indeed, the rule survives the settlor's death.
As well as an A&M trust for his grandchildren (which continues as such after 5 April 2008, albeit with the capital vesting age reduced to 18 to comply with the transitional relief provisions), the settlor has also made the following:
a discretionary settlement, in which his wife (but not the settlor) is a potential beneficiary;
a £10 'pilot' discretionary settlement, in conjunction with his will. This is not uncommon, and will effectively serve to 'tip' a pot of money into the pre-existing discretionary trust (see 6.40);
a trust of a seven-year IHT protection policy, to guard against the possibility of IHT becoming payable within seven years after the making of a PET. This will be a qualifying policy only for such time as the seven-year period stays in being; and
a small discretionary trust for his nephews and nieces, with the trust fund invested in a single premium investment bond.
There are therefore a total of five qualifying settlements and the annual exemption for any of the trusts which makes a gain will be only £1,060 for 2011/12.
5.40 A new regime was introduced by FA 2006 (found in TCGA 1992, Sch 4ZA). Where a single settlement has more than one 'sub- settlement' or 'sub-fund', even with separate trustees, the gains or losses on those sub-settlements or funds form part of the overall computation of chargeable gains, which is assessed on the trustees of the main settlement. In broad terms, the new regime allows trustees of the 'principal settlement' to elect that a fund or other specified portion of the settlement shall be treated for CGT purposes as a separate settlement. The creation of a sub-fund will involve a disposal by the trustees of the principal settlement. And the election cannot take effect on a date earlier than that on which it is made.
5.41 The four conditions are as follows:
the principal settlement is not itself a sub-fund settlement;
the sub-fund does not comprise the whole of the property in the principal settlement;
there is no asset an interest in which is comprised both in the sub-fund settlement and the principal settlement; and
no person is a beneficiary under both the sub-fund settlement and the principal settlement.
The four conditions must be satisfied when the election is made. And the last three conditions must be satisfied throughout the period from when the election is treated as taking effect and ending immediately before the election is made.
5.42 HMRC have provided a form (SFE 1) for making a sub-fund election. No election may be made after the second 31 January after the year of assessment in which the effective date falls. The sub-fund election must contain certain declarations, statements and information and it may not be revoked.
5.43 Following the disposal which the trustees of the principal settlement are treated as having made, the trustees of the sub-fund settlement are treated as having acquired the relevant property at the date of the election taking effect and for a consideration equal to the then market value of the relevant assets.
For income tax purposes corresponding provisions were introduced by FA 2006, now found in ITA 2007, s 477.
The Edinburgh Trust, made some ten years ago, comprises a wide portfolio of rented property, quoted investments and a variety of shareholdings in private trading companies. The beneficiaries are, in broad terms, the grandchildren and remoter issue of the settlor. For various administrative reasons, in 2010/11 the trustees want to hive off the shares in the private trading companies into a separate settlement run by separate trustees (though this is not necessary under the legislation).
So this they do, ensuring that the beneficiaries are restricted to the children of the settlor's elder daughter and that those beneficiaries cannot in future benefit under the principal settlement. Separate trustees are appointed. The trustees of the principal settlement are treated as making a disposal. However, regardless of the fact that the assets concerned are shares in trading companies, the gain can be held over by election by the trustees of the principal settlement under TCGA 1992, s 260 because that settlement is a discretionary or 'relevant property' trust (as indeed is the sub-fund settlement).
5.44 Trusts have a venerable history. While this book is about the tax aspects of trusts, some of the non-tax issues and advantages are nonetheless summarised in [3.23–3.27].
5.45 The very flexibility of a trust (as opposed to a company) has meant that over recent years they have been used as vehicles for tax planning. The most effective tax planning occurs where tax advantages are obtained within the context of overall family and/or commercial structuring. It is when tax saving becomes an end in itself and arrangements are made with no other purpose that the courts perceive taxpayers to have 'crossed over to the wrong side of the line' and will therefore try to redress the balance. This is the subject of numerous decided cases, which generally have prompted changes in the law.
A simple example of an anti-avoidance rule has been the settlor-interested trust regime (see 5.21–5.22), which seeks to counteract any perceived advantage a person may gain by using the mechanism of a trust from which he or his spouse can benefit to trigger disposal. From 2004/05 to 2007/08, the CGT rate for all types of trust has been 40%. For 2008/09 until June 2010 the rate was 18%, and so it was no longer necessary to charge the gains of a settlor-interested trust on the settlor as there was no perceived advantage gained.
