Draft amending legislation for Trust Modernisation legislation

On 9 October 2006 the Paymaster General, Dawn Primarolo, in a Written Statement to Parliament announced the intention to bring forward legislation in the Finance Bill 2007 to rectify an omission which had been identified in the Trust Modernisation legislation included in the Finance Act 2006.

This paper contains the draft rectifying legislation for the omission and also for a further omission in the 2006 Trust Modernisation legislation which has been identified more recently.

First omission

Certain types of capital receipts received by trustees are treated for tax purposes in their hands as income. This includes the situation where the trustees of a settlement receive a payment made by a company which is buying back its own shares from the shareholders. In that situation, the original legislation — section 686A Income and Corporation Taxes Act 1988 — provided that what was taxable was only the distribution element, and excluded the original subscription price received by the company which issued the shares.

Paragraph 3, schedule 13 of the Finance Act 2006 amended the original section 686A Income and Corporation Taxes Act 1988 so that in addition to its original function it also introduces a common mechanism for the various types of capital receipt which are assessable to income tax in the hands of trustees receiving them to be charged at the special trust rates. The “special trust rates” means the rate applicable to trusts (40%) or the dividend trust rate (32.5%)
There is, however, an omission in the wording of the new section 686A which has the result, in the situation of a company buying back its own shares, that the whole of the payment by the company to the trustees including the original subscription price is taxable and not just the element representing the distribution.

This result was not intended and therefore section 686A is being amended. The amending legislation backdates the correct position to 6 April 2006 to ensure that trustees in this situation will not be disadvantaged by the omission.
As part of the Tax Law Rewrite programme, section 686A is in the process of being replaced by what are presently clauses 481 and 482 of the Income Tax Bill (which will in due course, and subject to the approval of Parliament become the Income Tax Act 2007). This replacement legislation is also being amended.

We would advise trustees and their agents, who have to provide details of payments received in 2006/07, to file their returns after Parliament has approved the Finance Bill 2007 and Royal Assent has been given. The rectifying legislation restores the treatment of such payments to the situation that existed prior to the changes in Finance Act 2006. It is the amount of the qualifying distribution that should be returned and the notes to the 2006/07 return provide the appropriate guidance on the basis of the corrected legislation. Returns submitted before the replacement legislation becomes law will have to show payments in accordance with the legislation as it stands at the moment, which is the full amount of the payment received.

Second omission

The second omission relates to a further category of capital receipt within section 686A Income and Corporation Taxes Act 1988 which is treated as income in the hands of the trustees - chargeable event gains arising from some types of life insurance policy, capital redemption policy or life annuity contract. This time the omission relates to interacting legislation for trustees’ tax pools.

The tax pool is a statutory mechanism for ensuring that tax credits given to beneficiaries of a discretionary trust are covered by the tax paid by the trustees. When trustees make a discretionary payment from income to a beneficiary, that beneficiary is treated as receiving a gross amount of income carrying a credit at the rate applicable to trusts (40%). The credit is given to the beneficiary because the trustees will already have paid tax on the income as it arose to them and so there is a need to avoid that income being taxed twice.

Real tax paid should go into the pool but tax covered by non-payable tax credits or notional tax credits should not. There is a notional tax credit of 20% on some chargeable event gains which should not enter the tax pool. However the legislation relating to the tax pool was not amended at the time of Finance Act 2006 to ensure that it did not do so. The amending draft legislation therefore now rectifies the position.

The proposal is to rectify this for the tax year 2007/08 onwards. For certain chargeable events gains on life assurance policies arising to trustees in the tax year 2006/07 only, the notional tax credit of 20% would, exceptionally, enter the pool. However, the 2006-07 tax calculation and the Tax Calculation Guide that accompanies the Trust & Estate return both adopt the tax pool treatment that was intended rather than the statutory basis that currently exists. This means that the calculation only allows the real tax into the tax pool. Any notional tax treated as paid at 20% is not. We would advise trustees and their agents, who have chargeable event gains in 2006/07 to make a note in box 21.11 “Additional information” on page 12 of the return. The note should say that the tax pool should be increased by the amount in box 9.30 as the legislation has not yet been amended.

