Taxation of Chargeable Gains - Sale of Trust Interests and Transfers Linked to Trustee Borrowing: (Schedules 4A and 4B to the Taxation of Chargeable Gains Act 1992.)

 

Interpretations

We have been asked by representative bodies and individual firms of tax practitioners to offer guidance on the meaning of certain statutory terms and on the application of the legislation in Schedules 4A and 4B Taxation of Chargeable Gains Act 1992 [`TCGA']. The relevant legislation was enacted in Finance Act 2000. These schedules are part of a package of measures designed to prevent certain forms of avoidance of capital gains tax involving trusts.

Details: Schedule 4A

Schedule 4A is concerned with certain situations where there is a disposal of an interest in a UK resident settlement for consideration.

A1. Paragraph 3: `for consideration'.

Under paragraph 3(1) "A disposal is `for consideration' if consideration is given or received by any person for, or otherwise in connection with, any transaction by virtue of which the disposal is effected". (Paragraph 3(3) restricts this to actual consideration.) Our view is that `consideration' in this context does not extend to the incidental costs of the transaction, in particular reasonable fees charged by professional advisers for giving guidance as to the legal and fiscal effects of the transaction or for drafting and executing the relevant paperwork. Therefore, if there are no payments other than in respect of the incidental costs, the transaction does not fall within Schedule 4A.

A2. Paragraph 13(2)(b): `for practical purposes'.

This paragraph is concerned with the situation where there is a period between the beginning of the disposal of the interest in question and the `effective completion' of it in circumstances where Schedule 4A applies. In this situation the deemed disposal under paragraph 4(1) of the relevant trust assets occurs at the moment of effective completion of the disposal of the interest. This is required for testing the conditions relating to the residence status of the trustees and settlor (paragraphs 5 & 6) and the interest of the settlor in the settlement (paragraph 7). It is also relevant for the purposes of paragraph 8 where the identity of the underlying assets changes during the period, and paragraph 9 where the value changes during the period.

The conditions as to the residence of the settlor and the trustees are met if they applied for

  • the tax year in which the disposal of the interest began, or
  • the tax year in which it was effectively completed, or
  • any tax year in between.

The condition as to the interest of the settlor is met if it applied at any time between

  • the beginning of the tax year two years before the year in which the disposal of the interest began and
  • the date of the effective completion of the disposal.

These two dates are inclusive.

The beginning of the disposal is defined by paragraph 13(2)(a) as, in the case of a disposal involving the exercise of an option, the date of the grant of the option, and in any other case involving a contract, the date the contract was entered into.

The effective completion is defined by paragraph 13(2)(b) as `the point at which the person acquiring the interest becomes for practical purposes unconditionally entitled to the whole of the intended subject matter of the disposal'. The main purpose of the words `for all practical purposes' is to cover cases where the buyer has the power to compel the trustees to transfer the property to him on giving due notice. Another example would be where the buyer has a right to enjoy the property now, but is not entitled to it until a particular contingency is fulfilled, and there is no real likelihood of its not being fulfilled.

Details: Schedule 4B

Schedule 4B is concerned with situations where the trustees of a settlement falling within sections 77, 86 or 87 TCGA make a transfer of value which is treated as linked with trustee borrowing.

B1. Paragraph 2(1)(b): cash distributions which are income.

Where trustees of a discretionary trust make a distribution which is income of the recipient for UK tax purposes, this is not a `transfer of value' within paragraph 2, which is concerned with capital transactions.

B2. Paragraph 2(1)(a): beneficiary exercising rights under section 12 Trustee etc Act 1996.

In certain circumstances a beneficiary's occupation of property, instead of being the consequence of the volition of the trustees, may result from personal rights under section 12 Trusts of Land and Appointment of Trustees Act 1996. Our view is that if the rights of the beneficiary arise as a consequence of the wording of the deed or will, then the occupation does not give rise to a transfer of value. It may be otherwise where the rights have arisen as a consequence of the exercise by the trustees of a power of appointment or advancement.

B3. Paragraph 2(1)(c): `issue a security'.

We have been asked what the expression `issue a security' covers. It caters for those exceptional circumstances where trustees issue to a beneficiary or another trust a document acknowledging liability. Paragraph 13(2) of Schedule 4B provides that references to the transfer of an asset include everything that is or is treated as a disposal of an asset The issue of a security is not in itself the disposal or part disposal of an asset. Therefore paragraph 2(1)(b) does not apply to it, and it was necessary to have a specific provision to cover this possibility.

B4. Paragraph 4(1): meaning of `borrowing'.

It is not unusual for the trustees of a non-resident trust to borrow money from a non-resident company which they control. In this situation, if the company were resident in the UK, section 419 of the Income and Corporation Taxes Act 1988 might well be applicable. It has been suggested that in this situation the trustees are effectively `borrowing' from themselves and therefore outside paragraph 4(1). We consider this incorrect, particularly in the light of Chamberlain v CIR, 25TC357. It does not matter whether the borrowing is from a company controlled by the trustees or their associates, or from an entirely unconnected company. What matters is the use to which the borrowing is put.

The fact that money was borrowed before 21 March 2000 does not prevent it from being outstanding trust borrowing.

Where trustees are presented with a bill, for example for repairs to trust property, bona fide delay in payment would not convert this into a borrowing for the purposes of paragraph 4.

B5. Paragraph 6(4): application of proceeds to meet current expenses.

We have been asked whether trustee borrowings to meet payments on account or provision for future or past expenses are covered by the expression `current expenses'. One circumstance in which borrowings are applied for `normal trust purposes' (paragraph 6) is where they are applied by the trustees in making payments to meet bona fide current expenses incurred by them.

