Update: tax and trusts

Usually there is only one Finance Act each year and possibly two in an election year, but the change in government in May this year will lead to three. Following the two identically titled Finance Acts 2010, published before and after the general election, a third finance bill was published in September, expected to be enacted before the end of the year.

New rules for tax relief on pension contributions were announced on 11 October. From 6 April 2011, the special rules for those earning over £130,000, introduced by the last government, will be replaced by simpler rules which will apply to all taxpayers, regardless of their level of earnings. Tax relief will be based solely upon the annual allowance, which is being reduced from £255,000 to £50,000.

The impact of the change will be softened by rules which will enable any shortfall in contributions to be carried forward for up to three years, which will assist those who wish to contribute a larger sum of money into their pension schemes as a one-off payment. Any pension contributions made above the annual allowance will be added to the pension member's income and taxed at the relevant marginal rates of income tax (subject to the carry forward rules). The amount which someone can save over their lifetime will be reduced from £1.8m to £1.5m with effect from 6 April 2012. A new protection regime is to be announced for those who wish to retain their £1.8m lifetime allowance.

Rubber stamping

There have been a few statements by HMRC over recent months to clarify its practice in dealing with stamp duty land tax (SDLT).

Finance Act (No 2) 2010 increased the rate of VAT from 17.5 per cent to 20 per cent from 4 January 2011. The consideration chargeable to SDLT on a land transaction will include the VAT chargeable on the consideration, so the increase in the VAT rate will have a consequential effect on SDLT.

On 11 October, HMRC gave its view on how the calculation of the net present value (NPV) of the future rent should be made to take account of the change in VAT rate. HMRC's opinion is that the chargeable consideration for SDLT purposes should reflect the VAT rate at the effective date of the transaction. The treatment of VAT in the computation of the NPV of the rent will depend on whether the effective date of the lease is before, on or after 27 July (the date on which the Finance Act (No 2) 2010 came into force).

If the lease has an effective date on or after 27 July, the NPV should take into account the known rates of VAT during the first five years of the lease. Therefore the rate of VAT on the rent payable for the period from the effective date to the day preceding the first rent payment date on or after 4 January 2011 will be 17.5 per cent. The VAT element on the rent payable on and from the first rent payment date on or after 4 January 2011 should be 20 per cent.

There is no apportionment during a rent payment period and therefore the only relevant date is the date on which rent is due. If the lease has an effective date before 27 July (but after 4 January 2006) there is no amendment required as a result of the proposed change of VAT rate from 4 January 2011. Where that lease contains provisions for a variable or uncertain rent, a further return may be required under the normal rules, which require a review to be carried out. The further return will use the highest rent actually paid for any 12-month period in the first five years of the term (inclusive of VAT at the rate applicable at the time) for the whole of the remaining term.

SDLT relief is available where a land transaction takes place between members of a group of companies (that is where one company is a 75 per cent subsidiary of another or where the two companies are 75 per cent subsidiaries of another company).

On 11 October, HMRC released a statement that it has changed its view on whether a limited liability partnership is a 'body corporate' for the purposes of SDLT. Previously, HMRC took the view that a LLP was not a body corporate for group relief purposes and therefore LLPs were treated as transparent in considering whether a group relationship existed. Therefore, the members of the LLP were treated as being the beneficial owners of the LLP assets (so that group relief was denied).

However, HMRC now accepts that (for the purposes of SDLT group relief only) a body corporate does include an LLP. An LLP can therefore be the parent in a group structure, but it cannot be the subsidiary of other companies for SDLT purposes (because it does not have an issued share capital). In practical terms, an LLP continues to be disregarded for SDLT group relief purposes if it is the vendor or purchaser in a transaction, but, where the LLP holds two 75 per cent subsidiaries, it appears that transactions between those subsidiaries should qualify for group relief.

Discovery assessments

In general, once an enquiry period into a tax return has expired, HMRC cannot amend an assessment of income tax or capital gains tax. The enquiry period runs from the date on which a tax return is filed and ends one year later.

However, HMRC may make a 'discovery assessment' in certain circumstances after that enquiry period has closed. The rules and time limits for making a discovery assessment changed earlier this year, but there have also been two useful cases heard in September 2010.

According to section 29(4) and (5) of the Tax Management Act 1970, where a tax return has been made for a tax year, a discovery assessment can only be made where either:

(a) a taxpayer (or a person acting on his behalf) has acted carelessly or deliberately. Before April 2010, the requirement was for fraudulent or negligent conduct on the part of taxpayer or his adviser; or

(b) an enquiry for that period has been completed or the enquiry window has closed and HMRC could not have been reasonably expected on the basis of the information made available to them before that time to be aware of the tax assessment being insufficient.

New time periods were introduced on 6 April 2010. Apart from the special cases set out below, a discovery assessment for a tax year must be made within four years after the 31 January following the end of the tax year. Special cases arise where a loss of tax has arisen as a result of careless conduct or deliberate conduct on the part of the taxpayer or his adviser. Where there has been careless conduct, the time period is six years from the end of the relevant tax year and, where there has been deliberate conduct, the time limit is 20 years from the end of the relevant tax year.

In Hankinson v Revenue & Customs Commissioners [2010] UKUT 361 (TCC), the taxpayer claimed to be non-UK resident for the 1998/99 tax year. HMRC made an assessment for income tax and capital gains tax in 2005, as a result of information which it discovered about the time which the taxpayer had spent in the UK during 1998/99, and assessed him as UK resident. The First-tier Tribunal found that he was UK resident and that a discovery assessment had been validly made, because the conditions in (a) and (b) set out above were met. There was negligence (which was then the test, rather than carelessness as it is now) in disclosing the time periods which the taxpayer spent in the UK and abroad. The tribunal also found that HMRC could not reasonably have been expected to have been aware of the insufficiency of tax on the basis of the information given to them.

In his appeal to the Upper-tier Tribunal, the taxpayer argued that section 29 of the Taxes Management Act 1970 required an additional condition for a discovery assessment to be made (in addition to (a) and (b) above). He argued that HMRC had to also have considered the conditions in (a) and (b) and decided that one of them was met before the discovery assessment was actually made. As HMRC had not considered those factors before making the discovery assessment in this case, the taxpayer claimed that the assessment was invalid.

The Upper-tier Tribunal rejected the appeal by saying that the important factor was whether one of the conditions in (a) and (b) was met and not whether HMRC thought that it was met.

Bessie Taube Discretionary Settlement v Revenue & Customs Commissioners [2010] UKFTT 473 (TC), heard in September, confirmed the decision in Hankinson.

This case made it clear that a discovery assessment can be opened before or after the normal enquiry window has closed. The taxpayer argued that the failure of HMRC to open an enquiry on the basis of an insufficiency of tax discovered during the normal enquiry window prevented HMRC from raising a discovery assessment. The tribunal rejected that argument.

If the taxpayer had alerted HMRC to the insufficiency of the tax before the end of the enquiry window, a discovery assessment would have been prohibited.

To avoid a discovery assessment being raised at a later date, taxpayers should disclose as much information as possible in the tax return, using the 'white space' at the end of the tax return if necessary to set out relevant facts.

Bessie Taube also clarifies whether a receipt by trustees amounts to trust income or trust capital for tax purposes. The trustees of the settlement received a special dividend from a family company, as a result of a share reorganisation. If the dividend was deemed to be trust income, it would have been subject to income tax; whereas if it had been trust capital, it would not be subject to tax at all.

The First-tier Tribunal decided that the dividend was income in nature because it was paid out of the distributable profits of the company. There was no capitalisation of those profits which may have otherwise suggested that the dividend was a capital payment.