Meeting Points

RALPH RAY FTII, TEP, BSc (Econ), solicitor and MALCOLM GUNN FTII, TEP report this year's Key Haven Oxford Conference held in September.

Tax planning with foreign assets

James Kessler, barrister, highlighted the difficulties for inheritance tax purposes which arise where one spouse is domiciled in the United Kingdom and the other is not. In such a case, any gift of assets from the domiciled to the non-domiciled spouse receives a spouse exemption up to £55,000 only; any sum in excess of that amount could run a risk of being within the gift with reservation rules. Remember, however, that other exemptions may be in point, for example section 11(1), Inheritance Tax Act 1984 which provides for exemption in relation to a disposition between spouses for the maintenance of the other party. This would apply to the common case where the domiciled spouse gives a half share in a family home to the non-domiciled spouse.

A strategy to overcome the gift with reservation problem would be for the non-domiciled donee spouse to transfer gifted assets to a discretionary trust. Foreign assets in the trust will then be excluded property, so long as the domiciled spouse cannot be regarded as a settlor of the trust; that depends on whether he or she has provided property directly or indirectly for the settlement. James Kessler advised that the domiciled spouse would not be a settlor if the non-domiciled spouse had a genuine and wholly independent role in relation to the making of the settlement and had retained the gifted assets for at least one year.

To be certain of avoiding issues as regards who is the settlor, an alternative strategy would be for the non-domiciled spouse to form a non-resident company and give the assets to that company. The danger area here relates to the residence status of the company.

Revenue publications

Reg Nock warned that it has been known for a publication of the Stamp Office to be amended subsequent to initial publication of the paper version of the document being posted on the Revenue's website. Accordingly, when relying on a statement in a publication by the Stamp Office, it would be important to keep a paper copy of it, and to check, before finalising a transaction, that the document remains unchanged on the Revenue's website.

Income of settlements with benefit to settlor

Where a non-domiciled individual makes a settlement in which he or she retains an interest, section 660A, Taxes Act 1988 applies to treat all income of the settlement as that of the settlor for tax purposes.

Section 660G, Taxes Act 1988 preserves the remittance basis for taxation in relation to a non-domiciled settlor. It also states that the trust income is to be treated as arising under the settlement in the year in which it is remitted in circumstances where the settlor would be chargeable to income tax by virtue of residence in the United Kingdom if he were actually entitled to the income when remitted.

James Kessler said that at first sight this appeared to mean that settlement income arising while a settlor is non-resident, but remitted while the settlor is resident, is caught by section 660A and treated as arising in the year of remittance. It would therefore be taxable. This interpretation is, however, inconsistent with the scheme of section 660A, which is to put the settlor in the position he would be in, if he had not made the settlement. Income of a non-resident, non-domiciled person is not taxable if remitted during a period of residence in the United Kingdom.

Accordingly, James Kessler submitted that the section should be given a purposive construction so as to avoid a tax charge on settlement income of a period when the settlor is non-resident, but remitted when he is so resident.

More about Westmoreland

Guest speaker, Lord Hoffmann, took the opportunity to correct some misapprehensions which he considered may have arisen following his judgment in the case of MacNiven v Westmoreland Investments Ltd [2001] STC 237. For example, he had been made aware of a certain amount of criticism which had arisen by virtue of his categorisation of the word 'payment' as a commercial concept in one statutory provision, and a legal concept in another provision.

Lord Hoffmann said that this criticism fell into the error of focusing on a single word, rather than the complete sentence in which the word is found. Words take their colour from their context, and it was essential to construe legislation in complete sentences. He was particularly critical of those who look up the dictionary definition of a word and then build an entire case on that definition, without reference to the complete statutory sentence.

Inheritance tax planning: the family home

Reversionary lease schemes are still a possibility in inheritance tax planning for the family home, so long as the acquisition of the freehold by the homeowner was at least seven years previous to the grant of the lease. The scheme does, however, have considerable downsides, first in that it would be difficult to redesign the scheme if the homeowner wishes at a later stage to move house and, secondly, in that the scheme can manufacture a significant capital gain out of thin air; the reversionary lease will have virtually no base cost and eventually will acquire most of the value in the home.

