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10 January 2001
A washing exercise
A washing exercise
A parent has a second home showing a large gain and owned for many years. He proposes to place it into a discretionary trust for the benefit of his children and others, holding over the gain under section 260, Taxation of Chargeable Gains Act 1992. The trustees will, after a few months, entitle the son to occupy the property as his main residence, and he will live there for at least one year. The home will then be sold and it is claimed that under section 225, Taxation of Chargeable Gains Act 1992 no capital gains tax will be payable at all. At that stage the settlor will be added as a beneficiary – see above reference to 'and others'; and may collect all or some of the proceeds of sale.
Is it agreed that the section 225 relief will be unaffected, that section 660A, Taxes Act 1988 will have minimal effect (very little income) and sections 77 and 78, Taxation of Chargeable Gains Act 1992 are overridden by section 225? The settlor will have incurred an inheritance tax gift with reservation – but so what!
(Query T15,732) – Country Boy.
This scheme is vulnerable for a number of reasons. First, section 224(3), Taxation of Chargeable Gains Tax Act 1992 provides that no main residence relief shall be given 'if the acquisition of … the dwelling-house … was made wholly or partly for the purpose of realising a gain from the disposal of it'. As a matter of statutory construction, 'gain' is likely to be held by the courts as meaning a gain as computed for capital gains tax purposes, rather than the actual mathematical gain between the date of settlement and the date of disposal: see Commissioners of Inland Revenue v Burmah Oil Co Ltd [1982] STC 30. The introduction under self assessment of a prescribed form, IR 295, on which the election has to be made and which is not available until the start of the following tax year can, in certain circumstances, make it difficult to presume that the necessary pre-ordination is present for Ramsay to be called in aid by the Inland Revenue.
Thus, assuming the property to be freehold, were the hold-over to have been made out of a discretionary trust by appointment in equity to a beneficiary, it could be contended that, because the approbation of the beneficiary was unnecessary to the transfer of beneficial ownership, the transferee had no 'purpose' at the time of acquisition. This must be contrasted with the position here, where an asset is placed into trust. In such circumstances, the transfer of the property would have had to be executed by at least one of the trustees to be effective. It follows that it must be possible to attribute a 'purpose' to the trustees in this case at the time the settlement was created. Furthermore, it is likely to be difficult to contend with any degree of credibility that the 'game plan' was not known to the trustees from the outset. If section 224(3) were to apply, section 225 would not come into consideration.
Second, with regard to section 225, while the better view is that section 77(1)(a), Taxation of Chargeable Gains Act 1992 takes effect subject to it, this view has been challenged by the London Trusts District on a number of occasions. It follows that one of the underlying assumptions may not turn out to be a sound one. Uncertainty on this score could only be eliminated by deleting the power to add the settlor and his wife as future beneficiaries, and therefore the potential recipients of the proceeds of sale of the property (see section 77(2)(a)). This appears to undermine the main object of the scheme.
Third, any claim for relief under section 225, Taxation of Chargeable Gains Act 1992 will be dependent upon the application of Sansom v Peay [1976] STC 494. The problem here is that the Capital Taxes Office, rightly or wrongly, will treat such an arrangement as the creation of an interest in possession under Inland Revenue Statement of Practice SP10/79, i.e. the event of an exit charge under section 68, Inheritance Tax Act 1984, calculated by reference to the value of the property settled and the pre-existing state of the settlor's seven year 'clock'.
Fourth, in all probability, the termination of the son's right of occupation is likely to be regarded by the Capital Taxes Office as an event of charge on the son's 'clock' under section 52, Inheritance Tax Act 1984. Moreover, as the property would then fall back into a discretionary trust, the section 52 event would not be a provisionally exempt transfer under section 3A, Inheritance Tax Act 1984.
Fifth, the creation of the settlement would also not have been a potentially exempt transfer (indeed without this status, a holdover under section 260, Taxation of Chargeable Gains Act 1992 would not have been permissible). While the state of the settlor's seven year 'clock' would need to be taken into account, the chances are that the value of the property would have exceeded the nil rate band. In such circumstances, there would be a liability at the time the settlement was entered into, a second liability upon the son entering into possession and a third liability upon his vacating the property at the request of the trustees at the time of sale.
