Meeting Points

MALCOLM GUNN FTII, TEP and RALPH RAY FTII, TEP, BSc (Econ), solicitor report some planning points from this year's Key Haven Oxford Residential Conference; further highlights will be published in next week's issue.

Tax-efficient giving

The scheme in Commissioners of Inland Revenue v Melville [2001] STC 1271 was designed to enable valuable property to be given away in trust with the benefit of capital gains tax holdover relief, but without any inheritance tax being payable. The arrangement in that case is no longer effective as a result of section 119, Finance Act 2002, but Kevin Prosser QC advised that the same result can be achieved by the use of a reversionary interest, rather than a settlement power as in the Melville case.

Funds should be transferred to a settlement in which discretionary trusts endure for (say) 100 days and thereafter the settlor is absolutely entitled if he is then living, with remainders over if not. Capital gains tax holdover relief under section 260, Taxation of Chargeable Gains Act 1992 would apply on the disposal into the trust. For inheritance tax purposes, the value transferred is the difference between the value of the asset settled and the value of the reversionary interest; in order to prevent the open market value of the latter being depressed by reason of the potential capital gains tax liability assumed by the trustees, the settlor should release his statutory right of reimbursement of any tax assessed on him in respect of the trust gains.

During the initial 100-day period of the trust, the settlor would transfer his reversionary interest into interest in possession or accumulation and maintenance trusts of a second settlement. The settlor's reversionary interest is not a chargeable asset for capital gains tax purposes. Also it is not excluded property for inheritance tax purposes (see section 48(1b), Inheritance Tax Act 1984) and so a potentially exempt transfer would arise on the gift in settlement.

As the law now stands, a further section 260 holdover claim could be made at the end of the 100-day period, but to cater for the possibility that this relief might be withdrawn or curtailed, the settlor could be given power to extend the 100-day period.

More on Melville

Robert Venables QC outlined a variant on the new style Melville schemes (as outlined by Kevin Prosser QC) by which a settlor-interested discretionary trust is set up with the settlor giving away a reversionary interest retained in the settlement.

The alternative is for the client to set up a trust with two funds, one discretionary and one with either interest in possession beneficiaries or accumulation and maintenance trusts. The settlor would give valuable assets to the trustees to be held on the trusts of the discretionary fund, in which the settlor would have a reversionary interest after (say) 100 days. During that period, the settlor would resettle his reversionary interests on the trusts of the other fund in the settlement. In this way, there will be no capital gains tax disposal at the end of the 100-day period.

Robert Venables advised that the House of Lords decision in MacNiven v Westmoreland Investments Limited [2001] STC 237 has made it less likely that the Ramsay approach can be applied to these types of scheme.

Stamp duty planning for corporate vendors

If a valuable property is to be sold along with a business activity, the stamp duty position may be improved if the vendor company transfers the property and the business to a special purpose vehicle in return for non-redeemable shares. By claiming relief under section 76, Finance Act 1986, this reduces the charge at this stage to 0.5 per cent. The shares may then be sold to the purchaser at a further stamp duty cost of 0.5 per cent.

However, section 112, Finance Act 2002 has introduced a further condition for the section 76 claim as regards land in the United Kingdom. This is that the acquiring company (the special purpose vehicle) must not be associated with another company that is a party to arrangements with the target company (here the vendor) relating to shares of the acquiring company. Could this be applied to the formation of the special purpose vehicle? Kevin Prosser QC advised that it could not, since the vendor (being the target company) cannot be regarded as being a party to arrangements with itself.

Under section 113, Finance Act 2002 there is a withdrawal of the relief if, within two years, control of the acquiring company changes with the land still then being held. Intra group planning can easily circumvent this. To avoid the problems with section 112, Kevin Prosser QC advised that the acquiring company should be set up before there are any arrangements in sight with any purchaser.

Staff bonus on company sale

Where a family company is sold and the shareholders wish to reward the staff of it in a tax efficient manner, a simple payment of cash out of the proceeds of sale of the shares is likely to be treated as an emolument of the employment and will be therefore taxable under Schedule E.

