What changes, in overview, are made by this draft legislation?
Over the past ten years the government has introduced significant additional powers for HMRC to use to combat the promotion of abusive tax schemes. There is a lack of detailed evidence to undertake a useful evaluation of how effective these changes have been but given that the government is now seeking to further strengthen the sanctions against those who have continued to promote or enable tax avoidance schemes, it must be assumed that those promoting tax schemes have been able to frustrate HMRC’s ability to quickly suppress the promotion of such schemes.
The following key changes are now suggested:
Why does HMRC want to strengthen the existing regimes in this way?
The proposals are part of a wider policy to further curtail the behaviours of those who continue to design and promote aggressive tax avoidance schemes and to provide further clarity for the taxpayer in deciphering where they are being misled.
There is still a concern that taxpayers are being enticed into schemes without any real understanding of the risks. These powers will enable HMRC to intervene at an earlier stage to address this issue and allows HMRC to act where it concludes that the scheme cannot achieve what is being promised by the promoter.
The policy intent of the new powers can be considered alongside the continued action HMRC is taking against disguised remuneration schemes. In a recent call for evidence specifically related to such schemes HMRC talked about wanting to ‘disrupt the business model/ economics and supply chains of avoidance as well as helping taxpayers steer clear’.
Has HMRC used the POTAS rules much since their introduction in 2014?
The POTAS rules were really an additional deterrent and a means by which HMRC could monitor the activities of a small number of persistent repeat offenders. There is little tangible evidence of their use, but it may be reasonable to assume that HMRC has been more active than the evidence suggests.
Notwithstanding, it is clear that the overall level of tax avoidance activity has been significantly reduced in the main due to the combination of the DOTAS and accelerated payment notice regimes that plugged a significant gap. It was always hoped that few promotors would meet the given POTAS threshold conditions and thus be issued with conduct notices, and that from there most would comply with a conduct notice so that there would be no need to issue a subsequent monitoring notice.
HMRC describes the changes as 'necessarily far-reaching'. Should law-abiding tax advisers be concerned?
It was surprising that Sir Amyas Morse’s independent review of the loan charge published in December 2019 stated that since the introduction of the loan charge in 2016 over 20,000 new schemes had emerged and 8,000 of those emerged as late as 2019–20. This data was somewhat difficult to believe given the controversy caused by the loan charge and the extent of the consequent publicity but plainly some individuals have continued to play fast and loose with the rules.
The rules should not apply to those tax advisers who steer well clear of tax schemes and many advisers will support these changes as targeting anyone who continues to promote tax avoidance schemes and undermine the integrity of the profession.
Does the new consultation document shed any additional light on how the new provisions will be applied?
As with all new anti-avoidance measures HMRC must ensure that adequate procedural safeguards exist for the protection of the taxpayer and the difficulty is always ensuring that these do not compromise the effectiveness of the rules. Some further thought will be needed in relation to an appeals process.
Further measures are promised for the Autumn Budget 2020, do you have any views on what we might see?
As mentioned above, the new rules sit alongside a call for evidence on tackling disguised remuneration schemes so we should expect to see additional measures in this area. The existing rules are complicated for HMRC to apply and even with these changes HMRC is likely to find that there remain issues in how effectively it can tackle those most determined.
It seems likely that many of the anti-avoidance rules and corresponding taxpayer protection measures will continue to be streamlined to increase their effectiveness.
There are presently many strands of evidence-gathering concerning promoters of tax avoidance schemes, including a recent All-Party Parliamentary Group paper on responsible tax practices. As a result the government may conclude that even more wide-ranging changes, including a possible new Taxes Management Act, are required.
When will the Finance Bill 2021 measures take effect?
Many of the tweaks to the existing rules will take effect for all new schemes which are or continue to be promoted after the date of Royal Assent. The new information powers will apply to all current as well as future investigations into potential enablers.
Interviewed by Halima Dikko.
The General Court of the European Union has today annulled the Commission’s decision regarding two Irish tax rulings in favour of Apple. The Commission had considered that the two rulings constituted State Aid, granting Apple €13bn in unlawful tax advantages.
The annulment of the Commission’s decision was on the basis that the Commission had failed to meet the requisite standard of proof. In that regard the outcome is similar to the Court’s rejection of other state aid decisions.
While accepting the Commission’s argument that an OECD arm’s length test was an appropriate tool to assess profit allocation (notwithstanding the absence of such a test in the national law at the time) the Court has concluded that the Commission has failed to prove that profits should have been allocated to the Irish branches. The Commission also failed to show that the tax rulings in dispute were methodologically unsound or the application of discretion.
The Commission will have the ability to appeal this decision to the Court of Justice however, the nature of these findings may make appeal on some of the issues difficult.
The decision is very helpful to those taxpayers in the UK who are affected by the Commission’s decision to regard the partial and full exemption of non-trading financing profits as state aid. The nature of this ruling, consistent with other similar outcomes annulling state aid decisions in the Belgian Excess Profits and Starbucks cases, challenges the Commission’s approach to the UK provisions which assumes that those provisions produce an advantage generally to all taxpayers benefiting from them. Rather, the Court has now consistently required the Commission to prove an advantage in specific cases. The “one-size-fits-all” approach to state aid appears, at the level of the General Court at least, to be precarious.
For those interested in the UK financing profits state aid case, a virtual seminar is being arranged to discuss recent developments and issues which have arisen from HMRC’s collection activities. Please contact Michael Anderson if you would like to attend.
The Finance Bill 2020 contains relatively few inheritance tax changes. However, clauses 72 and 73 introduce some important amendments to the excluded property provisions governing settlements and, in particular, to IHTA 1984 s 48(3) and ss 80–82.
Background
Generally, non-UK assets held in a trust established by a foreign domiciled settlor qualify as excluded property. Excluded property is not ignored for all IHT purposes but importantly it is not subject to the relevant property regime nor charged under the reservation of benefit rules. Nor is the foreign domiciled settlor liable to an entry charge when settling such property into trust. The foreign settled property remains free of inheritance tax charges even if the settlor later becomes domiciled or deemed domiciled in the UK (IHTA 1984 s 48(3)).
When determining whether the trust holds non-UK assets, one looks at the situs of the property held by the trustees directly, not the property held in underlying holding companies. This means it is relatively easy to ‘resite’ UK property such as shares and art by holding it in trust in a foreign incorporated holding company. This process is sometimes called ‘enveloping’.
It is no longer possible to envelope UK residential property; such ‘Sch A1’ property is no longer excluded property. Furthermore, if the settlor was foreign domiciled when he settled the trust but had a UK domicile of origin, was born here and later becomes UK resident, the trust can lose its excluded property status going forward while the settlor remains UK resident. These exceptions are not discussed further here.
Note that the domicile of any beneficiary, even the life tenant, with one exception, is generally irrelevant for IHT purposes, as is the residence of the trustees. The only thing that matters is the domicile of the settlor at the time the ‘settlement was made’.
Example 1: Mr X is foreign domiciled and on his death leaves foreign assets into an interest in possession trust for his wife, Mrs X. Mrs X dies domiciled in the UK. The settled property is still free of inheritance tax on her death, provided the settled property at that time is foreign situated (and is not Sch A1 property). However, note that if the trust does not end then but the property continues to be held in trust, it will not be excluded property going forward but fall within the relevant property regime. This is because for the purposes of the relevant property regime Mrs X’s domicile is retested at the time her IIP ends (see IHTA 1984 s 80 and s 82).
Example 2: Conversely, assume that Mr and Mrs X are deemed domiciled. On Mr X’s death, he leaves his estate to his spouse, Mrs X, on a qualifying interest in possession trust. There is no tax on his death because the transfer qualifies for spouse exemption. However, Mrs X dies many years later having lost her deemed domicile because she returned to her country of origin. Although she is foreign domiciled at the date of death, IHT arises on her death because the property was settled by a settlor who was UK domiciled. If the trust continues it will be relevant property (see IHTA 1984 ss 48, 82). The one exception would be if Mrs X died non-UK resident and at that time the trust held certain qualifying UK government gilts, but that would not depend on her domicile.
Example 2A: Assume that Mr and Mrs X are both foreign domiciled. In 2005 he gives property on qualifying interest in possession trusts for his spouse. Then she dies foreign domiciled at which point the property is held on discretionary trusts. By then Mr X (but not Mrs X) is deemed domiciled. There is no tax on her death as all the property was settled when Mr X was foreign domiciled. However, going forward although the requirements of both s 80 and s 82 are satisfied, IHTA 1984 new s 81B will soon impose an additional requirement once the Finance Bill 2020 is enacted. Mr X’s domicile will also have to be retested at the date Mrs X’s IIP ends and if he is UK domiciled the property becomes relevant property (albeit it would appear that it is still excluded property for the purposes of reservation of benefit as s 81B only applies for the purposes of the relevant property regime.) In practice this must be relatively rare as in most cases by the time Mrs X’s IIP has ended Mr X will be dead anyway in which case his domicile will be irrelevant.