However, in the post 22 June period trust gains are now taxed at 28% whereas gains in the hands of the basic rate taxpayer continue to attract the lower 18% rate and, as such, this may pave the way for a reintroduction of the old regime..
5.46 Generally speaking, tax planning is permissible. The traditional distinction was between tax avoidance, which was permissible, and tax evasion, which involved a breach of the law (sometimes the criminal law). More recently (by way of summary categorisation only), tax avoidance has been divided into 'acceptable' tax mitigation and 'unacceptable' tax avoidance, which falls short of evasion.
On 1 August 2006 a disclosure regime was introduced for direct taxes. Arrangements with a view to tax avoidance which fall within one of seven prescribed descriptions, subject to exemptions, must be notified to HMRC within five days, failing which a fine of £5,000 will be levied.
HMRC continue to monitor types of transaction (sometimes sold as packages) whereby they perceive that the 'spirit' of the legislation is being undermined. Some of these 'tax avoidance schemes' have been legislated against in recent years, specifically in FA 2000, which attacked two UK trust schemes, two non-UK trust schemes and one scheme that applies wherever the trustees are resident; see below for examples.
Most recently, FA 2004 has introduced wide-ranging anti-avoidance rules in relation to settlor-interested trusts. As from 10 December 2003, a gain arising on transfer into a settlor-interested trust cannot be deferred by hold-over relief (see 3.5–3.7) and, also from 10 December 2003, the combination of hold-over relief on a gift into a relevant property trust and principal private relief for the trustees on a subsequent disposal is no longer possible (see 5.27).
The following two arrangements were among five counteracted by FA 2000 whereas the third rule was introduced by FA 2004:
5.47 There has been a long-standing rule that no chargeable gain arises when a beneficiary disposes of his interest under a settlement (TCGA 1992, s 76). This must be an interest original to the settlement and thus it will not protect a person who buys an interest in a settlement. It applies only to trusts which have always been UK resident.
A person might make a settlement in which he has an immediate life interest. He transfers to the trustees shares in a private trading company worth £1 million. He holds over the gain so that the trustees are treated as acquiring the shares with a base cost of, say, £100. The settlor is entitled to the income from the trust fund for life and the trustees also have power to advance capital to him. Both the settlor and trustees are UK resident.
Before 21 March 2000 the settlor might sell his interest in the settlement for say, £950,000. This would have been tax free. The purchaser would 'step into his shoes' in being appointed as a beneficiary. The shares could be advanced out under hold-over election and, the institution being exempt, would escape CGT on ultimate disposal. This is no longer possible.
5.48 Prior to 2000/01 (see 5.22: fourth bullet point under 'Effect of the rules') personal losses could not be offset against trust gains assessed under the settlor-interested rules on the settlor. Since 2003/04, but before 2008/09 (when the gains of settlor-interested trusts become assessed on the trustees), there is an automatic set-off.
Consider that an individual not connected with the trust owns shares in a private company 'pregnant with gain'. He acquires an interest in the settlement and is added to the settlement as a beneficiary. He advances the shares to the trust under hold-over election, the trustees sell the shares and offset the gain against their losses. The proceeds of the sale are advanced to the new beneficiary. Where this occurs on or after 21 March 2000, ie someone has acquired an interest in a trust for consideration, the trustees cannot use their own losses to offset gains on the assets transferred by that person into trust under hold-over election.
5.49 Transfers into trust under hold-over relief have in the past been used for three specific tax planning purposes:
as a device to enable valuable non-business property to be passed down a generation without paying either IHT or CGT, under 'son of Melville' arrangements (see Melville v IRC [2002] 1 WLR 407) (see 6.20);
to mitigate the effect of the 'tainted taper' problem where an asset has changed its status from non-business to business; and
in effectively 'doubling up' principal private relief for a second home as well as the individual's principal family home (see 5.25–5.27).
New rules effective from 10 December 2003 have put paid to all of the above and, specifically in relation to private residences, a further set of rules prevents the combination of hold-over relief and main residence relief to achieve the tax advantage illustrated in Example 5.9 at 5.27.
5.50 Any or all of the following possibilities should be considered as part of a tax planning routine:
Annual exemption (see 5.36–5.39): Do make use of it. Be aware of the circumstances where the anti-fragmentation rules apply and do make sure to claim the right amount each year.