One may note that there are three tests to be met.

  • The borrowings have been applied by the moment of the transfer of value (paragraph 5(2)(b)(i)).
  • They have been applied to meet bona fide `current expenses'.
  • The expenses are expenses of `administering' the settlement or any of the settled property.

In the case of borrowing to meet future expenses it is hard to see how the borrowings can be said to have been applied. But the time for making the test is not when the money is borrowed, but the time of the transfer of value (this is `the material time', as defined in paragraph 2(2)). In the case of payments on account there would be the requisite application and the liability to pay would have been incurred.

We do not regard `current' as restricting qualification to expenditure which for accounting purposes must fall in the year of borrowing, but we should regard it as excluding borrowing to make a provision for future expenditure or to meet expenditure that was incurred long before but left unpaid. In general where contracts for repairs of an ordinary kind have been entered into, we should regard the expenditure anticipated under those contracts to be current expenses at the moment of borrowing. Where trustees as the owner or tenant of a flat are obliged by contract or under the terms of the lease to make payments into a common fund to meet future maintenance or repair expenditure this would be regarded as a current expense.

The expression `administering the settlement or any of the settled property' should be construed widely to cover not only those expenses properly chargeable to income, or which would be so chargeable but for express provisions of the trust deed, but also capital expenditure such as capital taxes in the UK or elsewhere, or legal costs of a reorganization, in particular the costs of an application under the Variation of Trusts Act. Other capital expenditure would often be expenditure on the asset itself, and therefore qualify under paragraph 6(2). Contributions to the day-to-day running costs of a nominee company controlled by the trustees would also qualify.

B6. Paragraph 7: `ordinary trust assets': futures contracts.

We have been asked to say whether a futures contract relating to commodities is an `ordinary trust asset'. Such a contract is not a tangible asset nor does it give the holder an interest in such an asset. Therefore, it is not an `ordinary trust asset'.

B7. What happens when trustees put money into a conventional current or deposit account at a bank or building society?

Although in general law this is regarded as a loan from the customer to the bank, in the context of this legislation we do not consider that this comes within the meaning of `lend' for the purposes of paragraph 2(1)(a). The currency in which the deposit is made is immaterial.

B8. What happens when money is borrowed to purchase the freehold interest of a property which is then rented on a commercial basis?

It is important to appreciate that the expression `transfer of value' equates to the three types of transaction described in paragraph 2(1). It does not carry the kind of meaning that it has for inheritance tax purposes.

Under paragraph 13(2) references to the transfer of an asset include references to anything that is a disposal, and under section 21(2) TCGA references to a disposal include references to a part disposal. Paragraph 13(3) provides that references to a transfer of an asset do not include the transfer of an asset which is created by the part disposal of another asset. The grant of a lease is a part disposal of the freehold interest and therefore the grant of a lease is a transfer of the freehold interest for the purposes of paragraph 2(1)(b) and is not regarded as the transfer simply of the lease. If the freehold interest was bought with borrowed money it meets the test in paragraph 2(4)(a), and the amount of value transferred equals the market value of the freehold.

Assuming that there is outstanding trustee borrowing at `the material time', which is defined in paragraph 2(2) as the time the transfer is effectively completed, it is then necessary to consider whether the transfer of value is linked with trustee borrowing. Under paragraph 7 tangible property, and any interest in such property falls within the expression `ordinary trust assets'. However the property concerned must under paragraph 6(2)(b) either form part of the settled property immediately after the material time, or meet the alternative condition in paragraph 8(1)(b) that it is represented by ordinary trust assets which form part of the settled property immediately after the material time. Paragraph 6(2)(b) and paragraph 8(1)(b) may be looked at together. In this situation we say that the reversion to the lease is still part of the settled property, and the lease itself is represented by the right to the rental stream.

Therefore where trustees borrow money to acquire the freehold interest in a property which is then let commercially and, at the material time, there are no outstanding trustee borrowings other than those which have been applied for normal trust purposes, Schedule 4B does not apply. But the position will be different if at that moment there are outstanding trustee borrowings applied for other purposes.

The same considerations apply where trustees acquire a long lease which is sublet, and where the asset in question is a chattel rather than land or buildings.

B9 What happens when money is spent unproductively, for example on a planning application that fails?

Under paragraph 6(2) there are three conditions that must be met by a payment in respect of `an ordinary trust asset' if it is to be regarded as applied for normal trust purposes. The third, in paragraph 6(2)(c), is that the sum is allowable under section 38 TCGA (or would be but for section 17 or 39) as a deduction in computing a gain accruing to the trustees on a disposal of the asset. If an application for planning permission fails, then when the land is actually sold the costs relating to the application are generally not allowable; this is because they are not `reflected in the state or nature of the asset at the time of the disposal'. Paragraph 6(2)(c) however must be referring to a notional disposal not to a real one. In the context of paragraph 6 we consider that the reference can only be to a notional disposal taking place at the time when the expenditure is incurred.

Although one could not lay down as a universal rule that the expenditure would always qualify, the test is whether the existence of the current application for planning permission is reflected in the state or nature of the asset at the time of the notional disposal.

B10. How should we compute the base cost of assets for future disposals?

The trustees are treated as disposing of the whole or a proportion of each of the chargeable assets continuing to form part of the settled property. Suppose that an asset cost £600, the trustees are treated as disposing of two thirds of the asset at the material time (paragraph 10(1)), and the respective values of two thirds and one third immediately after that time are £900 and £450. Leaving aside indexation, if any, the computation is:

Cost

2/3 of 600

400

Deemed Proceeds

  

900

Gain

  

500
     

Remaining original cost

600 - 400

200

Deemed Acquisition

  

900

Revised cost

  

1100
   
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