The problems
A longstanding argument with HMRC relates to:
Additions to trusts
Section 48(3) simply tests the settlor’s domicile at the time the settlement is made. Read literally, this means that property added by the settlor to a settlement made when he was foreign domiciled will always be excluded property irrespective of his domicile. HMRC’s view was that, in relation to any particular asset, ‘a settlement was made’ when that asset was transferred to the trustees to be held on the declared trusts. HMRC’s Inheritance Tax Manual (at IHTM27220) notes:
‘[T]he legislation refers to the settlor’s domicile at the time the settlement was made. You must proceed on the basis that, for any given item of property held in a settlement, the settlement was made when that property was put in the settlement… S, when domiciled abroad, creates a settlement of Spanish realty. Later he acquires a UK domicile and then adds some Australian property to the settlement. The Spanish property is excluded property because of S’s overseas domicile when he settled that property. However, the Australian property is not excluded property as S had a UK domicile when he added that property to the settlement.’
In effect, HMRC considered that every addition to an existing settlement constituted the making of a new settlement in relation to that property. The example above makes it clear that adding property to an existing settlement which is excluded did not, in HMRC’s view, jeopardise the exemption from inheritance tax for the original property, provided that it was kept segregated. It merely meant that the new property did not qualify for protection.
In Revenue Interpretation RI 166, HMRC said: ‘If assets added at different times have become mixed, any dealings with the settled fund after the addition may also need to be considered.’ Most commentators doubted that this view was correct. It is true that property becomes comprised in the settlement at the time when it is added, but this is different from saying that a new settlement is ‘made’ when the settlor adds the property. As a matter of trust law, there are not two separate settlements and there is no deeming provision in the IHT legislation to treat additions as separate settlements.
HMRC justified its view on the basis of the definitions of settled property and settlement in IHTA 1984 s 43. It considered that each gift to a settlement was a disposition and that each disposition represented a new and separate settlement. However, this view did not easily fit with the wording either in s 43(2), which itself defined settlement as meaning any disposition or dispositions of property; or in s 44(2), which provides for separate settlements where two settlors add property to the same settlement. Such a section would be largely unnecessary if every disposition of property was treated as a separate trust. The case of Rysaffe Trustee Co v IRC [2003] STC 536 was also unhelpful for HMRC.
Transfers between trusts
Example 3: Assume that trustees of Trust 1 transfer property from Trust 1 (made when the Mr X was foreign domiciled) to a new Trust 2 (made when Mr X was UK domiciled). Does the requirement that the settlor is not domiciled at the time ‘the settlement was made’ focus on the settlor’s domicile at the time Trust 1 is created or on the domicile of the settlor when Trust 2 is created?
In these circumstances, not only s 48(3) but also ss 81 and 82 are in point. Section 81 provides that when property passes from one settlement to another, it is treated for the purposes of the relevant property regime as remaining comprised in the first settlement. Section 82 provides that the property transferred to Trust 2 is not thereafter excluded property for the purposes of the relevant property regime unless the settlor of Trust 2 was neither domiciled nor deemed domiciled in the UK when Trust 2 was made. In this example, Trust 2 would not hold excluded property even under the old rules. The transfer to Trust 2 has lost that favoured treatment.
Example 4: More complicated scenarios often arise. For example, the trustees may transfer property from Trust 1 to Trust 2. Both trusts might have been made when the settlor was foreign domiciled but the transfer actually takes place when he is UK domiciled. In these circumstances, is the property transferred excluded property? HMRC accepted that where both trusts were settled when the settlor was foreign domiciled and the transfer was made by the trustees when the settlor was deemed domiciled, it nevertheless remains excluded property for all purposes.
The Barclays Wealth case
These points were considered in Barclays Wealth v HMRC [2015] EWHC 2878 (Ch) and [2017] EWCA Civ 1512. The facts were as follows. In 2001, Michael Dreelan settled property, including company shares, into a trust when he was not deemed domiciled in the UK. In 2008, when deemed domiciled here, the shares were appointed to a new trust that he had set up after he was deemed domiciled here (effectively example 3 above). The shares or sale proceeds were deemed to remain in the 2001 trust for the purpose of the relevant property regime by virtue of s 81 (and so the ten year anniversary of Trust 1 operated) but were not excluded property, as that would have required the second trust to have been made by a non-domiciled settlor.
Subsequently just before the ten-year anniversary of the first trust in 2011, the cash was appointed back from the second trust to the first trust. The question was whether the cash had become excluded property. HMRC argued that the cash had lost its status as excluded property once appointed to the second settlement, as this transfer was made when Dreelan was UK domiciled and was therefore caught by s 82; and that the cash could not regain excluded property status when appointed back to the first trust. The taxpayer argued that since the first settlement was ‘made’ when he was not domiciled in the UK, subsequent additions of property, including appointments back of the original cash, were irrelevant; and the cash could thereby reacquire its excluded property status. In a sense then, the case raised both problems outlined above.
The High Court found in favour of HMRC and determined that the word ‘settlement’ is capable of describing both the making of the original settlement and the subsequent addition of property to that settlement. It is not merely referring to the ‘trust structure’. The result of this was that if, at the time of any subsequent addition to an existing settlement, the settlor was domiciled in the UK, the property added is not ‘excluded property’, despite the settlor being non-domiciled at the time the settlement was set up.
However, the judgment was reversed by the Court of Appeal at [2017] EWCA Civ 1512. The taxpayer argued that:
HMRC argued that a new trust had been made when the trustees of Trust 2 transferred the sale proceeds back to Trust 1 in 2011; i.e. a separate settlement is created for inheritance tax purposes whenever a settlor (or trustee) adds property to an existing trust. As Mr Dreelan was then deemed domiciled in the UK, HMRC’s view was that the sale proceeds were not excluded property and were therefore subject to the anniversary charge.
The leading Court of Appeal judgment was given by Henderson LJ. First, he held that once the 2011 appointment moving the cash back from Trust 2 to Trust 1 had been made, the deeming effect of s 81 was spent and it was no longer property to which s 81 applied for the purposes of s 82. There was no need to deem the cash derived from the sale of the shares to be comprised in Trust 1 since that was now the reality. Hence, the issue of whether the cash was then excluded property depended on s 48(3), and particularly on the answer to the question of when the settlement was made [para 45].
Here, Henderson LJ held that it was implausible to suppose that in s 48(3) the same word ‘settlement’ was intended by Parliament to have two different meanings. A settlement is a single settlement, as it is constituted from time to time even if a number of transfers are made into the settlement. The settlement is made when the settlor first executes the trust document and provides the initial trust property and it is at that point only that his domicile is tested. As the cash was deemed to have remained throughout in Trust 1, it could not be treated as the subject of a separate disposition into Trust 1 at the same time. There was nothing surprising in the conclusion that the cash was excluded property.
Example 5: Christina is foreign domiciled when she sets up and funds trust 1 with foreign cash. Some years later when deemed domiciled here, she adds £1m to the trust. This is an immediately chargeable transfer and 20% inheritance tax is due. However, going forward the £1m may be excluded property and not subject to exit and ten year anniversary charges, although this point was left open by the Court of Appeal.
The proposed legislation
HMRC quickly announced that it intended to legislate to reverse the effect of Barclays Wealth. The draft legislation was published on 11 July 2019 and has been slightly modified in the republication in Finance Bill 2020. It is not easy to follow. The proposed revisions are as follows:
1. Additions
Where property is added to an existing settlement, the domicile of the settlor will be considered for the purposes of the excluded property rules at the time of the addition, rather than at the time the settlement was first created. Even if property was added to an excluded property trust before Finance Act 2020 comes into effect, it will not be protected from future inheritance tax charges arising after that date (including on the settlor’s death) if the settlor was domiciled in the UK at the date of addition.
The proposed draft legislation at clause 72 amends s 48 so that instead of referring to when a settlement is made, it tests the settlor’s domicile by reference to when property ‘becomes comprised’ in an existing settlement. Loss of excluded property status only affects the added property, not the property originally settled when the settlor was foreign domiciled. However, the change raises some serious issues if the settlor remains a beneficiary at the date of his death, as the added property is no longer excluded property.
Example 6: Sharma set up a discretionary trust when foreign domiciled in 2009, settling £10m into it. In 2015, when deemed domiciled for IHT purposes, Sharma added some business property to it (thus avoiding an entry charge). In 2019, there is no ten year charge as all the property is excluded; additions are not counted. Post-2020 (in 2029), there will be a ten year anniversary charge on the value of the business property (subject to the availability of any BPR), as this will no longer be treated as excluded property for the purpose of the relevant property regime. In addition, there is a potential reservation of benefit on Sharma’s death in relation to the addition if Sharma can still benefit from the settled property as it is no longer excluded property.