Losses (see 5.13–5.15): Remember that current year losses must be set against current year gains, even if the effect is to 'waste' the annual exemption. Brought forward losses on the other hand, can be used only so far as is necessary to reduce the gains down to the annual exemption threshold. Losses arising on a disposal to a connected person can be set off only against a gain arising to the same connected person. Do remember to claim losses as they occur.
If multiple disposals are made during the tax year, consider within a month or so of the end of it, ie early March, whether further disposals should be made to use the annual exemption or whether instead it might be worth triggering losses in appropriate cases to relieve tax liabilities.
Note that, from 2006/07 a settlement whose beneficiaries includes the minor unmarried children of the settlor, not in a civil partnership, is now settlor-interested. This rule continues to be relevant where a person wants to give an asset standing at a gain to a trust, as he will not be able to hold over the gain (see 3.5). Further, if within broadly six years after the end of the tax year in which the gift is made, the trust becomes settlor-interested, any hold-over relief previously claimed (on a disposal since 10 December 2003) is clawed back. There is no de minimis or pro rata let-out.
Where the trustees own a property that is, or might be, occupied by a beneficiary so that principal private residence relief applies (see 5.25–5.27), do ensure that the relief is maximised, ie it should not be considered after the property is sold. Consider the use of timely principal private residence relief elections where the trustees own what is manifestly not the beneficiary's main home: the election must be made within two years after the property is occupied by that beneficiary. But bear in mind the anti-avoidance rules described in 5.27.
Base costs: Where, having sold an asset, the gain cannot be established because the base cost has never been agreed, consider the CG 34 procedure (see 5.18–5.20) with a view to agreeing the figures well before the time comes to pay the tax.
EIS: By all means consider a subscription in qualifying shares as a means of deferring tax, but do not let the 'tax tail wag the investment dog'. Never make an investment just because it is tax efficient – the full investment may be lost (and the beneficiaries will be quick to react).
Payment of tax (see 5.53): Do bear in mind following the end of the tax year what CGT will have to be paid on 31 January next, and budget for it. If the consideration is payable by instalments, consider the possibility of arranging with the inspector a deferred tax payment plan (see 5.6).
5.51 The form for returning capital gains tax is supplementary page SA905 (to be included within the main trust and estate return): see 5.54–5.57.
The only circumstances in which SA905 need not be completed are (for 2010/11):
the total chargeable gains were less than, or equal to, the annual exempt amount (see 5.36–5.39); and
the assets disposed of during the tax year realise net proceeds of no more than four times the individual's annual exempt amount in total (ignoring exempt assets). For 2010/11, this amount is £40,400 and for 2011/2012 £42,400.
That said, it is not a bad discipline to fill in the pages as part of the on-going 'housekeeping' of the trust. In particular, it is important to use the form:
to claim allowable losses which may be used in future;
to make other claims or elections that require reference to, and completion of other HMRC forms, viz:
private residence relief: help sheet HS 283;
roll-over relief: help sheet HS 290;
entrepreneurs' relief: help sheet HS 275;
hold-over relief for gifts: help sheet HS 295;
EIS deferral relief: help sheet HS 297;
business transfer relief (where a business is transferred to a company in return for the issue of shares): column G on TC2;
unremittable gains (asset disposed of outside the UK where exchange controls or shortage of foreign currency make the gain unremittable): column G on TC2;
negligible value claims – see help sheet HS 286 and column G on TC2; or
relief for foreign tax paid: if tax credit relief has not been claimed, the foreign tax ranks as a deduction against the chargeable gain. If tax credit relief is claimed, page TF3 on the trust and estates foreign pages should be completed and help sheet IR 390 referred to.
5.52 Date for return |
31 January 2012 if delivered online (or 31 October 2011, if delivered in paper form and where HMRC are to calculate the tax) |
Payment of tax |
31 January 2012 (or three months after the issue of the self-assessment return if later than 31 October 2011), subject to payment by instalments (see 5.6)* |
Interest and penalties |
* CGT on gifts of certain assets (broadly those subject to instalment relief for IHT – see 11.90–11.93) can on written election be paid by ten equal yearly instalments (TCGA 1992, s 281). The first instalment is payable on the usual due date, with any subsequent instalments payable on the subsequent anniversaries. Unpaid instalments carry any interest payable in the usual way. The instalment option is available also where assets leave a settlement and the disposal does not qualify for hold-over relief.
