UK life interest trust being treated as a UKdiscretionary trust


#1

I am looking for some guidance on this. Any pointers will be very helpful.

I am dealing with a disclosure case where the trustees of a 2003 UK life interest trust have been treating the trust as a discretionary trust. The trust is not settlor interested and there are three principal beneficiaries.

The trustees have filed UK trust tax returns and paid tax on all income and gains arising from trust assets.

The income rightfully belongs to the three principal beneficiaries.

My query is:

Do we treat the tax paid by trustees as distribution of capital to the beneficiaries?

or

Do we claim a refund of taxes paid on income for the trustees and let the beneficiaries pay the outstanding taxes (plus interest & any penalties) personally?

What is HMRC’s approach to these type of situations?

Many thanks
Sameera


(malcfinney1) #2

I have never come across this situation.

How is it possible that for 14 years such a mistake has been made?

Are their any professional trustees?

Did the trustees not receive tax advice from a professional?

Did the trustees never submit the Trust & Estate Tax Return pre 31 October so HMRC would compute the trust’s tax liabilities?

The Notes to the above Return specifically address whether the Trust is an iip or discretionary trust.

Whether the trust is an iip or discretionary trust the trustees would have an income tax charge (unless income had been mandated to the iip beneficiaries) albeit at different rates.

Did the trust make any “distributions” to the beneficiaries and as the trustees were under the impression it was a discretionary trust the trustees supplied R185s.

Answers to the above may well dictate how any approach to HMRC should be made.

Malcolm Finney


(Andrew M Mortimer) #3

Unfortunately both in my time with HMRC and subsequently I have come across
similar situations.

I also believe there could be a lot more trusts around which have not been
dealt with correctly (not just by a lay person) both from a tax and trust
law perspective.

At one time all trust deeds (and Wills creating trusts) were submitted to
HMRC and a ‘ruling’ was issued by Claims Branch Advisory Division but this
stopped as part of the first waive of of the apparently still continuing
cost cutting measures.

In ‘the good old days’ this type of situation was was usually sorted out
during sensible discussions/correspondence with a specifically identifiable
person within HMRC, involving a comparison between tax paid by the trustees
which was not payable and tax that should have been paid by the
beneficiaries.

Given current HMRC staffing levels and their apparent technical
ability/understanding I dread to think about what their response will be
now.

Basically it seems to me that

The trustees have overpaid income tax which they might not be able to
recover

I doubt very much that strictly any of the income tax paid by the trustees
can be treated as capital payments to or made on behalf of the beneficiaries

The beneficiaries have not declared income which they should have done and
have a duty to declare this to HMRC.

The hope would be that:

HMRC will agree that no further action is taken in connection with tax
liabilities for earlier years of both the trustees and beneficiaries since
the income tax paid by the trustees is likely to be higher than the income
tax liabilities of the beneficiaries.

Only from 2016/17 onwards (or possibly just the last few years) are the
trust and beneficiaries matters put on a correct footing.

Certainly if I was dealing with this situation this is the approach I would
advocate

As regards the undeclared tax liabilities of the beneficiaries capital
gains tax does not come into the equation as it has always been the
trustees liability

Might I suggest that advice is obtained from someone who properly
understand both interpreting trust instruments and trust tax liabilities.

In this respect I would suggest that the terms of the trust deed are
carefully looked at since I have come across trusts that on the face of it
might appear to create interests in possession but because of the wording
used are in fact discretionary trusts for income tax purposes e.g. trusts
involving the use of ‘negative’ discretion

Andrew M Mortimer


#4

Thanks Malcolm

The trustees are the parents of the three principal beneficiaries.
The father is now in his early 80s so 14 years ago he was close to being 70. At their death, professional trustees will be appointed.

The family has few other discretionary family trusts.

There was advice from a tax adviser, which clearly states that all income has to be distributed to the three principal beneficiaries.

There is a small firm of accountants dealing with the trust’s tax returns. However, it seems to me that they are a bit clueless. My understanding is that the trustees just told them to file the trust tax returns and they did so assuming it’s a regular trust where income and gains are taxed on the trustees…
This is something I have come across quite a bit i.e. the accountants don’t ask for trust documents or tax advice given to check what type of trust it is. However, they don’t have any reason to doubt what the trustees tell them.

There are some tax returns where HMRC has calculated the tax (pre- 2006/7), but it seems to me that there was no mention in the trust return that it’s an IIP/fixed life interest trust, so HMRC has calculated tax on income declared in those returns.

In 2013 distributions were made to the beneficiaries and the trust paid a large chunk of tax on the tax pool adjustment.
No R185s were provided.

This has only come to light because we are dealing with the family’s other trusts and the income & gains to the family from these other trusts.

it is a bit of mess…

I have spoken to the HMRC inspector dealing with this and he said that at ‘first glance’ the beneficiaries will be given credit for tax paid by the trust on their behalf. Has not committed to it yet.

Thank you
Sameera Nathoo


(Simon James Northcott) #5

Recently hmrc have been very cooperative in this type of situation, largely I suspect because they do not have the staff to look at the finer detail unless very large sums are concerned. So you should be fine.

Simon Northcott