2. Transfers between trusts
Clause 73 provides that where property is transferred from one trust to another or from Trust 2 back to Trust 1 after FA 2020 is enacted, the settlor must be foreign domiciled at the time of each transfer, not just when each settlement was first made for the settled property to remain excluded property. If the settlor has died deemed or actually domiciled and the transfer takes place later (not on his death) then that transfer will not lose excluded property status. Hence, on that basis, in both examples 3 and 4 the settled property in Trust 2 will no longer be excluded property.
It is hard to know why HMRC would object to example 4 as no new property has come into the excluded property regime at a time when the settlor is UK domiciled. Of course, since April 2017 transfers between settlements can no longer be made anyway if a settlor is deemed domiciled and UK resident, as the recipient trust would lose protected trust status for income tax and CGT purposes by being tainted.
If the settlor has died deemed or actually domiciled but the transfer to Trust 2 takes place sometime after his death, then that transfer will not lose excluded property status if Trust 1 was an excluded property settlement. However, until then trustees have very little flexibility after a settlor has become domiciled or deemed domiciled to make transfers between trusts.
More worryingly, problems now arise if Trust 1 and Trust 2 were set up when the settlor was foreign domiciled but he was deemed domiciled at the time the transfer was made and the transfer was done many years ago before FA 2020 was enacted. In that event, the assets transferred will not be subject to relevant property charges, but if the settlor is a beneficiary of the transferee trust the assets transferred will be included in his estate on death meaning the excluded property rules no longer trump the reservation of benefit rules after Finance Act 2020.
Example 7: Kingsley set up two trusts when he was foreign domiciled with £1m in each. In 2016, when he was deemed domiciled for IHT purposes, the trustees transferred all the property from Trust 1 to Trust 2 and ended Trust 1. Trust 2 now holds all the property.
There are no relevant property charges going forward if no UK situated property is held by the trustees at that time, as the transfer was done prior to FA 2020 and both trusts were actually funded when the settlor was foreign domiciled. The property in Trust 2 remains excluded property for the purposes of the relevant property regime and no ten year charges should arise.
However, the addition to Trust 2 is no longer excluded property for reservation of benefit purposes, as property has become comprised in a trust at a time when Kingsley was deemed domiciled. Section 48(3) no longer protects the property in Trust 2. If Kingsley is a beneficiary of Trust 2, then there is IHT payable on his death at 40%. Kingsley should be excluded – ideally before FA 2020 receives royal assent to prevent a seven year run off. Otherwise he is deemed to make a PET under FA 1986 s 102(4).
Accumulations of income
There has been a welcome change to the provisions on accumulated income since the 2019 draft. On the basis that accumulated income ‘becomes comprised’ in the settlement when it is accumulated, a change in the domicile status of the settlor from non-UK domiciled to UK domiciled between the date of the settlement and the date when income is accumulated would result in such accumulations becoming relevant property comprised in the settlement at the time when the settlor was UK domiciled, even though arising out of excluded property. A new clause 72(2)(d) has been inserted, to become new IHTA 1984 s 48(3F), which ‘provides that accumulations of income are treated as having become comprised at the same time as the property (producing that income) became comprised in the settlement’. See also new IHTA 1984 ss 64(1BA) and 65(8BA). In effect, the legislation ensures that accumulations of income from property that was originally settled when the settlor was foreign domiciled remain excluded property.
Conclusions
As STEP commented in its recent submissions on these clauses: ‘Sections 80-82 are already complex and difficult to understand… [T]he proposed new legislation only adds to those uncertainties.’ The legislation on additions can be justified on the basis that this simply represents what HMRC always considered to be the case. Practitioners who ignored this advice did so knowingly. Transfers made between trusts where they were both funded when the settlor was foreign domiciled generally had no tax avoidance purpose and often fall within the facts of example 4 above, which HMRC previously confirmed gave rise to no IHT problems. It is particularly worrying, however, that such transfers could now end up losing excluded property status going forward for the purposes of the reservation of benefit rules. Such transfers will no longer qualify as excluded property for the purposes of the reservation of benefit rules, as in effect property has been ‘added’ when the settlor was deemed domiciled. This seems most unfair for those trustees who relied in good faith on HMRC practice and assurances (and indeed the view was sound in law as confirmed in the Court of Appeal Barclays Wealth judgment). Trustees will now need to look carefully at all inter trust transfers and additions and the status of the settlor at the date of each transfer.
No changes were made in committee to these clauses. The sensible approach would be to deal with additions of value but ensure that transfers between settlements funded where the settlor was foreign domiciled remains excluded property for all IHT purposes, not just for the purposes of the relevant property regime. However, it seems too late to achieve this objective now. The best option may be to obtain clear Revenue guidance.
HMRC’s Trusts and Registration Service (TRS) was born back in 2017 as part of the implementation of 4MLD[1]. 5MLD[2] has mandated notable amendments to the operation of the TRS that clients and practitioners should not overlook. We have created a Q&A to help to navigate the new upcoming compliance obligations.
Does my trust need to register under 4MLD?
Yes- if it is a relevant taxable trust. This means a trust with a UK tax consequence i.e. the trust has a liability to pay UK income tax, CGT IHT or SDLT. There is no deminimus threshold. Registration deadlines are tied to when a tax liability is crystallised which itself depends on the type of tax liability payable.
Under 4MLD it is possible for non-UK resident trusts to fall in and out of TRS depending on when they have a UK tax liability e.g. a liability arises only on the occasion of a 10-year charge.
What about a trust with an IHT liability due to enveloped property?
4MLD did not extend to ATED. Assuming the property was held at company rather than trust level and the company was not a mere nominee then there would be no TRS obligation despite the Schedule 10 F(no2)A 2017 IHT look through.
So, what has changed in light of 5MLD?
5MLD has removed the tax consequence requirement and now all UK resident express trusts and some non-EU resident trusts must register irrespective of whether they have incurred a tax liability.
A non-EU trust must register with the TRS where the trust either acquires land in the UK after 10 March 2020 or after this date enters into a business relationship with a UK-based entity which is subject to AML rules. It is irrelevant where the trust itself is resident.
What does business relationship mean?
One off advice from a UK accountant or law firm is not covered but if it is advice given to the trust over some period then the trust will have to register – this aspect of the rules is controversial and not yet finally accepted particularly by those who are worried it will deter clients seeking UK tax advice. If you’ve already got an ongoing legal relationship with the UK firm prior to March 2020 then you don’t need to register just because of this existing business relationship.
What about if the business relationship is with the underlying company?
The business relationship should have an element of duration between the relevant person and the trust itself.
Is the register public? If so who has access?
It is important to appreciate that under 5MLD, individuals who have a legitimate interest in information concerning the beneficial ownership of the trust can apply to access certain information. This is potentially quite alarming for those who value their privacy. Someone asserting that they have a legitimate interest will have to provide information to substantiate that interest, such as why the applicant suspects that the trust has been used for money laundering.
If you have already registered does this mean you are exempt from legitimate interest requests?
This remains unclear at the date of writing.
What about a Foundation?
The obligations imposed on trustees should be assumed to apply to the managers of a Foundation which for English law purposes would generally be characterised as a trust.
Can you register voluntarily?
The prospect of highly sensitive information regarding key individuals being delivered to HMRC and potentially being available to interested parties perhaps including investigative journalists albeit in strictly controlled circumstances will make few want to register unless obliged to do so.
What’s the timing on all of this?
The deadline for registering all pre-10 March 2020 trusts is 10 March 2022 and new trusts created after 10 March 2020 have 30 days to register. Any changes to the beneficial owners of the trust must be reported within 30 days. The 30 days deadline may prove to be quite a challenge for many trustees and will certainly be problematic for trusts created on death as it can take time for assets to vest.
What information needs to be registered?
When registering, the following information will be required:
For UK resident individuals name, date of birth and NI number is required. For non-UK resident individuals name, address and passport/ID number must be provided.
Trustees are required to make an annual declaration that the details on the register are correct. Information provided will be retained on the register for 6-10 years after the trust is terminated.
Is the above different from existing information already held/ required under 4MLD?
Where a trust is already registered for TRS under 4MLD, some additional information will need to be provided in order to fulfil the requirements of the new 5MLD (including whether or not a trust holds a controlling interest in a third party entity).
Are all trusts included?
5MLD covers express trusts. An express trust is one established deliberately by a settlor. Therefore, excluded from scope are: statutory trusts, resulting trusts and constructive trusts. Unit trusts are also considered to be outside the scope of the definition of express trust.
UK registered pension schemes, UK charitable trusts are excluded as are trusts consisting solely of an insurance policy, such as a life insurance policy, which is a pure protection policy and payment is not made until the death or terminal illness of the insured. More detailed discussion of these exclusions should be considered if necessary.
Trusts established to meet legislative conditions such as PI trusts, trusts for the vulnerable, share option schemes, co-ownership trusts are also excluded.
What about nominee arrangements?
Bare trusts are expected to be excluded but HMRC clarification on this is still pending.
What happens if I don’t register?