5.53 The self-assessment of CGT operates in tandem with income tax (whereas compliance for IHT is entirely separate). The same tax district and reference deals both with income tax and CGT, whether for individuals or for trustees. SA905 is the most complex of the supplemental pages. SA905 has the benefit of substantive notes SA905 (Notes) running to 20 pages and including 23 worked examples for 2010/11.
5.54 SA905 falls broadly into two parts – chargeable gains and allowable losses:
The trustees must identify total chargeable gains (after any reliefs) and allowable losses for the year. These will be computed on pages TC2 and TC3 of SA905. From the net gains will be deducted the relative annual exempt amount, which is basically £5,050 for 2010/11 (but could be less – see 5.36–5.39), to produce the taxable gains to which the rate of 18% or 28% is applied dependant on the date of disposal.
As to capital losses, losses for the current year, must be deducted from current year gains. Unusually, the increased CGT rate of 28% which applies to gains realised post 22 June 2010 (with gains realised in the period 6 April 2010 to 22 June 2010 taxed at 18%) has necessitated the need for loss identification – losses may be set off in the most beneficial order which as a general rule will be set first against those gains attracting the 28% rate (post 22 June 2010). Brought forward losses need be deducted only from current year gains to the extent that gains remain in charge over the annual exempt amount for the year. A loss arising on a transaction with a connected person (eg on a transfer from the settlor) can be offset only against gains made on disposals by the settlor to the trustees. Page TC1 enables notice to be given of a loss realised in tax year 2010/11 which may not be needed and can be carried forward. In the past there was a time limit of five years and ten months from the end of the tax year for claiming losses but this has been reduced to four years from1 April 2010.
Death of a beneficiary with an interest in possession, provided the trust does not then fall within the relevant property regime for IHT purposes (see 9.10).
A person becomes absolutely entitled to trust property (see 9.10).
Any chargeable gains are taxed on the settlor as a settlor-interested trust (see 5.21–5.22).
5.55 Example 5.13—Computation on property disposal On 28 May 2010 the trustees sold for £150,000 a cottage which they acquired on 31 March 1982 for £40,000 (and which they had let on successive long tenancies). The calculation is as follows: Note: Had the disposal taken place on 31 July 2010, the gain would have been charged at the higher rate of 28% to produce tax due of £25,746. |
5.56 Question 12 form SA900 asks 'Have any assets or funds been put into the trust during the year?' The essence of a settlement or trust is that funds are contributed by way of 'bounty' or gift. That is, the sale by the trustees of an asset included in the settlement for value would not be relevant to this question. However, if that sale were made at a gain, there would be a gain for the trustees.
HMRC need to keep track of the funds subject to the settlement and therefore if further assets are contributed there must be given:
the settlor's name and address;
a description of the asset; and
the value of the asset.
5.57 There is no reason in principle why one person cannot contribute assets to a settlement made by another. However, this is not generally a good idea and it is best in practice to keep each settlement for assets contributed by a single settlor. The only exception could perhaps be joint husband and wife settlements, especially where the amounts contributed are the same, although even then there can be complications.
Such complications arise in particular with the anti-avoidance rules for settlor-interested trusts (see 4.26–4.29 for income tax and 6.16–6.21 for the reservation of benefit rules for IHT). It is important to be able to determine which property was contributed by which settlor and, unless very strict segregation of funds is operated, this becomes more and more difficult with the passage of time as assets are sold and reinvested.
One perceived advantage of having a single settlement with more than one settlor might be a saving in administrative and compliance costs. However, these could soon be outweighed. There is, further, a CGT advantage in having more than one settlement as each settlement will have its own annual exemption (subject to 'anti-fragmentation' rules; see 5.37–5.38).