Robert Venables QC offered a means of dealing with the capital gains tax problem. The solution is to form a trust with two funds, one fund to own the lease, and the other to own the freehold. The trusts of the two funds would be entirely independent so that the freehold interest would be held for the homeowner and the reversionary lease for the heirs of the homeowner. As a result, for inheritance tax purposes the two interests are deemed to be owned by different persons, with no reservation of benefit arising. However, for capital gains tax purposes the existence of the two funds is disregarded and there is only one trust. The legislation does not recognise the existence of sub-funds except in certain specialist areas. Accordingly, the principal private residence exemption available to the homeowner will cover all gains arising in the trust on the property, thus meeting both the inheritance tax objectives of the scheme and also avoiding the capital gains tax downside. Robert Venables advised that the wording of the trust requires very careful drafting.

Spouse exemption trust

Robert Venables QC advised that, in his view, it is usually possible to avoid the application of the gifts with reservation of benefit provisions by settling property on trusts under which one's spouse takes an interest in possession, as it is expressly stated that this is excluded from the reservation of benefit provisions. The view is not universally accepted and Robert Venables also noted that the planning would be ineffective if either the spouse was foreign domiciled (because there is only limited spouse exemption in such a case) or if the inheritance tax maintenance of family exemption applied (because in such a case there is no transfer of value and thus nothing on which the spouse exemption can be applied).

If the scheme is used in relation to a property, on the termination of the spouse's initial interest in possession, problems would arise if the settlor spouse had sole occupation of the property; even in a discretionary trust, the Revenue would argue that an interest in possession has then arisen. The risks would be reduced but not eliminated where the settlor is permitted to occupy only in common with others. Therefore, from a taxation point of view, the safest course is for the settlor to provide that his beneficiaries will after an interval of time become absolutely entitled. They can then allow him to occupy the property on whatever terms they think fit.

If the property is not the main residence, Robert Venables advised that the scheme could not be adapted to avoid capital gains tax liability arising.

(Note: it is understood that a case on this type of arrangement is expected to be heard by the Special Commissioners in the near future.)

The Hastings-Bass principle

Simon Taube QC explained that if trustees exercise a power and afterwards discover that it has produced unforeseen results, the principle in re Hastings-Bass [1975] CH 25 may come to the rescue. The principle was expressed in rather confusing terms in that case and was better stated in the later case of Re Mettoy [1990] 1 WLR 1587 in the following terms:

'Where a trustee acts under a discretion given to him by the terms of the trust, the court will interfere with his action if it is clear that he would not have acted as he did had he not failed to take into account considerations which he ought to have taken into account.'

In the Hastings-Bass case, the judgment indicated that it would need to be shown that the trustees would (without any doubt) have acted differently had they fully appreciated the consequences of their actions; in the later case it seemed to be indicated that it would be enough if it could be shown that the trustees might have acted differently.

The principle has saved the day for trustees in two cases where their acts had disastrous unforeseen consequences: see Green v Cobham [2000] WTLR 1109 and also Abacus Trust Company (Isle of Man) Limited v NSPCC [2001] STC 1344.

The principle has its limits, however. In Breadner v Granville-Grossman [2001] Ch 523, Mr Justice Park refused to set aside a power of appointment exercised by trustees one day after the time limit for its exercise had expired. The evidence showed that, had they appreciated the time limit properly, they would have exercised the power to appoint particular trusts. Mr Justice Park said that setting aside the exercise of the power in this case would be an unwarranted extension of the Hastings-Bass principle. It would not be declaring a decision of the trustees to be void, but rather declaring that they should be treated as having exercised it at some other time. Mr Justice Park said that 'It cannot be right that whenever trustees do something which they later regret and think they ought not to have done, they can say that they never did it in the first place'.

Employee benefit trusts

Andrew Thornhill QC outlined a scheme for providing employee remuneration via an employee benefit trust. The trustees would buy shares in the employer company and then advance an interest-free loan to a new trust created out of the existing one. The trustees of the new trust purchase shares from the employee benefit trust and appoint the shares to an employee, subject to and charged with the loan due to the original trust. The trustees retain legal title while the loan remains outstanding.