Initial failure to register will be met with a nudge letter and there will be no financial penalty for a first offence of failure to update details but thereafter there will be a penalty of £100 per offence. Deliberate failure to register on time or update the register will carry significant penalties.
What if my trust is registered in another jurisdiction?
Some trusts will end up with registration obligations in multiple jurisdictions but if the trust is already registered in another EU member state then it does not need to also be registered in the UK under 5MLD.
[1] The Money Laundering, Terrorist Financing and Transfer of Funds (Information on the Payer) Regulations 2017 (SI 2017/692) (MLR 2017) came into force on 26 June 2017 to implement the Fourth Money Laundering Directive ((EU) 2015/849)
[2] Directive (EU) 2018/843 of the European Parliament and of the Council of 30 May 2018 amending Directive (EU) 2015/849 on the prevention of the use of the financial system for the purposes of money laundering or terrorist financing, and amending Directives 2009/138/EC and 2013/36/EU
As the dust settles on changes to the non-domiciled regime and, moreover, changes to the way in which UK tax will dictate how non-UK-resident or non-UK-domiciled individuals hold UK property, is the UK, and London in particular, still as desirable a place to own a Mayfair pied-à-terre?
Tax on purchase
In the 2020 budget, Chancellor of the Exchequer Rishi Sunak announced plans for a 2 per cent stamp duty land tax (SDLT) surcharge for non-UK resident purchasers of UK residential property, in another attempt to discourage global high-net-worth individuals from using the UK property market as a financial instrument with huge returns and low risks. The surcharge will take effect from 1 April 2021. Taxpayers ought to be made aware that this prompts a test of residency at the point of purchase. It remains to be seen how these new rules will transpose into statute.
Tax on disposal
From April 2019, the disposal of any UK property (residential or commercial) held by a non-UK resident (individual or corporate) is within the scope of UK non-resident capital gains tax or corporation tax on chargeable gains where the disposal is by a non-UK-resident company.
More significantly, disposals of interests in companies whose value derives from an interest in UK land may also be chargeable to UK tax. The legislation refers to direct and indirect disposals, the former referring to an actual disposal of UK land and the latter giving rise to a tax charge where the asset actually disposed of is not UK land but rather shares in a company that holds UK land. No longer is the principle that companies are not transparent for UK tax purposes strictly observed.
Schedule 1 to the Finance Act 2019 (the Act) effectively rewrites part 1 of the Taxation of Chargeable Gains Act 1992, and applies where a non-UK resident holds an interest of 25 per cent or more in what is termed a property rich entity, or has done so at some point in the previous two years, ending with the date of the disposal. An entity is considered property-rich if, at the time of a disposal, 75 per cent or more of the value of the asset disposed of derives directly or indirectly from UK commercial or residential land. The 75 per cent test looks at the gross asset market value of the entity at the time of the disposal without any deduction for loans. A disposal might be of the interest in the entity directly, or it may be a disposal of a holding company or an interest in a trust or structure that, when looked at together, meets the property-rich test.
Note the potential for the same economic gain to be taxed twice if a non-resident shareholder disposes of their shares and the company then disposes of the property that is taxable on the company.
Inheritance tax
When considering inheritance tax (IHT) exposure, there remains a difference in treatment depending on whether the property is residential or commercial. Irrespective of whether it is commercially let, residential property held via a non-UK company whose shares are not UK-situs assets, and so were once considered to be excluded property for IHT purposes and outside the scope of IHT, are now within the IHT net, according to sch.A1 of the Inheritance Tax Act 1984 (the 1984 Act). The 15 per cent SDLT rate introduced in 2012 for the purchase of enveloped dwellings and the 2013 introduction of the annual tax on enveloped dwellings clearly did not do enough to discourage this common
tax structuring technique used by non-UK-domiciled individuals. It is important to note that IHT mitigation through the use of a non-UK company when it comes to purchasing and holding commercial property is still possible.
Going forward
The changes brought in by the Act are a clear step to try to align the tax treatment of UK residential and commercial property and a further move to eliminate tax advantages available by using corporate structures. Perhaps the next step will be to extend sch.A1 to the 1984 Act to cover commercial property as well. As the changes have been piecemeal, the legislation in this area remains disparate and complex, and great care is required.
EU Directive 2018/822 of 25 May 2018 (mandatory automatic exchange of information in the field of taxation in relation to reportable cross-border arrangements) amends for the sixth time Directive 2011/16/EU on administrative cooperation in the field of taxation (“DAC 6”) and requires the disclosure of information relating to certain cross-border arrangements (“CBA”).
The main objective of DAC 6 is to strengthen tax transparency and prevent what are considered to be harmful tax practices through the automatic exchange of information between the EU Member States on potentially aggressive tax planning. The UK Regulations will require any CBA involving two countries, where at least one is an EU Member State (considered to include the UK) to be reported where it meets certain criteria (referred to as the “Hallmarks”) that could indicate aggressive tax planning – these are known as a reportable CBA, or “RCBA”. The obligation to disclose such an arrangement will be on an intermediary involved in the arrangement. Although classed as intermediaries, lawyers will usually be exempt from submitting a report due to legal professional privilege.
On 8 May 2020, in response to the global pandemic, the European Commission published a proposal to delay disclosure deadlines imposed by DAC6 by three months but it should be noted that the proposal only defers the reporting deadlines, the beginning of the application of DAC 6 remains 1 July 2020. Professional advisers will need to be alert to DAC6 and clients will notice amended terms of engagement and a new focus from the outset on these new compliance obligations as penalties for non-compliance can be up to £1 million in serious cases.
Key Points
What’s the issue?
An ever increasing deluge of ink on the statute books is dedicated to quashing any perceived tax avoidance before it even sees the light of day. Over time, legislation has also been drafted to increase HMRC’s powers and attempt to streamline the process of tax collection.
What can I take away?
The legislation and case law are unambiguous, and it is commendable that in practice we have come such a long way towards closing the loopholes in tax law. But in analysing the rafts of new legislation, one must question whether it has all been necessary.
What does it mean to me?
There has been a seismic shift in the field of tax avoidance. Government resources now ought properly to be directed at policing and enforcement.
An ever increasing deluge of ink on the statute books is dedicated to quashing any perceived tax avoidance before it even sees the light of day.
The introduction of the DOTAS rules in Finance Act 2004, under which a scheme promoter or user is required to disclose the main elements of any avoidance scheme to HMRC, was groundbreaking.
The government consultation ‘Raising the stakes on tax avoidance’ was published in August 2014, setting a clear pathway. In February 2016, the criteria for the DOTAS rules were broadened substantially. The legislation in Finance Act 2014 and 2015 complemented DOTAS in relation to tackling any promoters of tax avoidance schemes with the ability for HMRC to monitor promoters and issue conduct notices. The introduction of the GAAR from July 2013 to invalidate any abuse also sent a very clear message.
Sir Amyas Morse published his independent review of the controversial loan charge on 20 December 2019. Part of his remit was to consider whether the original 2016 policy was both necessary and proportionate. His report expressed deep concern that since the new legislation was introduced, there have been well over 20,000 new loan charge schemes, 8,000 of which have emerged since the start of the 2019/20 tax year. Sir Amyas concluded that the loan charge was a necessary piece of legislation, although he did not accept it was proportionate for it to go back for 20 years. He had a specific recommendation for promoters:
‘The government must improve the market in tax advice and tackle the people who continue to promote the use of loan schemes, including by clarifying how taxpayers can challenge promoters and advisers that may be mis-selling loan schemes. The government should publish a new strategy within six months, addressing how the government will establish a more effective system of oversight, which may include formal regulation, for tax advisers.’
Over time, legislation has also been drafted to increase HMRC’s powers and attempt to streamline the process of tax collection. Finance Act 2014 introduced follower notices (FNs) and accelerated payment notices (APNs) which essentially require a taxpayer to remove any tax advantage claimed and for any tax in dispute to sit with the Exchequer whilst a resolution is found. With only three months to act, the consequences of receiving a notice are very serious. Penalties for non-compliance are hefty and can easily amount to up to 50% of the value of the denied tax advantage.
More recently with a shift towards global tax transparency, cross border exchange of information and the Common Reporting Standard, the focus moved to offshore evasion.
Finance Act (No2) 2017 introduced the Requirement to Correct, requiring taxpayers with overseas assets to regularise their historic UK tax position. Non-compliance after 30 September 2018 triggers severe penalties of up to 200% of the potential lost revenue and potential naming and shaming. The legislation has become very robust and the penalties for non-compliance send a clear message.
Evolving precedent
In the past few years, we have also seen numerous cases occupying court and tribunal time to ensure that any perceived or actual abuse of the tax rules is simply no longer conceivable.