Example 5.14—The Harry and Lucy A&M Trust Harry and Lucy were joint settlors of this trust, each contributing £125,000 at the outset. This settlement was made before the anti-avoidance rules for parental income came into effect from 9 March 1999. That means that income paid or applied for the benefit of any of Harry's and Lucy's children will be assessed pro rata on Harry and Lucy. As was pointed out in 4.24–4.29, there is an interesting effect for income assessed on Lucy in so far as she is only a basic rate taxpayer. Consider that some eleven years later, in 2010, ie after 9 March 1999, Lucy inherits some capital from her father's estate. The trust fund is now worth £500,000 and Lucy wants to add a further £100,000 to the trust fund. Although, for IHT purposes she does so by varying her father's will within two years after his death (see 13.1–13.4), for income tax, and indeed, CGT purposes she is the 'settlor'. It has to be established what income accrues from her £100,000 addition (as opposed to the original £250,000 settled) for two purposes:
|
The easiest solution would be to retain the £100,000 addition as a segregated fund. However, this might not be so easy (and would not be welcomed by the stockbroker or investment manager). A sensible working solution might simply be to divide the income into 12 parts each year, assess two of those parts on Lucy in any event, and the remaining ten parts equally on Harry and Lucy in so far as distributions are made to or for the benefit of the children. |
5.58 Question 16 on page 9 of form SA900 asks: 'Has the trust at any time been non-resident or received any capital from another trust which is or has at any time been non-resident?' If 'Yes', have the trustees made any capital payments to, or provided any benefits for, the beneficiaries?'
It is assumed in this book that the trust concerned has always been UK resident. What relevance, therefore, could there be, if a non-UK resident trust has paid any capital to our UK trust? The answer lies in TCGA 1992, s 87. A brief discussion of the anti-avoidance rules for non-UK resident trusts is necessary.
5.59 The 'settlor charge' in TCGA 1992, s 86 taxes a UK resident and domiciled settlor on gains made by non-UK resident trustees of certain settlements made by him.
Section 87 (the 'capital payments' charge) taxes UK resident and domiciled beneficiaries on capital payments received by them to the extent of the 'trust gains' (or, since 2008/09, the 'section 2(2) amounts') (TCGA 1992, s 87A) made by non-UK resident trustees (insofar as they have not already been attributed to 'capital payments'). From 2008/09 the capital payments charge applies even where the recipient UK resident beneficiary is domiciled outside the UK (although the trustees can by election ensure that trust gains that accrued before 6 April 2008 cannot be attributed to capital payments made to non-UK domiciled beneficiaries and, where the payment is received outside the UK, a remittance basis may apply if the beneficiary has elected for the remittance basis charge).
Furthermore, the rules have applied since 1998/99 even if the settlor of the trust was, and remains, non-UK domiciled. Nor does the horror end there. In an effort to encourage prompt capital distribution there can be a 'supplementary charge' levied on the beneficiary by reference to the time that has elapsed between making the trust gain and the capital distribution – such charge calculated with reference to a maximum period of six years, increases the tax charge by 10% per annum. That is, the beneficiary could be facing a post 22 June 2010 tax charge of up to 44.8% (28% plus ((10% of 28%) × 6)) compared to a 2009/2010 and 2008/2009 tax charge of 28.8% (18% plus ((10% of 10%) × 6)) and a 2007/2008 tax charge of 64%)
5.60 Most commonly, such capital payments charges might arise where the payment is made directly to the beneficiary. However, anti-avoidance rules mean that channelling the payment through another trust, including a UK-resident trust, would trigger the rules. Hence question 16. A Court of Appeal decision in Billingham v Cooper [2001] STC 1177, confirmed HMRC's view that the benefit of an interest-free loan is a capital payment to the extent of the interest foregone. HMRC also take the view that rent-free enjoyment by a beneficiary of trust property is a capital payment.
If the question is answered affirmatively, the total capital payments or value of benefits provided must be given, together with their allocation between the beneficiaries, if more than one (whose names and addresses must be given). Equally, if the trust has received capital from any other trust that may have been non-UK resident, the name of the trust, the address of the trustee, the date of the establishment and the value received must be given.
The Hector trust, being non-UK resident, makes a payment to the Albert discretionary settlement of £100,000. The Albert trustees decide to lend £50,000 to a beneficiary on 5 October 2010, interest-free, repayable on demand.
The beneficiary is treated as having received a capital payment of the interest forgone on £50,000 for six months. At the beneficial loan rate of 4% from 6 October 2010 to 5 April 2011 the capital payment is only £1,000 (which would translate to £2,000 for the full year.)
If, however, the other £50,000 were advanced to the beneficiary absolutely on 5 October 2010, the capital payment would become £50,000. The effective rate of tax in 2010/11 could be anything between 18% and 44.8% depending upon when the relative trust gains were realised by the Hector Trust – and this may not be easy to find out.