Sixth, none of these liabilities would be reduced by reason of the fact that the settlor had reserved a benefit within the terms of section 102, Finance Act 1986. Indeed, as indicated above, only by his and his wife's deletion from the list of potential beneficiaries could the uncertainty under section 225, Taxation of Chargeable Gains Act 1992 be eliminated. But, yet again, it has to be said that this appears to undermine the main object of the scheme, which is to enable the settlor to sell the property and participate in the proceeds of sale without the payment of capital gains tax.
Seventh, irrespective of whether section 224(3), Taxation of Chargeable Gains Act 1992 applies, it is just conceivable that the retention of the settlor as a potential beneficiary might enable the Inland Revenue to disregard the interposition of the settlement for the purposes of capital gains tax under Furniss v Dawson [1984] STC 153. In the light of Pigott v Staines Investments Ltd [1995] STC 114, and Griffin v Citibank Investments Ltd [2000] STC 1010, the fact that the events took place over a period of 18 months or so might well not suffice as a sufficient period of time to break the necessary Ramsay 'circularity'. – Zibultong.
Section 225, Taxation of Chargeable Gains Act 1992 expands sections 222 to 224 by recognising a split in the normal combined status of 'owner' and 'resident'. The capacity of 'owner' is satisfied by the trustee and the capacity of 'resident' is satisfied by the person entitled to occupy the residence under the terms of the settlement.
The son and the trustee should give a joint notice under section 222(5)(a) within two years of the son going into residence. There is no magic in the proposed year's duration but the quality of that residence is important (see Goodwin v Curtis [1998] STC 475).
A problem would arise if the son took up residence from the inception of the trust. A danger in this respect was pointed out by Ralph Ray as reported in Taxation, Meeting Points, 17 August 2000 at page 518. The hold-over claim could be invalidated if an interest in possession was alleged to exist, rather than a discretionary trust. – M.C.N.
Editorial note. This is a well-established and commonly proposed scheme. 'Zibultong's' authoritative comments on it may appear to end any hope of it achieving success and, whilst his points from the third one onwards are unlikely to be contentious, readers should carefully consider the merits of the first and second points.
For a contrary view on the first point, it may be argued that trustees are never given any choice about what property is settled under a trust deed and so they themselves cannot have a purpose in acquiring the property, other than to hold it upon the terms of the trust. The tax saving purpose is that of the settlor which (arguably) is not relevant for section 224(3). It would no doubt be better for the settlor not to be a trustee.
A parent has a second home showing a large gain and owned for many years. He proposes to place it into a discretionary trust for the benefit of his children and others, holding over the gain under section 260, Taxation of Chargeable Gains Act 1992. The trustees will, after a few months, entitle the son to occupy the property as his main residence, and he will live there for at least one year. The home will then be sold and it is claimed that under section 225, Taxation of Chargeable Gains Act 1992 no capital gains tax will be payable at all. At that stage the settlor will be added as a beneficiary – see above reference to 'and others'; and may collect all or some of the proceeds of sale.
Is it agreed that the section 225 relief will be unaffected, that section 660A, Taxes Act 1988 will have minimal effect (very little income) and sections 77 and 78, Taxation of Chargeable Gains Act 1992 are overridden by section 225? The settlor will have incurred an inheritance tax gift with reservation – but so what!
(Query T15,732) – Country Boy.
This scheme is vulnerable for a number of reasons. First, section 224(3), Taxation of Chargeable Gains Tax Act 1992 provides that no main residence relief shall be given 'if the acquisition of … the dwelling-house … was made wholly or partly for the purpose of realising a gain from the disposal of it'. As a matter of statutory construction, 'gain' is likely to be held by the courts as meaning a gain as computed for capital gains tax purposes, rather than the actual mathematical gain between the date of settlement and the date of disposal: see Commissioners of Inland Revenue v Burmah Oil Co Ltd [1982] STC 30. The introduction under self assessment of a prescribed form, IR 295, on which the election has to be made and which is not available until the start of the following tax year can, in certain circumstances, make it difficult to presume that the necessary pre-ordination is present for Ramsay to be called in aid by the Inland Revenue.
Thus, assuming the property to be freehold, were the hold-over to have been made out of a discretionary trust by appointment in equity to a beneficiary, it could be contended that, because the approbation of the beneficiary was unnecessary to the transfer of beneficial ownership, the transferee had no 'purpose' at the time of acquisition. This must be contrasted with the position here, where an asset is placed into trust. In such circumstances, the transfer of the property would have had to be executed by at least one of the trustees to be effective. It follows that it must be possible to attribute a 'purpose' to the trustees in this case at the time the settlement was created. Furthermore, it is likely to be difficult to contend with any degree of credibility that the 'game plan' was not known to the trustees from the outset. If section 224(3) were to apply, section 225 would not come into consideration.