Elaborate or circular schemes, complete with a ‘pre-ordained series of transactions into which there are inserted steps that have no commercial purpose except the avoidance of a liability to tax’ (IRC v Burmah Oil Co Ltd 1982 STC 30) will not be tolerated; and anyone party to or promoting such arrangements will be punished harshly and rightly so. In many circumstances (notably in relation to FA 2003 s 75A), a tax avoidance motive is not even necessary to be deemed to have suppressed a scheme, as the Supreme Court set out in Project Blue Limited v HMRC [2018] UKSC 30.
It is abundantly clear (from WT Ramsay Ltd v IRC [1982] AC 300, UBS AG v HMRC [2016] UKSC 13 and Hancock and another v HMRC [2019] UKSC 24, to name but a few) that when it comes to analysing any potential exploitation of the legislation, there can no longer be a blinkered approach to the facts.
It is well established that the ‘ultimate question is whether the relevant statutory provisions, construed purposively, were intended to apply to the transaction, viewed realistically’ (Collector of Stamp Revenue v Arrowtown Assets Ltd [2003] HKCFA 46).
The view from the profession
The legislation and case law are unambiguous, and it is commendable that in practice we have come a long way since the days of dubious tax professionals marketing and implementing schemes to exploit loopholes in tax law against what must have been Parliamentary intent. Credit must be given to the 2017 edition of ‘Professional conduct in relation to taxation’ for ensuring that the tax profession takes the lead in upholding high ethical standards in relation to any potential facilitation of tax avoidance.
In analysing the rafts of new legislation, one must question whether it has all been necessary. Arguably yes, but could Taxes Management Act 1970 s 55 (recovery of tax not postponed) have been used instead of the hundreds of pages of new statue introducing complex rules regarding FNs and APNs? And take Finance Act 2019 Sch 4 in relation to profit fragmentation arrangements.
The legislation is designed to counter avoidance where UK traders and professionals arrange for their UK-taxable business profits to accrue to entities resident in territories where significantly lower tax is paid than in the UK. Does this not smack of the transfer of assets abroad rules with a hint of the transfer pricing and controlled foreign company rules thrown in?
Did we need Finance Act (No.2) 2017 Sch 16 in relation to enablers? Will the additional legislation really influence and promote behavioural change beyond which has already been achieved? Or did we need FA 2007 Sch 24 paras 3A and 3B, introducing a presumption of carelessness in avoidance cases and the concept of guilty until proven innocent?
Legislation that will never need to be employed is not helpful. Many commentators have questioned the potential superfluous nature of the GAAR sitting alongside the many TAARs. In the first GAAR ruling, the panel decided that a complex employee benefits trust scheme involving payment in gold bullion or platinum sponge was not a reasonable course of action. Even the most optimistic taxpayer having read the Rangers case (RFC 2012 Plc (in liquidation) v AG for Scotland [2017] UKSC 45) would have struggled to see how HMRC could possibly have lost the legal argument at tribunal so was a GAAR referral necessary? The vast majority of GAAR referrals have centred around employment taxes, and more specifically marketed schemes, so the role of the GAAR panel is significant in that the opinions will be of useful broader application.
The GAAR Advisory Panel opinion of 7 August 2019 is potentially of wider interest. The specific issue concerned the extraction of value from a company by its directors and shareholders through the use of employee shareholder shares. The opinion recorded that the use of employee shareholder shares by existing shareholders was reasonable in the context of the legislation and additionally that a reorganisation of activities to ensure the legislative requirements were met was also reasonable. However, the specific terms of the shares used meant that value flowed out of existing taxable shares into new exempt shares, which was not considered reasonable. The panel gives credence to its role in plugging a gap where the legislative draftsman had not considered or anticipated the potential value shift. The opinion expressed the view that it was never the intention of Parliament for the law to be applied in the given manner. As a concept this works, as the GAAR is primary legislation; perhaps, though, one could rightly be concerned that it may make the draftsman less fastidious if he knows that he has a safety net in the GAAR panel. This will not aid our quest to make the legislation clear, unambiguous and all encompassing.
Direction of travel
We must acknowledge that there has been a seismic shift in the field of tax avoidance. Even simple structuring advice to clients is starting to require contingent counterarguments if anything is ever challenged. So, what next? Government resources now ought properly to be directed at policing and enforcement.
What we need now is to be sensible and we need fiscal honesty. When we analyse the tax gap figures, in 2019 the tax gap is estimated to be £35 million or 5.6% of tax liabilities. 37% of this is from income tax, NICs and capital gains tax. The biggest offenders are small businesses, which account for 40% of liabilities; individuals account for only 11%. Failure to take care and legal interpretation accounts for 18% of the gap, and evasion for 15%, while avoidance is a reassuring 5% (£1.8 billion). Non-payment is 11%. We need to focus on restoring public faith and be assured that the door has been closed on tax avoidance behaviours via legislation, judicial view and professional practices.
Tax receipts were down by £26 billion in April as the UK’s economy was hit by the coronavirus crisis. HMRC figures show that the April tax take was £35 billion which is £26 billion (42%) less than the £61 billion received in April last year.
HMRC has it seems now quietly resumed taxpayer investigations which had been put on hold at the peak of the pandemic and have started to contact taxpayers and advisers again where there is any suspicion of non-compliant activity.
Taxpayers previously under inquiry who had a brief period of respite should now prepare for investigations to resume with aplomb and perhaps with added vigour as HMRC have a close eye on the £337billion hole in the public purse.
IHT cases can be a little like buses: there are none at all for some years, and then two come along in swift succession. Two important cases clarifying the scope of the reservation of benefit (ROB) provisions were recently heard by the Court of Appeal: Buzzoni and others v HMRC ; In re the Estate of Kamhi, decd (Buzzoni) [2013] EWCA Civ 1684 and Viscount Hood (Executor of the Estate of Lady Diana Hood) v HMRC (Lady Hood) [2018] EWCA Civ 2405. Both consider the ROB legislation, although the Court of Appeal reached different conclusions in each case. The case law generally illustrates the difficulty of applying the ROB provisions to practical situations.
In the home loan ‘test’ case of Shelford (Executors of J Herbert) v HMRC [2020] UKFTT 53 (TC), it was hoped that further light would be shed on the ROB provisions and, in particular, on the associated operations provisions and whether a sale to a qualifying interest in possession trust for a settlor is a gift at all. However, in the event, the judge did not consider the ROB legislation at all and found against the taxpayer on other grounds.
What are the ROB provisions attempting to do?
Under capital transfer tax, there were no anti-avoidance provisions stopping people giving away their property and continuing to benefit from it. As they were taxed at the point when they made the lifetime gift it was not necessary. On the introduction of the potentially exempt transfer (PET) concept in 1986 it became possible to make a tax-free lifetime gift and to retain the use of/benefit in the gifted property.
This led to the introduction of gift with reservation (GWR) legislation (lifted from estate duty). The objective was to stop people making gifts and still benefiting from the property, i.e. ‘have your cake and eating it’ arrangements.
The key provision is FA 1986 s 102(1), which is as follows:
‘(1) … this section applies where, on or after 28th March 1986, an individual disposes of any property by way of gift and either—
‘(a) possession and enjoyment of the property is not bona fide assumed by the donee at or before the beginning of the relevant period; or
‘(b) at any time in the relevant period the property is not enjoyed to the entire exclusion, or virtually to the entire exclusion, of the donor [limb 1] and of any benefit to him by contract or otherwise [limb 2];
‘and in this section ‘the relevant period’ means a period ending on the date of the donor’s death and beginning seven years before that date or, if it is later, on the date of the gift.’
The effect of a ROB
If there is any property subject to a ROB then that property is deemed for all IHT purposes as property to which the deceased donor is beneficially entitled immediately before his death (FA 1986 s 102(3)). If the reservation ends within seven years of the death, the donor is deemed to make a PET (FA 1986 s 102(4)).
The rule is intended to be penal in nature. Not only is the donor subject to IHT on death, there is no capital gains tax uplift. There is also, HMRC argues, no spouse exemption even if the reserved benefit property passes to the spouse/civil partner. The property remains part of the donee’s estate so can be taxed on that donee’s death. Moreover, if the gift is into a discretionary trust from which the donor can benefit, there are ten year and exit charges to pay as well as the 40% charge on death. No credit is given for one against the other.
Consider the following examples.
Example 1
Chris gives a picture worth £10,000 to his daughter Anna in 1987. Anna hangs the picture on her walls for 30 years, but then in 2017 she tells Chris he can have it back for a while and says she will just keep it on her insurance. Chris dies with the picture in his living room. It is discovered it is a long-lost Turner worth £1m at Chris’s death. Tax is due on the picture at 40% (assuming Chris has no available nil rate band). Although his free estate passes to his widow and is exempt from IHT, as the property is owned by Anna there is no possibility of spouse exemption. Liability for the IHT falls on Anna first but if she fails to pay it within 12 months then on Chris’ personal representatives (IHTA 1984 ss 204(9) and 200).
In order to pay the IHT, Anna sells the picture. She pays tax on the gain of £990,000. The shock kills her, and she dies leaving everything to her children. Further IHT is then payable on the picture (as quick succession relief is not relevant here).