As mentioned above, the trust legislation including the Trust Modernisation legislation is being replaced, as part of the Tax Law Rewrite programme, by provisions in the Income Tax Bill (later to be the Income Tax Act 2007). The rectifying draft legislation for this omission therefore amends what is presently clause 498 of the Income Tax Bill.

If you would like to comment on the draft legislation included in this paper, please send your response to:-

Andrew Hayward
Charity, Assets and Residence
HM Revenue and Customs
Room G45
100 Parliament Street
London
SW1A 2BQ

Fax: 020 7147 2749
E mail: Andrew.hayward@hmrc.gsi.gov.uk

The deadline for responses is 28 February 2007

Draft Clause A – purchase of company shares

Trust income

(1) In section 686A(2)(a) of ICTA (receipts to be treated as income subject to special rate of tax: payment by company) after “made” insert “by way of qualifying distribution”.

(2) In Type 1(b) in section 482 of the Income Tax Act 2007 (types of amount to be charged at special rates for trustees) after “made” insert “by way of qualifying distribution”.

(3) This section shall have effect in respect of payments made to the trustees of a settlement on or after 6th April 2006.

Commentary on Draft Clause

Subclause (1) provides that in relation to payments received by trustees which fall into the category in section 686(2)(a) (payments made by a company on the redemption, payment or purchase of shares in the company or on the purchase of rights to acquire such shares) what is being charged to income tax is the part of the payment which falls within the definition of “qualifying distribution”, and not the whole of the payment.

Subclause (2) amends the statutory successor from 6th April 2007 to section 686A, that is Type 1 section 482 Income Tax Act 2007, in the same way.

Subclause (3) provides the commencement provision for the amendments to both section 686A and clause 482 of the Income Tax Act 2007. Section 686A will have been repealed by Income Tax 2007 so the amendment will have effect for the tax year 2006/07. Section 482 Income Tax Act 2007 will have effect from tax year 2007/08.

Draft Clause B – chargeable event gains arising from some types of life insurance policies

Trust gains on contracts for life insurance, &c.

(1) Section 498 of the Income Tax Act 2007 (trustees’ tax pool) is amended as follows

(2) In subsection (1) –

(a) in Type 1, for “2 or 3 or 3A”, and
(b) after Type 3 insert –

"Type 3A

The amount of tax at the nominal rate on any amount in respect of which –

(a) the trustees are liable to income tax under section 467 of ITTOIA 2005 (gains from contracts for life insurance, &c.),
(b) the trustees are liable to income tax at the trust rate by virtue of section 482, and
(c) tax at the savings rate is treated as having been paid by virtue of section 530 of ITTOIA 2005 (life insurance)."

(3) After subsection 2 insert –

"(2A) In relation to Type 3A, the reference to the nominal rate is a reference to a rate equal to the difference between the trust rate and the savings rate."

(4) This section shall have the effect in relation to gains arising to the trustees of a settlement on or after 6th April 2007.

Commentary on Draft Clause

Subclause (1) provides that section 498 of the Income Tax Act 2007 is to be amended. This section sets out the types of income tax that goes into the tax pool.

Subclause (2) adds Type 3A, an additional type of income tax – Type 3A -into section 498(1). This provides for the restriction of the amount of tax going into the tax pool in respect of chargeable event gains on certain life insurance policies. As a result, only the actual tax of 20% paid will be allowed in and not the notional tax credit of 20% which applies to chargeable event gains where income tax is treated as paid under section 530 ITTOIA.

Subclause (3) defines what is meant by the term “nominal rate” in the new Type 3A. It is the difference between the trust rate (40%) and the savings rate (20%).

Subclause (4) provides that the amendments to section 498 shall have effect from the tax year 2007/08 onwards.