The specific question I have is, if the trustees of a discretionary trust resolve to make a distribution of income now, but don’t actually pay it out until after 5 April (due to lack of cash in the trust), in which tax year is the distribution of income made? There is no express power in the trust deed to distribute income by resolution (nor have I ever seen one).
There are a number of precedents for trustee resolutions in Practical Trust Precedents, including resolutions to distribute income and resolutions to advance capital, but no discussion as to their legal effect.
There appear to be two conflicting statements in the HMRC manuals. At CG37332, which concerns the date of absolute entitlement for CGT purposes, it states that “In England and Wales a resolution of trustees is not in itself enforceable. Absolute entitlement will not occur until a deed is executed or property is actually transferred.” Whereas at TSEM3759 which considers the date of an income distribution, it states that the date of payment is “The date the beneficiary became legally entitled to require the trustees to pay over the income. This could be when the payment indefeasibly vested, following the trustees’ resolution.”
I must confess that I am inclined to agree with HMRC’s CGT analysis, that trustee resolutions are not legally enforceable, but is it really the case that the legal effect of a trustee resolution is different for income than for capital?
I agree that it seems inappropriate for the enforceability of trustee resolutions to be dependent upon whether it involves capital or income.
What if it involves both capital and income – does it create a short term interest in possession until the (HMRC) requirements for it to be enforceable over the capital element are met.
The CGT argument is, to my mind self-defeating if one looks at the position where a PR appropriates assets to a beneficiary. The appropriation takes effect on the date the PRs make the appropriation. This may be by resolution only. In some cases the PRs resolve to execute a deed of appropriation, in which case the appropriation will be effective as at the date of that deed. If the beneficiaries require shares to be appropriated and sold (without the resolution requiring any deed to be executed) when is property “actually transferred” – when the proceeds of sale are paid over?
My understanding is that once the trustees have completed a resolution to do something then that resolution is enforceable, subject to any condition or contingency referred to within therein, such as the execution of a deed or, if money is being lent, the provision of security, for example.
In the actual case in question, I believe the beneficiary will be entitled to the income from the date of the resolution, but will be treated as receiving it for UK income tax purposes on the date it is paid.
Paul Saunders FCIB TEP
Independent Trust Consultant
Providing support and advice to fellow professionals
I note that your comment with regards to the date of distribution of income appears to conflict with the views of HMRC expressed in the trust manual, which states that the date of payment for tax purposes is the date when the beneficiary became “legally entitled to require the trustees to pay over the income”. If you believe that the beneficiary “will be entitled to the income from the date of the resolution”, and the resolution is signed in the current tax year, it appears that HMRC would then treat the income as paid in the current tax year.
Do you agree? Or have I misunderstood your analysis on this particular point?
I haven’t considered this issue before because typically in practice the date of payment/receipt is normally adopted for income tax purposes and so long as this is applied consistently usually no problems arise.
ITA 2007 s493 refers to “trustees of a settlement make an annual payment to a person … in the exercise of a discretion…”.
ITTOIA 2005 s683 deals with charges to tax on annual payments and s684 provides that “tax is charged …on the full amount of annual payments arising in the tax year”.
Until the trustees exercise their discretion a beneficiary has no right to any trust income and none “arises”. Once exercised, an entitlement arises on the part of the beneficiary on the date of the resolution at which time the beneficiary has (as HMRC put it) an indefeasibly vested interest irrespective of the actual date of payment (unless the exercise of the discretion by way of resolution indicates payment will be made at a future date).
The analysis for CGT is I think irrelevant to the current scenario.
s.493 ITA 2007 refers to the tax year in which the trustees make an annual payment in the exercise of their discretion.
s. 684 ITTOIA 2005 refers to tax being charged on the full amount of the annual payments arising in the tax year.
Both refer to “payment”.
HMRC refers to the date of payment being when the beneficiary is legally entitled to require the trustees to pay over the income.
In the case you have raised, you state the trustees have no income in the tax year in which the resolution was made, but will have the cash to make the payment in the following (?) tax year. This being the case, does the beneficiary have an immediately enforceable claim against the trustees? In their consideration, the trustees will have been aware of the fact that immediate payment could not be made and no doubt they would have taken that into account although, reading between the lines, perhaps it was implicit rather than explicit when they resolved to make the distribution.
If one strictly applies the HMRC reasoning, and trustees exercise their discretion to pay to a beneficiary all of the next 12 months income of the trust, it seems to me that (for income tax purposes) the whole year’s income will it be deemed to have been received by the beneficiary when the resolution was made, whereas I believe it will be treated as being received by the beneficiary as each dividend, etc. is paid?
Whilst I agree that the HMRC interpretation is that the distribution is taxed upon the beneficiary when they are “legally entitled to require the trustees to pay over the income”, it seems to me that the beneficiary can only enforce such right when the trustees have the income to be paid over (as identified in the scenario immediately above).
Paul Saunders FCIB TEP
Independent Trust Consultant
Providing support and advice to fellow professionals
I should have been clearer in my original post. The trustees wish to make a distribution of retained income, which includes income from both the current and previous years. The income from previous years has not been accumulated, in that the trustees have made no decision to add it to the capital of the trust fund, but it has been invested. I do not believe investment of the income automatically makes it capital, and the value has been shown in the accounts simply as retained income.
The problem the trustees face is one of liquidity. They don’t hold enough cash at present to make the income distributions and would prefer to defer selling investments until the next tax year, to avoid CGT, as they have already used their allowance. However, it would be better for the beneficiaries to receive the income this tax year, as their income is likely to increase next year. That is why I wondered about the effectiveness of a resolution.
I have also considered whether the income distribution could be satisfied by an appropriation of investments with an accompanying claim for holdover relief, but as there are a number of beneficiaries involved that would get rather messy.
I’m not sure whether the above additional explanation affects your analysis?
I agree that the investment of the income should not automatically cause it to become capital, although believe that there was a case a few years ago where the court held otherwise, and one before that where the court held that the trustees needed to formally resolve to accumulate if the income were to be capitalised. HMRC has taken a middle course with the inclusion of income which remains undistributed for 5 years or more being caught in the IHT periodic charge. I understand that whether or not income has actually been accumulated by being invested is probably still an open question.
In the present instance, that the trustees are holding undistributed income means they could satisfy the distribution immediately upon making the resolution should they so wish. I therefore think it may be difficult to successfully argue that for income tax purposes the distribution is due at the date of payment, rather than when the resolution was made, unless there is anything within the resolution which suggests payment will be made at a later date.
If the trustees intend that for income tax purposes the distribution should be made in the current tax year, regardless of the date of payment, provided that the resolution does not indicate any deferral of payment I suggest that is the position that currently exists. Should the resolution refer to the payments being made only once cash is available, investments could be realised in good time to enable the distributions to be made in the current tax year. Had there been no undistributed income, I would not have revised my analysis.
Paul Saunders FCIB TEP
Independent Trust Consultant
Providing support and advice to fellow professionals
I don’t think I need to modify my above responses in the light of the above additional information.
Regarding “I have also considered whether the income distribution could be satisfied by an appropriation of investments with an accompanying claim for holdover relief” any receipts by the beneficiaries would be a receipt of capital and not income; broadly, appointments out of trust capital are capital on the part of the beneficiary (unless such payments are to top up the income of the beneficiary).