Contrast this with the position where Chris did no planning. On his death, the picture would have passed to his wife tax free. She could then have given it away with no CGT payable and would just need to survive seven years (and avoid a ROB).
Generally, gifts between spouses are protected from ROB problems by FA 1986 s 102(5); however, gifts between cohabitees are not protected from ROB, even if they later marry.
Example 2
Harry gives his London flat to his boyfriend in 2004. In 2019, they marry and Harry continues to use the flat rent free. There is a ROB on his death that is not cured by the marriage. Harry should have retained a share in the London flat and taken advantage of FA 1986 s 102(B) discussed below.
Spouse/civil partner exemption
Transfers between spouses can cause problems under ROB where they have a different domicile. The following gifts are wholly exempt and therefore protected from ROB under FA 1986 s 102(5):
But the following gift is not protected.
Example 3
Imelda, a foreign domiciled wife is given some valuable shares by her husband Bill, a UK dom. That gift is not spouse exempt (assuming Imelda does not elect to be deemed domiciled under IHTA 1984 s 267ZA) except as to £325,000. If Imelda now settles the shares into an excluded property trust, assuming the shares are foreign situs she avoids an entry charge, but Bill must be excluded as a beneficiary and not receive any benefit otherwise there will be a ROB on his death.
Technical provisions
When working out the ROB position, it is worth going back to both the legislation and examining how the extensive case law is applied. FA 1986 s 102 is very similar to the estate duty provisions.
Section 102(1)(a) requires that possession and enjoyment of the gifted property is bona fide assumed by the donee. The main case here is Commissioner of Stamp Duties of New South Wales v Perpetual Trustee Co Ltd [1943] AC 425, where the donor settled shares to which he retained legal title as trustee for his son’s benefit for the trustees to apply during the son’s minority the whole or any part of the income or capital as the trustees thought fit for the son’s maintenance and advancement. Once the son turned 21, the trustee was to transfer the capital and all accumulations of income to him. No part of the dividends or income were paid to the son during his minority. The Revenue argued that possession and enjoyment had not been assumed by the donee. The Privy Council held that the donee was the recipient of the gift (whether the son alone was the donee or the son and the body of trustees). ‘The son was (through the medium of the trustees) immediately put in such bona fide beneficial possession and enjoyment of the property comprised in the gift as the nature of the gift and the circumstances permitted’. The retention of legal title by the settlor as trustee was irrelevant, and there was no ROB.
Section 102(1)(b) has two limbs:
that the gifted property is in fact enjoyed virtually to the entire exclusion of the donor (limb 1); and
that there is no benefit to the donor by contract or otherwise (limb 2).
Clearly, for both limbs, it is necessary to identify precisely the gifted property. As Lord Hoffmann put it in Ingram v IRC [1999] STC 37 (at 41): ‘The theme which runs through all the cases is that although the section does not allow a donor to have his cake and eat it, there is nothing to stop him carefully dividing up the cake, eating part and having the rest.’
Both limbs require the donor’s benefit or enjoyment to be referable to the gifted property not the retained property; this is the so-called ‘carve out’ concept (see also HMRC’s Inheritance Tax Manual at IHTM14333). Lord Hoffmann noted in Ingram: ‘If the benefits the donor continues to enjoy are by virtue of property which was never comprised in the gift, he has not reserved any benefit out of the property of which he disposed.’
Munro v Commissioners of Stamp Duty of New South Wales [1934] AC 61 is a good illustration of the referability point in relation to limb 1. The donor granted a partnership of which he was a member an informal tenancy to farm his land. The tenancy continued in favour of the partnership after the gift, so the donor did enjoy the land as partner (even though he may have received no benefit) but it was held there was no reservation as the gift was made subject to the rights of the partnership. His occupation was referable to property not included in the gift. This carve out principle has been a theme of much new and old case law. See, for example, St Aubyn v A-G [1952] AC 15 in relation to gifts of shares. In the more recent cases of Buzzoni [2013] EWCA Civ 1684 and Lady Hood [2018] EWCA Civ 2405, the sub-lease gifted to the donees was subject to covenants in favour of the donor. Although in the end it was held that limb 2 not limb 1 was in point, in both cases the Court of Appeal held that the rights conferred on the donor by the covenants given by the donee were obtained by virtue of the gifted property, and not by virtue of the reversion retained by the donor. Hence the ‘carve out’ argument failed.
Of course, FA 1986 ss 102A–102C (inserted by FA 1999) have significantly limited the applicability of the carve out principle in relation to land, but the concept is still relevant for gifts of other assets or in relation to terminations of qualifying interests in possession in settled property (s 102ZA). (These issues are not discussed further here.)
Limb 1 has a narrower focus than limb 2. It requires that the donor is ‘virtually’ excluded from any enjoyment of the gifted property. With one exception the fact that the donor may receive no actual benefit (e.g. because he pays full consideration) is immaterial. As was noted in Chick v Comms of Stamp Duties[1958] 2 All ER 623 ‘if [the donor] has not been so excluded [from the subject matter of the gift] the eye can look no further to see whether his non-exclusion has been advantageous or otherwise to the donee.’ Here the facts were similar to Munro above except that the partnership was entered into after rather than before the gift.
The one statutory exception that allows enjoyment provided there is no benefit relates to land and chattels. Actual occupation or enjoyment is disregarded if the chattel or land is enjoyed for full consideration in money or money’s worth (FA 1986 Sch 20 para 6(1)(a)). However, giving cash to an individual who then lends it back to the donor charging a commercial rate of interest would, in HMRC’s view, be caught by limb 1, even though there is no benefit (see IHTM14336).
For limb 2, benefit (not merely enjoyment) of the gifted property is required. Three points must be satisfied before a ROB arises under this limb.
First, the benefit to the donor must consist of some advantage which the donor did not enjoy before he made the gift. Millett LJ in Ingram v IRC [1997] STC 1234, 1268 in the Court of Appeal noted: ‘From these cases, I conclude that to come within the scope of the second limb ... the benefit must consist of some advantage which the donor did not enjoy before he made the gift.’ This was specifically endorsed by Moses LJ in Buzzoni (at para 51) and in Lady Hood (at para 63).
Second, the donor’s benefit must be by virtue of the property he has given away. That goes to the referability concept discussed above which applies equally to limb 1 and requires identification of the gifted property.
Third, there must be detriment to the donee. (Note that this requirement is irrelevant to limb 1; all that is required under that limb is for the donor to enjoy the property.)
Until Buzzoni, the detriment argument was doubted by many to be valid under the IHT legislation. However, in the Court of Appeal Moses LJ noted:
‘The second limb of section 102(1)(b) of the 1986 Act requires consideration of whether the donee’s enjoyment of the property gifted is to the exclusion of any benefit to the donor. The focus is not primarily on the question whether the donor has obtained a benefit from the gifted property but whether the donee’s enjoyment of that property remains exclusive. The statutory question is whether the donee enjoyed the property to the entire exclusion or virtually to the entire exclusion of any benefit to the donor. If the benefit to the donor does not have any impact on the donee’s enjoyment, in my view, then the donee’s enjoyment is to the entire exclusion of any benefit to the donor.’
In short, the fact that the donor enjoyed a new benefit as a result of the gift is a necessary condition of limb 2, but may not in all cases be a sufficient condition. In that case the donees had immediately before the gift already entered into covenants directly with the freeholder and therefore the presence of the covenants in the gifted property was not to their detriment – they were already bound by them. By contrast, Lady Hood failed because the covenants given to the donor by the donees were a new benefit conferred on her and were detrimental for the donees – they had not already entered into a sub-licence with the freeholder. Some may feel this is a distinction without a difference.
Current areas of difficulty with HMRC
For more than 30 years, HMRC has generally applied the ROB rules in a reasonable and pragmatic way. However, some areas of doubt remain.
One relates to the position where the settlor is not a beneficiary of a discretionary trust but could be added. In Eversden (exors of Greenstock dec’d) [2002] STC 1109, Lightman J agreed with the Special Commissioner that if the settlor was a discretionary beneficiary he was not entirely excluded from the settled property as he had a right to be considered as the potential recipient of benefit by the trustees even if the trustees do not actually benefit him. However, where the settlor is not a beneficiary but could be added, in the view of this author, arguably no ROB arises until such time as the settlor is added provided that as a matter of fact the trust fund is enjoyed to the settlor’s entire exclusion, and the settlor receives no actual benefit. The trustees are under no requirement to consider the settlor who is not a beneficiary. Therefore, neither limb in s 102(1)(b) is relevant. HMRC does not accept this view; although from its example at IHTM14393 (below), it seems difficult to see how Anthony is enjoying the gifted property if he is not a beneficiary (and does not actually benefit):
‘Anthony transfers assets into a discretionary settlement under which he is not included in the class of beneficiaries. There is however power to the trustees to add beneficiaries including Anthony to the class at some future date. That Anthony can be considered as a potential beneficiary is sufficient to say that the trust fund is not enjoyed to the entire or virtually the entire exclusion of benefit to him under the settlement and the gift will be a GWR (CIR v Eversden). Only if the trust irrevocably excluded Anthony from being a beneficiary under the trust will a GWR not arise.’