Andrew Thornhill QC advised that there should be no tax charge, however, if the matter is restructured as an interest free loan to the staff. In paragraph 1 of Schedule 7 to the Taxes Act 1988 there is a definition of those loans which are obtained by reason of a person's employment. Where the employer was a close company, a loan is caught if it is made by a person having a material interest in that close company, but if the loan is made after no material interest is held then it is outside the scope of the charging provisions.

Tax planning by means of conditional shares for employees

Section 140A, Taxes Act 1988 governs the position where an employee acquires shares by reason of his employment, but the terms of the shares satisfy the tests set out in the section for being 'conditional'. The main advantage of the section is that the share issue can be arranged to be tax free initially (except where issued at undervalue) and the tax liability arises when the shares cease to be conditional or when they are disposed of.

Andrew Thornhill QC advised that the potential tax charge on such shares can be minimised if there is an across-the-board bonus issue of non-conditional shares. This would be arranged to devalue the conditional shares and the new shares would not be acquired as employee, but rather as shareholder. Those new shares could be sold with the benefit of full business asset taper relief in due course.

Planning with excluded property.

Overseas assets in a settlement made by a non-domiciled settlor are excluded property, so that it is possible for a purchaser of an interest in possession in such a trust to convert his or her estate wholly or partly into excluded property by means of the purchase shortly prior to death. Note that a reversionary interest in the trust will not be excluded property by virtue of section 48(1), Inheritance Act 1984 which expressly leaves purchased reversionary interests within the scope of charge.

The possibilities for tax planning by this means have been curtailed by section 119, Finance Act 2002 (settlement powers). A settlement power is defined as 'any power over, or exercisable whether directly or indirectly in relation to, settled property or a settlement'. Robert Venables QC pointed out that this is a very wide definition and it would include not only a special or general power of appointment but also a power to appoint or remove trustees or a protector or appointor.

The impact on the arrangement to buy an interest in an excluded property trust arises from the fact that a settlement power is frequently acquired along with a beneficial interest in the trust. For example, if settled property is held on trust for A for life, remainder to B, the trust being governed by English law, A will be able to restrict the exercise of a settlement power, namely the power conferred on the trustees by section 32, Trustee Act 1925 to advance funds to B. Therefore any purchaser of A's interest will be acquiring a settlement power by that transaction. New section 55A, Inheritance Tax Act 1984 states that the purchase of the settlement power causes the purchaser to make a transfer of value and the value transferred is to be determined without bringing into account the value of anything acquired by the disposition.

Hence, the entire purchase price paid constitutes a transfer of value and it is not possible to bring into account the fact that a life interest is also acquired along with the settlement power.

Possible further developments with the Hastings-Bass principle

In the case of Re Hastings-Bass (deceased) [1974] 2 ALL ER 193, a principle was enunciated whereby a discretionary appointment by trustees will be set aside by the court if the trustees acted without due consideration of all relevant matters.

Nicholas Warren QC reported that, at a recent lecture, Lord Justice Robert Walker (now elevated to the House of Lords) expressed substantial reservations about the whole scope of this principle. He was sceptical about the view that the effect of the application of the principle, even when it is properly applied, is to render the transaction void rather than voidable. He would clearly prefer to see the principle subsisting only as part of Equity's control over trusts and trustees and to give the court merely discretionary powers to remedy defects when justice demands. It is probably only a matter of time before a case concerning the principle arrives at the House of Lords, perhaps following a Revenue appeal, and the remarks at this lecture indicate that the House of Lords might well introduce some restraints and limitation.

The distinction between an appointment being void on the one hand and voidable on the other has important consequences. An appointment which is void ab initio is treated as never having been made in the first place, but one which is voidable is set aside only at the date of the relevant Court Order and is effective up to that time. In the latter case therefore, the initial capital gains tax and income tax consequences of the appointment remain, although inheritance tax is unlikely to be a problem because of the specific provision on voidable transfers in section 150, Inheritance Tax Act 1984 which enables a voidable transfer to have the same consequences as one which is void ab initio.

Rectifying mistakes

Where a settlor executes a trust deed under a misapprehension as regards the effect of the document, there is no principle corresponding to that in Re Hastings-Bass, by which the settlement can be declared void. There is, however, a line of authority (see Gibbon v Mitchell [1990] 1 WLR 1304) which shows that a voluntary disposition can be set aside when the transaction did not have the effect which the donor intended. However, in both that case and in latter cases on the same theme, it has been held that a distinction must be drawn between unforeseen effects and unforeseen consequences; the document will only be set aside in cases of mistake as to the effect and not the consequences.

