Update: tax and trusts

There is surprisingly little to report on the March 2010 Budget and the (first) Finance Act of 2010. There were concerns that the Budget would contain an announcement on an increase in the rate of capital gains tax, possibly with the realignment of CGT rates and income tax rates. That led to considerable activity among tax and trust lawyers with a raft of new instructions for the creation of new settlements or the termination of existing settlements in order to crystallise a disposal.

Although the expected increase in CGT rates did not materialise, it is safe to assume that the rate of CGT will not remain at 18 per cent for much longer and the second Budget of 2010 will probably increase the rate (and vindicate the advice and legal work which was carried out earlier in the year).

Negligible value claims for CGT

There was an interesting case at the end of last year which involved the disposal of private company shares, but which would have been unaffected by the rate of capital gains tax, whatever it was, because the case related to a negligible value claim.

In Harper v HMRC [2009] UKFTT 382 (TC), a taxpayer subscribed £150,000 for shares in a company in June 2002 and subscribed a further £250,000 for shares in December 2003. In April 2004 the taxpayer in question made a negligible value claim under section 24(2) TCGA 1992.

The taxpayer claimed income tax relief for the capital loss under section 574 ICTA 1988. Although HMRC agreed that the shares were of negligible value at the date of the claim, they said that the shares had a negligible value when they were issued in June 2002 and December 2003, and, therefore, the shares did not 'become' of negligible value. The First-tier Tax Tribunal agreed with HMRC's analysis.

This case is a good reminder that a taxpayer has to prove that the shares had a positive value when they were acquired in order to make a negligible value claim.

In this case, the First-tier Tax Tribunal effectively said that the taxpayer had made a bad bargain when he acquired the shares.

Drafting of wills and documents

Many experienced private client lawyers will have been surprised by the decision in RSPCA v Sharp [2010] EWHC 268 (Ch), which related to the interpretation of a will and the application of inheritance tax.

In this case, a will provided (in clause 3) for a legacy of an amount equal to the maximum sum which the testator (T) could give without inheritance tax becoming payable in respect of that gift.

The gift was made outright as to 78 per cent for T's friends (Mr and Mrs S) and as to 22 per cent for T's brother. Clause 4 of the will contained a specific legacy of a property to Mr and Mrs S which was expressed to be free of tax and the costs of transfer. The residue of the estate was given to the RSPCA.

The RSPCA argued that the gift of the property should be taken into account in calculating the maximum amount which could be given under clause 3, with the result that the gift should have a value equal to the balance of the nil rate band of inheritance tax available at the date of death, less the value of the property.

On the other hand, the legatees of the 'nil rate band gift' argued that the gift contained in clause 3 of the will was intended to be made in addition to the gift of the property in clause 4.

The court decided that T's intention was to make the specific tax free gift of the property in addition to the nil rate band gift and therefore did not intend the gift in clause 3 to be diminished by the gift in clause 4. The court came to that conclusion because it considered it unlikely that T would have wanted the gift to his brother to be wiped out if the property had increased in value to the extent that it exceeded the available nil rate band at the date of his death.

The court commented that this interpretation was not contrary to the principle in section 4 of the Inheritance Tax Act 1984, which requires inheritance tax to be charged on the deemed transfer of value of the whole estate on a death even though the words in clause 3 referred to the gift as being the maximum amount which could be given without inheritance tax becoming payable in respect of that gift (that gift being a part of the whole estate and not viewed in isolation for the purposes of section 4).

This case is important in considering the way in which wills and other documents are drafted for tax purposes. This case must be considered on its own facts, because if the additional gift in clause 3 had been a cash gift the court's interpretation of T's intention may have been different.

The only way to be sure of the correct interpretation is to make the intention clear in the document.

Transfer of value by omission to exercise rights

In the late 1980s, the Inland Revenue (as it then was) made a statement that it would apply section 3(3) of the Inheritance Tax Act 1984 to cases where a person in ill health decided to defer taking pension benefits (and thereby extend the period for which a death benefit would be payable under the pension scheme). The case of Fryer and Ors v Revenue & Customs Commissioners [2010] UKFTT 87 (TC), heard in February this year, was exactly this sort of case.

A member of a personal pension scheme had a 'normal retirement age' of 60. About five months before her 60th birthday she was diagnosed with cancer. She did not take her pension benefits at age 60 and died a few months afterwards.

HMRC claimed that a transfer of value was made on her 60th birthday because her failure to exercise a right resulted in a reduction in value of the estate (the value of the benefits not taken) and also an increase in the value of the death benefit held on discretionary trusts. It was held that:

1 It was a deliberate omission to exercise a right. The burden of proof in section3(3) requires that the omission is deemed to be deliberate unless shown otherwise.

2 The omission reduced the value of the estate (not by the benefits foregone butby the value of the policy itself).

3 The omission resulted in the death benefits being paid to the trustees of the discretionary trust.

The executors failed to show that the transfer of value was exempted by section 10 (no intention to confer a gratuitous benefit). There was therefore a transfer of value for inheritance tax purposes, but the transfer of value did not arise on the 60th birthday, as claimed by HMRC, and therefore was not a chargeable lifetime transfer to a trust without an interest in possession.

The transfer of value arose on the date of death because the omission to exercise a right continued throughout the deceased's lifetime and the latest point in time when she could have exercised was the point immediately before her death.

There does not appear to be anything which a person can do in order to avoid this potential inheritance tax charge, although it is possible that the issue of 'legitimate expectation' could be raised given that a pension member contributed to a pension fund on the understanding that any death benefits payable would be held on discretionary trusts outside of his or her taxable estate.

Agricultural property relief

The case of Atkinson v HMRC [2010] TC00420 was heard in March this year. A farmer owned land and let it to a farming partnership in which he was a partner. The farmer lived in a house on the land from 1966 to 2002, when he went into hospital and then lived in a care home. He died in 2006 without resuming full-time residence in house.

The executors claimed agricultural property relief on the value of the house but HMRC denied relief on the basis that the house had not been occupied (by the partnership) for the requisite period of seven years prior to the deceased's death.

The First-tier Tribunal held that, despite the period of absence, the deceased still occupied the house for the purposes of agriculture as he kept his belongings there, he continued to participate in partnership business and he did spend time at the house from time to time, even though it was not his permanent or main residence.

This tribunal case may be useful in interpreting the meaning of the word 'occupation' for other tax purposes. For example, there has been uncertainty in many case as to the meaning of 'occupation' for the purpose of applying pre-owned assets tax where a person only resides in a property periodically or only keeps his or her possessions there. This decision may, of course, be appealed.