Another problem is HMRC’s attitude to the availability of the spouse exemption on the death of the donor. This is becoming increasingly important since 6 April 2017 in two respects.
First, some settlors of trusts that were funded when foreign domiciled may die resident in the UK. If they were born here with a UK domicile of origin, then from 6 April 2017 they are subject to specific anti-avoidance provisions. IHTA 1984 ss 267(1)(aa) and 48(3E) effectively provide that a formerly domiciled resident who is UK resident for more than one tax year loses any IHT protections on trusts set up, whatever their actual domicile.
Example 4
Nick is the settlor and beneficiary of a discretionary trust set up in May 1998. He was foreign domiciled when he set up the trust. He was born in the UK and at that time his parents were married and his father was English and his mother Swiss. His parents divorced when he was two years old, and he has lived in Switzerland most of his life. He is posted to the UK on a five-year banking assignment in 2015. From 2017, the trust is not excluded property while he is UK resident. In May 2018, the trust will have to pay a ten-year anniversary charge (although at a reduced rate). Moreover, if Nick dies while UK resident the trust property would be subject to a ROB charge.
Second, similar problems arise even for foreign domiciled persons with no connection to the UK if they are the settlor and beneficiary of a trust that holds Sch A1 property (enveloped UK residential property).
What then is the position if the trust ends on the settlor’s death, there is a ROB and the property passes to the spouse outright? HMRC does not consider that spouse exemption is available (see IHTM14303), but it is difficult to see the basis for this view where under the terms of the settlement the property factually becomes comprised in the spouse’s estate on the settlor’s death. The donor is deemed beneficially entitled to the property for all IHT purposes and on the transfer to the spouse the conditions of s 18 are satisfied as the spouse’s estate is increased. The position would be different if the property was appointed by the trustees to the spouse outright in the donor’s lifetime. In these circumstances, the donor is effectively excluded and a deemed PET arises under s 102(4). There is no scope then for spouse exemption to apply.
Assuming HMRC is wrong about the availability of the spouse exemption on death of the settlor who has reserved a benefit in settled property, is there a better option than the spouse becoming absolutely entitled on Nick’s death which could still secure spouse exemption? Absolute entitlement by the spouse may be undesirable for CGT or non-tax reasons. The trustees could confer on Nick a testamentary general power of appointment which he then exercises by Will, settling the trust property on interest in possession trusts for the spouse on his death. In these circumstances the spouse takes an immediate post death interest under IHTA 1984 s 49A (as the property is deemed resettled by will under the power) and the settled property is deemed comprised in her estate. Spouse exemption should then be available on Nick’s death, despite his ROB.
The principle of creating an immediate post-death interest (IPDI) by use of a general power of appointment was confirmed by HMRC (at answer 15 in the 2008 questions and answers with STEP/CIOT; see www.tmsnrt.rs/2xh5ml7). Note that, in our example, above it is Nick who must exercise this power by general appointment in his will, not the trustees.
Let outs and reliefs
The full consideration let out has already been referred to (FA 1986 Sch 20 para 6(1)(a)). It may be useful to consider the options if a reservation has been identified; for example, where the donor gave away a house and continues to occupy it. In these circumstances, the donor could start paying full consideration for occupation and hopefully survive seven years. The consideration must be reviewed regularly and continue to be paid until the donor’s death (or until he moves out of the house).
Another relief is found in FA 1986 Sch 20 para 6(1)(b). This provides that occupation of land by the donor is disregarded if:
Example 5
Mary is an elderly relative who gave away her London home many years ago to her daughter, moving into a small cottage by the seaside. Mary has now lost capacity and is unable to care for herself. Her daughter decides to bring her back to the London home where her daughter is living so that she can be cared for properly. In those circumstances the above exemption can apply.
A much used statutory relief is a sharing arrangement. FA 1986 s 102B(4) provides that there is no ROB where:
There is no requirement for occupation by the donor and donee as a family home. In theory, the donor could give any share (even 90%) away and retain 10%, although HMRC now indicates that this could be disclosable under the IHT DOTAS regulations. If A and B each own a 50% share in land and A gives his entire share to C but continues to occupy, read literally the section still applies.
Example 6
Glen, now a widower and retired academic, lives in the family home in Oxford. His married daughter lives in London and comes to stay with her two young children in holidays and some weekends. His son is based in France. Glen gives the daughter a 50% share in his Oxford house and continues to pay all the outgoings on the property. The following should be noted:
Assume that Glen dies within seven years of the gift to his daughter leaving his remaining estate (comprising mostly his share in the Oxford house) to his son. The gift to his daughter uses up his nil rate band, with the result that the son pays tax on the entirety of his inheritance. This can result in unfairness between siblings.
Conclusion
The ROB legislation continues to be relevant to IHT planning, and the 2017 changes to foreign domiciliaries have extended its scope and importance. It prevents planning of the sort that many ‘mid wealthy’ people often want to do, namely give away their home and continue to live there. This article does not discuss the more complicated interactions with the pre-owned asset tax (POAT) and excluded property, but practitioners should be aware of the potentially wide-ranging and penal nature of these provisions.
It is a truth universally known that inheritance tax is unpopular. In its Inheritance tax review: first report (November 2018), the Office of Tax Simplification (OTS) cited a 2015 YouGov poll of UK voters, which found that 59% of respondents felt that inheritance tax was unfair, compared to just 22% who thought it was fair (bit.ly/2vO7D6f). In January 2020, the All Party Parliamentary Group (APPG) published a report on the reform of IHT, co-written by the current author, discussing the pros and cons of a wealth transfer tax and looking at some alternatives (www.step.org/appg).
Despite its unpopularity, IHT raises relatively little revenue. In 1895/96, the £14m from death duties represented about 35% of Revenue taxes. By 1968, estate duty produced only about £382m or about 5.8% of total Revenue receipts. The yield in 2018/19 stands at a record £5.4bn but now comprises less than 1% of total tax revenues. Fewer than 5% of deaths actually result in payment of inheritance tax.
The history of wealth transfer taxes in the UK – from estate duty in 1894 to capital transfer tax in 1974 and inheritance tax in 1986 – is essentially one of failure. Little money is raised overall, lifetime transfers of wealth remain largely untaxed, the system is immensely complicated and the incidence of IHT is currently regressive at the higher levels. As the Office of Tax Simplification (OTS) pointed out in its first report, the average rate of tax is 5% for estates with a net value of under £1m, and up to 20% for estates valued at £6m to £7m. It then falls to 10% for estates with a value of £10m or more. This does not take account of lifetime giving, which probably increases the distortion still further, as people whose main asset is the family home cannot easily give it away during their lifetime. (See, for example, the recent case of Shelford (Executors of J Herbert) v HMRC [2020] UKFTT 53, where an attempt to do so failed.)
In the light of such unpopularity, should the UK now follow Commonwealth countries such as Australia, New Zealand, Canada, India and Pakistan, which have abolished estate duty, and perhaps replace it with CGT on death? Or should the UK follow the Irish model and opt for a form of accessions tax? Russia, China, Israel, Sweden, Norway and Austria have no death taxes. Do we actually need any wealth transfer taxes?
This article rejects piecemeal reform: IHT is too flawed to work properly. Abolition is also rejected broadly on principles of fairness. A reformer is therefore faced with two alternative wealth transfer tax systems. The first system levies tax on the donor (an estate tax). The second charges the donee on gifts and legacies cumulatively over that donee’s lifetime (an accessions tax). The current UK IHT is an estate tax system. Ireland is an accessions tax system.
Although superficially attractive, accessions tax poses significant problems in terms of administrative complexity, compliance and record keeping, and above all in terms of trusts, where the model tends to break down. The author therefore favours the flat rate gift tax (an estate tax) detailed in the APPG report, which provides detailed analysis including worked examples. This article examines the reasons for that view, looking at some design aspects that must be considered for a wealth transfer tax to work effectively.
Design issues for wealth transfer taxes
The scope of the charge
One has to consider the following factors:
Currently, IHT offers a rather arbitrary form of relief. Foreign domiciled donors who have been in the UK for less than 16 years only pay IHT on UK assets; and even after 15 years will not pay IHT on foreign assets settled into trust before the 16 year deadline. Hence, IHT is linked not only to long term residence but also to the concept of domicile of the donor. The residence or domicile status of the donee is irrelevant, which is logical for an estate tax but leads to avoidance and leakage. A family now entirely based in the UK can have access to wealth held in trust IHT free for generations if the settlor was foreign domiciled when the trust was established.