On the appointment of the shares to the employee, little value will have been received because of the outstanding loan. The employee is not, however, taxable under the benefit in kind provisions relating to employer loans (section 160, Taxes Act 1988), as he is not in receipt of any loan. Nor is he taxable under section 162 of that Act because his interest in the shares is virtually valueless. Nor is he taxable under section 140A, Taxes Act 1988 (conditional acquisition of shares); there could in some circumstances be problems with the forfeiture rules as the shares would have to be sold to repay the loan, but section 140C(1)(b) should apply in this case to prevent liability, as the employee is not entitled to receive an amount equal to or more than that which he would get, in the absence of any forfeiture provision, from a sale of his interest at open market value.

Commercially, the employee has the equivalent of an option over the shares at today's price. If the shares fell in value, the employee's interest would be worthless, but he would not be liable on the loan as he would never have incurred a personal liability.

Temporary non-resident non-domiciliaries

The capital gains tax charge on temporary non-residents (see section 10A, Taxation of Chargeable Gains Act 1992) applies to both United Kingdom domiciled and non-domiciled individuals alike. The difficult question arises as to how the section applies to foreign assets of a non-domiciled individual. Gains of such individuals are normally governed by section 12 of the Act where there is a remittance basis charge if the remittance is in a year of residence or ordinary residence.

James Kessler considered that, in the case of a non-domiciliary who falls within the temporary non-resident rules, one first applies section 10A, which says that the taxpayer is to be charged to capital gains tax as if the gains were gains accruing in the year of return to the United Kingdom, and then one applies section 12 which overrides with a remittance basis. Accordingly, if the gains are not remitted, they should not be charged to capital gains tax. On the other hand, if they are remitted during a year of residence in the United Kingdom, there is a tax charge. If a foreign domiciliary disposes of foreign assets during the non-resident period and remits the proceeds to the United Kingdom during the non-resident period, James Kessler considered that section 12 should override section 10A and there would be no liability.

Turning capital into income

Kevin Prosser QC outlined a possible method by which the trustees of a non-resident trust could avoid significant liabilities to capital gains tax (at up to 64 per cent) arising in respect of undistributed gains. The idea was that the trustees could put funds from the trust into a wholly owned company which should become an unlimited company. The company would then declare a substantial dividend, ensuring that it is within the Schedule F provisions by suitable trading operations in the United Kingdom. A disposal of the shares would then be arranged and a loss would arise by virtue of the extraction of funds by the payment of the dividend. The value shifting rules would not apply because the benefit of the dividend is not tax free; it is within the charge to income tax under Schedule F.

The idea could be adapted for individuals becoming temporarily non-resident in the United Kingdom. If they have cash funds, they could form a company whilst non-resident and take a large dividend from the company, assuming it to be unlimited. The dividend would not be taxable in the United Kingdom owing to the shareholder's non-resident status. It would, however, be necessary to examine foreign taxation in relation to the dividend. On returning to the United Kingdom, the shareholder would liquidate the company and would have a loss on the shares for capital gains tax purposes which could be used to offset any gains at that stage.

Shareholder going non-resident

Kevin Prosser QC pointed out that, for a shareholder planning to take a pre-sale dividend from a family company before a sale of the shares, it would be advantageous to contract to sell the shares on, say, 1 April prior to going abroad before 5 April; a pre-sale dividend declared by the company could be dated for payment on 30 April, after the shareholder has become non-resident. The dividend would not then be taxable in the United Kingdom and the consideration for capital gains tax purposes attributable to the resident period would be reduced tax free.

Alternative Melville arrangements

Kevin Prosser QC preferred a simpler trust structure to that which is commonly proposed in relation to tax planning of the type illustrated in Melville v Commissioners of Inland Revenue [2001] STC 1271. The basic strategy is to hold over a capital gain to a discretionary trust whilst also minimising the chargeable transfer for inheritance tax purposes. The simpler structure involves discretionary trusts which endure for a fixed period of, say, six months or one year followed by a reversionary interest to the settlor. During the life of the discretionary trusts, the settlor would give away his reversionary interest.

Maximising relief under double tax treaty

Kevin Prosser QC pointed out that section 13, Taxation of Chargeable Gains Act 1992 (capital gains of non-resident companies) operates by treating the gain of a non-resident company within the provisions as accruing to the United Kingdom shareholders. The Revenue therefore accepts that if the company is situated in a jurisdiction with a suitable double tax treaty, treaty protection applies both to the company and the shareholders under section 13. Accordingly, such a company can realise a gain without it being apportioned to shareholders.

In order to extract the gain from the company, one possibility would be for the shareholder or shareholders to go non-resident for a year. During that period the non-resident company would be imported into the United Kingdom and would declare a dividend. The tax credit on the dividend would be the only extent of the non-resident shareholders' liability to United Kingdom tax in relation to the dividend.

Moving home after Ingram

Where an inheritance tax lease carve out arrangement has been carried out (prior to the change in the law as a result of Ingram v Commissioners of Inland Revenue [1999] STC 37), problems will arise if the client wishes to move home. It might be thought easy enough for the client to assign his or her lease to a purchaser of the freehold interest so that the two merge into one. Robert Venables QC pointed out that this could conceivably give a charge to income tax under section 35, Taxes Act 1988; this applies where there is an assignment of a lease which was originally granted at an undervalue. However, section 35 only applies, on its terms, where there is an assignment and accordingly it should not apply if there is just a surrender of the lease.

Income into capital

Taper relief offers the opportunity to realise profits in investment companies by those not holding a material interest at a tax rate of 10 per cent, possibly after only two years after the next Budget. Kevin Prosser QC pointed out that the investment company could be a non-resident 'protected cell' company where the taxpayer has for example, A shares which give rights to dividends and surplus assets referable to the company's A fund consisting of investments which the taxpayer would have invested in directly. Provided that sufficient investors participate, no one will have a material interest and it will not be a close company. As to the requirement of the shareholder having an office or employment with the company, this can be satisfied by the taxpayer being a director of a company with a 'relevant connection'.

Shares in dependent subsidiaries

Where executives have shares in a subsidiary company it will be treated as a dependent subsidiary for the purposes of section 79, Finance Act 1988 unless certain conditions are satisfied (see section 86), including the provision of certificates annually to the Inland Revenue by the holding company. If this has not been done, the dependent subsidiary provisions may apply with disastrous income tax results.

Andrew Thornhill QC outlined a possible strategy to deal with the problem. The shareholders could transfer their holdings to their spouses, after which the original shares would be flooded by a new bonus issue. Although section 83(2), Finance Act 1988 operates to treat the original shares as remaining in the possession of the original shareholders for the purposes of the legislation, this deeming provision would not appear to have any application to the bonus shares. Therefore most of the taxable value could, it would seem, be siphoned into the bonus shares and thus escape the dependent subsidiary charge.

Stamp duty and company distributions

Reg Nock said that a distribution in specie by a company can be certified for stamp duty purposes as a gift, therefore attracting no duty. If a distribution of this type is made during liquidation, the document can be certified as one under which there is no change of beneficial interest, thereby attracting £5 duty.

Company reconstructions

Sections 75 and 76, Finance Act 1986 set out stamp duty reliefs where there is the transfer of the whole or part of an undertaking of another company to an acquiring company. Reg Nock said that a company's interest in a joint venture can be part of an undertaking for this purpose, because, in normal circumstances, all participating companies are actively involved in the joint venture. Likewise, subsidiaries can be part of an undertaking so long as the parent company is actively involved in the management and carrying on of the subsidiary's business. If the top company has been running down its interest in the subsidiary, there is less likelihood of persuading the Revenue that the reduced interest in the subsidiary is 'part of an undertaking', because the reducing shareholding may be taken to indicate a lack of managerial interest in the company. On the other hand, where the holding is being built up, this presents a stronger case for the shareholding to be part of an undertaking.

Similar considerations might be applied for the purposes of the capital gains tax reconstruction provisions.

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