Second, with regard to section 225, while the better view is that section 77(1)(a), Taxation of Chargeable Gains Act 1992 takes effect subject to it, this view has been challenged by the London Trusts District on a number of occasions. It follows that one of the underlying assumptions may not turn out to be a sound one. Uncertainty on this score could only be eliminated by deleting the power to add the settlor and his wife as future beneficiaries, and therefore the potential recipients of the proceeds of sale of the property (see section 77(2)(a)). This appears to undermine the main object of the scheme.
Third, any claim for relief under section 225, Taxation of Chargeable Gains Act 1992 will be dependent upon the application of Sansom v Peay [1976] STC 494. The problem here is that the Capital Taxes Office, rightly or wrongly, will treat such an arrangement as the creation of an interest in possession under Inland Revenue Statement of Practice SP10/79, i.e. the event of an exit charge under section 68, Inheritance Tax Act 1984, calculated by reference to the value of the property settled and the pre-existing state of the settlor's seven year 'clock'.
Fourth, in all probability, the termination of the son's right of occupation is likely to be regarded by the Capital Taxes Office as an event of charge on the son's 'clock' under section 52, Inheritance Tax Act 1984. Moreover, as the property would then fall back into a discretionary trust, the section 52 event would not be a provisionally exempt transfer under section 3A, Inheritance Tax Act 1984.
Fifth, the creation of the settlement would also not have been a potentially exempt transfer (indeed without this status, a holdover under section 260, Taxation of Chargeable Gains Act 1992 would not have been permissible). While the state of the settlor's seven year 'clock' would need to be taken into account, the chances are that the value of the property would have exceeded the nil rate band. In such circumstances, there would be a liability at the time the settlement was entered into, a second liability upon the son entering into possession and a third liability upon his vacating the property at the request of the trustees at the time of sale.
Sixth, none of these liabilities would be reduced by reason of the fact that the settlor had reserved a benefit within the terms of section 102, Finance Act 1986. Indeed, as indicated above, only by his and his wife's deletion from the list of potential beneficiaries could the uncertainty under section 225, Taxation of Chargeable Gains Act 1992 be eliminated. But, yet again, it has to be said that this appears to undermine the main object of the scheme, which is to enable the settlor to sell the property and participate in the proceeds of sale without the payment of capital gains tax.
Seventh, irrespective of whether section 224(3), Taxation of Chargeable Gains Act 1992 applies, it is just conceivable that the retention of the settlor as a potential beneficiary might enable the Inland Revenue to disregard the interposition of the settlement for the purposes of capital gains tax under Furniss v Dawson [1984] STC 153. In the light of Pigott v Staines Investments Ltd [1995] STC 114, and Griffin v Citibank Investments Ltd [2000] STC 1010, the fact that the events took place over a period of 18 months or so might well not suffice as a sufficient period of time to break the necessary Ramsay 'circularity'. – Zibultong.
Section 225, Taxation of Chargeable Gains Act 1992 expands sections 222 to 224 by recognising a split in the normal combined status of 'owner' and 'resident'. The capacity of 'owner' is satisfied by the trustee and the capacity of 'resident' is satisfied by the person entitled to occupy the residence under the terms of the settlement.
The son and the trustee should give a joint notice under section 222(5)(a) within two years of the son going into residence. There is no magic in the proposed year's duration but the quality of that residence is important (see Goodwin v Curtis [1998] STC 475).
A problem would arise if the son took up residence from the inception of the trust. A danger in this respect was pointed out by Ralph Ray as reported in Taxation, Meeting Points, 17 August 2000 at page 518. The hold-over claim could be invalidated if an interest in possession was alleged to exist, rather than a discretionary trust. – M.C.N.
Editorial note. This is a well-established and commonly proposed scheme. 'Zibultong's' authoritative comments on it may appear to end any hope of it achieving success and, whilst his points from the third one onwards are unlikely to be contentious, readers should carefully consider the merits of the first and second points.
For a contrary view on the first point, it may be argued that trustees are never given any choice about what property is settled under a trust deed and so they themselves cannot have a purpose in acquiring the property, other than to hold it upon the terms of the trust. The tax saving purpose is that of the settlor which (arguably) is not relevant for section 224(3). It would no doubt be better for the settlor not to be a trustee.