It is suggested that domicile is abolished altogether as a relevant concept in taxing transfers of wealth. Liability should depend not on someone’s domicile but be linked solely to an objective test of long-term residence. Logically, an estate tax should be charged only by reference to the residence status of the donor, and an accessions tax by reference only to the status of the donee. However, this could lead to significant leakage. It is suggested that whatever model is adopted, the tax base should be extended to cover all transfers where either the donor or donee is a long-term UK resident (say, resident here for more than ten out of the last 15 tax years).
One difficulty this raises is double taxation. For example, Geoffrey, who has lived in France all his life, leaves foreign shares worth £10m to his daughter Ruth on his death. Ruth is a UK resident and domiciliary. Under IHT there is no tax. Under the above suggestion, however, Ruth would pay UK tax on receipt, but Geoffrey would also be liable to tax in France. Hence, a mechanism must be given for assigning taxing rights and providing reliefs where two different people are liable for tax on the same event – death. Our current treaties are largely inadequate for this purpose.
What happens if the long-term resident leaves the UK? It is suggested that the donor/donee would need to remain within the scope of wealth transfer taxes if UK resident for ten out of the last 15 tax years to prevent deathbed emigrations. Again, the double tax consequences of this would need to be considered carefully, as the donor may be subject to death taxes in two countries.
As regards the situs connection, it is suggested that regardless of the system, all UK assets should (as at present) be subject to wealth transfer tax, including residential property held in enveloped vehicles.
Spouses, cohabitees and relatives
Most countries provide for some relief, if not outright exemption, on transfers of property between spouses and civil partners (although the UK was almost the last to do so in 1972 under estate duty). Some think that spouse exemption should be extended to cohabitees or even siblings living together.
The argument for spouse/civil partner exemption is greater where rates are higher, as the hardship suffered on the first death is greater. However, a progressive estate tax raises further issues, as the surviving spouse will pay more on a single estate of £1m than they would on two estates of £500,000 each. In the case of accessions tax there are other complications. If, say, a husband’s inheritance from his deceased wife is spouse exempt, should this inheritance be ignored altogether in calculating the rate of tax on the husband’s other inheritances? Does it make a difference if the husband inherits a life interest from his wife, rather than inheriting outright?
A related question is whether gifts to distant relatives or friends should be taxed more heavily than gifts to (say) children, on the basis this is more in the nature of a windfall. This is more relevant to a progressive accessions tax than a flat rate estate tax. Any differentiation in favour of close family members would arguably increase concentrations of wealth, when one of the main objectives of this system is to disburse wealth more widely. The Resolution Foundation favoured an accessions tax in 2018 and did not suggest differential rates.
Special reliefs
Currently, the UK gives generous tax breaks to trading businesses and agricultural land. Should these continue? Much depends on the rate of tax. A high rate will generally require greater reliefs for family businesses, which will object that otherwise they need to be sold to pay the unplanned tax due on death. However, the current IHT system also creates avoidance and distortion by encouraging donors to retain the business until death to obtain the CGT step up. Most high rate wealth tax systems provide some relief for businesses. A low flat rate estate tax could instead offer no reliefs for businesses other than instalment relief over ten years. The effective cost for business at a 10% rate is 1% p.a.
Whatever the system, it may be sensible to exclude any gift not exceeding £250 in value (the current small gifts exemption) and, instead of the current medley of lifetime reliefs, have a higher annual allowance of, say, £20,000 or £30,000 p.a. (per donor if estate tax or per donee if accessions tax). This would allow some limited tax free lifetime giving without significant cost but larger lifetime gifts would be caught. The nil rate band, residential nil rate band, and all other lifetime and death reliefs other than spouse and charity exemptions would be abolished.
Rates
Fundamental to any wealth transfer tax design is the question of rates. Should tax rates be progressive or flat? At what level should tax start to be levied? If rates are low, there is less need for reliefs. The problem with the 40% IHT headline rate is that it leads to many reliefs that tend to favour the better off. But a flat rate seems non-progressive.
The type of system adopted also influences rates. The principle of accessions tax, which taxes a donee on all accessions of inheritances, necessarily envisages a progressive cradle to the grave system. The flat rate system recommended by the APPG was a 10% rate on all lifetime gifts above £30,000 and on death for estates between £325,000 and £2m; thereafter, 20% would be charged on death for estates of over £2m. There would be no nil rate band available in life but a single death allowance of £325,000. While this might seem a large headline cut from 40% to 10%, the effective average IHT rate currently rarely goes above 20% anyway and even that figure ignores lifetime gifts outside seven years.
Trusts
Trusts and similar entities, which provide benefits to people without actually transferring wealth to them, always pose problems in any wealth tax system. In many trusts, income accrues to one group of beneficiaries, while capital accrues to another. How should these different interests be taxed? Should the trust be treated as transparent to the settlor or taxed as a separate entity?
HMRC suggests that taxation should be neutral between outright gifts and gifts in trust so that a donor uses a trust for purely non-fiscal reasons. (See, for example, the consultation on the taxation of trusts published in 2018 by HMRC at bit.ly/2SZ1YSJ.) The current IHT system is far from neutral. It is broadly very favourable to trusts set up by foreign doms and harsh on trusts set up by UK doms, besides being complicated for little actual yield.
Trusts pose particular problems for accessions taxes. The general effect of trusts is to maintain concentrations of wealth and discourage distributions, which is the opposite of the objectives of an accessions tax. If you tax a life tenant at the same rate as an outright gift to him, how does this affect that individual’s lifetime cumulative accessions total, particularly if he never actually receives any capital but just an income interest? Is it fair to tax the donee at a higher rate and as if he had received the underlying capital if he merely takes a revocable income interest? If you tax him on the value of an income interest, how is it to be valued if revocable? What rate should be imposed on entry into a discretionary trust, given that it may have no history of inheritances as donee? Even if you cumulate all discretionary trusts set up by the donor, this does not necessarily fulfil the objectives of an accession tax, which focuses on the tax position of the donee rather than the donor. It is less easy to work out a compensating ‘neutral’ position for trusts compared with outright gifts under an accessions tax system.
It was suggested above that tax should be levied in relation to estate tax and accessions tax if either the donor or the donee were UK resident. Given this, one option is to impose wealth transfer taxes on trustees wherever resident, if any of the following are satisfied:
(i) the assets of the trust are UK situated;
(ii) the settlor is a long-term UK resident; or
(iii) any beneficiary is a long-term UK resident.
Under this route, the residence of the trustees (which can easily be manipulated) is irrelevant. However, (iii) could raise significant design problems. For example, a foreign resident settlor who settles foreign assets into trust may be able to avoid the entry or periodic charges for some time simply by ensuring that there are no long-term UK resident beneficiaries named, even if later added. France has adopted this type of model with limited success. Is it fair that even the presence of a discretionary beneficiary can subject the trust to periodic charges?
A better option (at least for a flat rate estate tax) may be as follows:
Interaction with other taxes
Wealth transfer taxes cannot be viewed in isolation. Some of the arguments for and against an annual wealth tax or mansion tax in conjunction with a wealth transfer tax have been considered in the APPG report and the Mirrlees report on taxation of wealth, and for reasons of space are not considered further here.
Should CGT be charged on death? When CGT was first introduced in 1965, death was also an occasion of charge, although deductible against estate duty. The charge was abolished in 1971 and a step-up introduced. The abolition was for the practical reason that (in the government’s view) the levy of two taxes on the same event, CGT as well as estate duty, imposed an excessive burden on estates, and particularly family businesses. By contrast, the CGT charge on lifetime gifts remains unless the gifted asset is a qualifying business or is given to a lifetime trust, in which case the gain can be held over (see TCGA 1992 s 260). In the case of an estate tax, the liability for both CGT and estate tax on gifts will fall on the donor. In the case of accessions tax, the donor bears the CGT and the donee pays the accessions tax. Nevertheless, it is still likely to be perceived as double taxation. In itself, this is not necessarily irrational, as the two taxes are doing different things; however, whether in practice this would be tolerated is doubtful, quite apart from the additional compliance burden on executors as many more estates would be brought into charge.
A compromise may be to roll over the accrued gain on any gifted asset (whether transferred during lifetime or on death) to the donee. In this way, the gain will be subject to tax in the long run but the double charge to CGT and wealth transfer tax on the same occasion is avoided. However, this will require heirs to track the original base cost of the deceased or donor. On assets such as farms and businesses that continue for several generations, the CGT bill may become disproportionately large and harder to calculate. Inflationary gains may be taxed. How would main residence work? Would credit be given for the deceased’s period of occupation? On that basis, if John died having owned and occupied a house for 15 years and his children sold the house five years later having rented it out, only 75% of the gain would be exempt.
Final thoughts
In conclusion, there are no easy solutions but, in the author’s view, taxing wealth better requires some radical reforms, rather than more tinkering with IHT, and some consideration given to CGT as well. Cut the rates and abolish the reliefs, and try to bring lifetime giving into a more rational system for transferring wealth.