Nicholas Warren QC said that the distinction is very hard to define and so there must be considerable uncertainties as to what can be achieved under this aspect of the law. Nevertheless, in his opinion the type of case which might well be set aside by reason of mistake would be, for example, where a settlor created a settlement which was clearly intended to create accumulation and maintenance trusts, but where the trust deed failed to satisfy the detailed conditions for such trusts by virtue of a clear mistake. In his view, it should be possible to have the whole settlement set aside as having been made on the basis of fundamental mistake about the effect of the trusts.

Suppose, however, that the making of a settlement had given rise to an inheritance tax liability on the settlor which has been overlooked by his advisers. Would it be possible to have the settlement set aside, and if so upon what basis? Under Gibbon v Mitchell, this would undoubtedly be regarded as a mistaken consequence and so outside the confines of set aside by virtue of mistake. Nevertheless, Nicholas Warren QC considered that it should be possible to put a case to the court in such circumstances for recovery of the settlement funds on purely restitutionary principles. It should be arguable that the settlor ought to recover money paid to a trustee under a significant mistake as to the effect or consequences of the settlement.

Corporate tax planning for sale of mixed activity subsidiaries

Where a trading company holds shares in a subsidiary which has trading activities but also investment activities so that the main 'substantial shareholding' exemption in Schedule 7AC to the Taxation of Chargeable Gains Act 1992 does not apply, David Goy QC advised that exemption should be achieved if the trading activities are transferred to a new subsidiary and the shares in that new subsidiary are then sold. In these circumstances, the main exemption under the Schedule would not apply as the trading test in paragraph 19 of the Schedule would not be satisfied for the necessary period; however, the subsidiary exemption in paragraph 3 of the Schedule will apply to give exemption on the sale.

Substantial shareholdings

The main exemption for disposals of companies with substantial shareholdings in Schedule 7AC to the Taxation of Chargeable Gains Act 1992 requires, under the main exemption provisions, that detailed conditions are satisfied at the time of disposal and immediately after it. Where those conditions are not satisfied, there is a subsidiary exemption in paragraph 3 of the Schedule which applies if the main exemption conditions would have been satisfied on the assumption that the disposal had taken place at some time in the previous two years. The subsidiary exemption will therefore commonly assist in situations where either the investing company or the target company has ceased to trade in the previous two years and thus, at the time of disposal, does not satisfy the main exemption condition as to trading status. For the purposes of the subsidiary exemption, both the investing and target companies are to be treated as satisfying the trading requirement on the assumed disposal in the previous two-year period.

David Goy QC advised that the subsidiary exemption should apply where, for example, a non-resident company owns all the shares in a United Kingdom holding company which in turn owns all the shares in a trading subsidiary. If the shares in the trading subsidiary are sold, the main exemption will not apply, because the United Kingdom holding company does not satisfy the trading test. However, under the subsidiary exemption the trading requirement is deemed to be satisfied if the other conditions for exemption would have been satisfied in the previous two years. The remaining hurdle with the subsidiary exemption in these circumstances is an anti-avoidance provision in subparagraph 3 of the paragraph; this disapplies the subsidiary exemption where the only reason why the main exemption is not met is because the investing company is not trading, in circumstances other than where it is, or is about to be, wound up. Accordingly if, immediately after the sale of the trading subsidiary, the United Kingdom holding company is wound up, the subsidiary exemption should be available and the anti-avoidance provision in subparagraph 3 will not disapply it.

United Kingdom homes for non-domiciliaries: avoiding a benefit

In view of the tax problems which allegedly arise under sections 145 and 146, Taxes Act 1988 where non-domiciliaries wish to purchase a United Kingdom home through the medium of an offshore company, Andrew Thornhill QC and Kevin Prosser QC offered an alternative structure. Funding for the property should be provided to an offshore trust which would then make the purchase and lease the property rent free to the settlor for a suitable period, perhaps ten or fifteen years. Thereafter the freehold will be transferred into a newly-formed company owned by the trustees at a stamp duty cost (for which further planning may be appropriate).

Issue: 3885 / Categories: