I am looking at a standard discretionary trust deed drafted by solicitors in 2010 with Husband and Wife as the Settlors. The only trust asset is the matrimonial home, which was owned jointly by H and W.
The discretionary trust excludes H and W from benefit, so from that point of view, it is not Settlor-interested for any tax purpose.
However, for the bulk of the period since 2010, H and W have continued to occupy the property rent free. Therefore, it is clearly a GRoB.
Can it be a GRoB and not Settlor-interested? Or does the actual occupation of the property override the exclusion clause in the Will, rendering the trust Settlor-interested?
I hasten to add that I was not involved at the outset and I am struggling to understand the rationale for creating the trust in the first place. It appears to have made the tax position worse!
If the trust excludes H and W then rent-free occupation has been provided in breach of trust. For income tax it is doubtful whether such a consequence should be taken into account. TSEM is silent. s625 (1) ITTOIA 2005 requires that trust income or property is applicable or will or may become applicable to the settlor or spouse. Contrast s169F (3) TCGA which additionally operates where a benefit is derived directly or indirectly from it. It thus seems open to question whether a de facto benefit in breach of trust is covered for income tax whereas it is for CGT. The CGT section was inserted by FA 2004 whereas the income tax provisions though re-written in 2005 go back much earlier. Did HMRC wake up to a defect? If so why did they not clarify the income tax provisions.
I suspect that they would argue that the occupation was part of a single arrangement with the trust, especially as the trust property was the matrimonial home before being settled and presumably immediately after. As there is no trust income the the point is academic in this case. But for CGT presumably PPR was claimed when the house was settled. As hold-over relief would not have been claimed s226A TCGA will not prevent PPR applying to a gain on sale or distribution by the trustees or a hold over relief claim for any part gain not so relieved
As the house was settled after 2006 the transfer in was a chargeable transfer for IHT. Despite being a GROB there can still be interim and anniversary IHT charges on the trust. What is the nature of the occupation rights? If an interest in possession could have been granted lawfully there would be no charge under s65(1)(a) because the trust would have remained an RPT. But was the permitting of occupation a depreciatory “disposition” within s65(1)(b) or failure to terminate it an omission within s65(9)? There is an argument that a disposition in breach of trust is not covered but unless the couple were granted a legally enforceable tenancy (which would be highly unlikely) the reduction in value of trust property through the disposition/omission would be negligible as they could be evicted in fairly short order. If they do move out they are deemed to make a joint PET: s102(4) FA 1986. The reason does not matter and might be a sale but the risk could be insured. It would not prevent further IHT trust charges.
We are not given the identity of the trustees but they may be the two spouses. In principle there is a risk of a breach of trust action by those who are beneficiaries. The trustees probably have wide powers and while they cannot appoint to the spouses they may be able to use them in favour of adult objects who are family and who can indemnify them under s61 TA 1925. I can’t assume the general means of the spouses but an outright appointment to adult children, ending the trust might allow the latter to gift the house back to their parents. It is vital that this should not be a fraud on a power, which would be a void appointment and HMRC inter alia could argue the point, but an arrangement that the children allowed their parents to live in the house on generous terms would seem safe and might even come within s11(4)(6) IHTA. If not the loss to donor should be small, if the parents’ occupation was as precarious as the law allows, and would be a PET under s3A(2)(b).
On reflection I question availability of PPR to the trustees (H and W do not occupy “under the terms of the settlement”) so hold over relief would probably need to be claimed on a disposal.
I wonder if the situation might be classified as a sham, resulting in there being no trust and the settlors’ ownership continuing for both IHT and CGT purposes? Not sure who would have sufficient standing to argue the point, though.
Paul Saunders FCIB TEP
Independent Trust Consultant
Providing support and advice to fellow professionals
On the way into the trust, I have assumed that PPR relief would apply. It was the matrimonial home throughout the prior period of ownership.
The Trustees are family members. On a practical level, I doubt the breach of trust argument will be taken up.
The Settlors have now moved out of the property, but only relatively recently. Therefore, the reservation has been released and is now a deemed PET by each Settlor instead.
My analysis is that on a sale of the property, the Trustees cannot make a claim for any PPR relief because under the terms of the trust, the Settlors were excluded as beneficiaries. Therefore, the Trustees could not exercise their powers in favour of the Settlors to allow them to occupy.
Any future sale of the property will crystallise a large capital gain. The most likely route to mitigate that liability is for the Trustees to appoint out the property to a number of the beneficiaries, claim holdover relief on the appointment out, and then sell as bare trustees so that the gains are made in the hands of the beneficiaries (with multiple personal allowances available and lower rates of tax to apply hopefully). Does anyone see an issue with that?
My initial question really boiled down to whether a GRoB in a trust automatically results in the trust being Settlor-interested (even if the trust deed purports to exclude that scenario)?
I am not sure on the sham front. It is a professionally drafted trust deed (although, not the best!) and the property title has been transferred to the Trustees at the Land Registry, which would suggest it wasn’t intended to be a sham. Then against that, the Settlors continued to live there rent-free for nearly all of the trust’s lifetime to date.
Apologies, as this is off the top of my head; is there any Hastings-Bass equivalent for Settlors that are mistaken as to the tax consequences of a trust they create?
The term “settlor interested” is not a term used for IHT purposes; only, income tax and CGT.
In the absence of further information and based on the definition of “sham” I doubt that the structure would be open to attack under this doctrine.
Jack notes a difference in the definition of “settlor interested” as it applies to income tax versus CGT. I don’t, however, believe that this difference could give rise to a difference in tax treatment where a breach of trust has occurred.
The CGT definition comprises two aspects which would constitute “settlor interested”, namely, (1) where property in the settlement IS or WIILL or MAY become payable to/for the benefit of the settlor et al [s169F(2)] OR (2) where such property IS de facto applied for their benefit [s169F(3)].
The income tax definition simply lacks explicit reference to de facto application of property for benefit of settlor et al (ie (2) above) [s625(1)].
In any case, if a beach of trust has occurred (ie due to the trustees’ action) it would seem harsh to then tax any person who benefited therefrom (assuming no collusion). Surely, when reading and interpreting the definitions in the TCGA and ITTOIA the settlor et al must be treated as benefitting only where the trustees do not step outside the terms of the trust deed.
My initial question really boiled down to whether a GRoB in a trust automatically results in the trust being Settlor-interested (even if the trust deed purports to exclude that scenario)?
It’s possible for the donor of a gift into trust to fall within the definition of “beneficiary” and thus the trust is settlor interested. However, if the donor/beneficiary does not enjoy the trust property within the 7 years prior to death no GWR arises.
If however the donor enjoys the trust property during this 7 year period a GWR arises and the trust would be settlor interested.
So if a GWR arises the trust will be settlor entered but a trust many be settlor interested without a GWR arising.
Where a breach of trust occurs then I do not believe a GWR arises.
On the question of a sham, regardless of the steps that might be taken to give the illusion of “correctness” it is the intention of the settlor(s) and trustees that together give rise to a “sham” if that common intention is to do something other than appears on the “face” of the trust. On the facts, as currently known, it could be argued that the settlors intended to continue in occupation, and the trustees were aware of that intention when they took up their role, which could give rise to the allegation of a sham.
If it is claimed that the settlors created the trust under a mistake as to the consequences thereof, it may be open for them to apply for the trust to be set aside although, as identified by the Supreme Court in the conjoined cases of Pitt v. Holt and Futter v. Futter the bar is set reasonably high for a claim in reliance on the equitable doctrine of mistake to be successful.
Paul Saunders FCIB TEP
Independent Trust Consultant
Providing support and advice to fellow professionals
1 There is insufficient information to determine the sham point. In a bilateral trust both settlor and trustees must have a common intention to mislead amounting to dishonesty. This is a subjective test and notoriously hard to prove by the person alleging it, who has the burden to the civil standard. A professionally drafted trust will carry a degree of presumption of validity. A sham is void, so HMRC can argue it, but it is valid until declared void. A proponent will have to litigate it. It is a drastic outcome for non-culpable beneficiaries. The court will regard culpable parties as estopped from arguing it as a defence.
2 The landmark analysis of Hastings Bass and mistake is Pitt v Holt [2013] UKSC 26 per Lord Walker. If a decision is outside the trustees’ powers it is void (“excessive execution”) and not truly part of the rule. If it is within their powers it can be voidable if, by breach of their fiduciary duty, they fail to give proper consideration to all relevant matters. This is the true rule and the court has a discretion, so litigation is a sine qua non.
A mistake by the settlor or trustees must be causative, of sufficient gravity, and would result in injustice if left uncorrected. It may be as to the legal effect or nature of the disposition or transaction or as to its consequences, including tax. The court has a discretion, so it must be litigated. We do not know here what the parties did about tax (if anything) and if they received advice.
HMRC will not readily concede a point which turns on the court’s discretion unless it is litigated and they tend to sit it out and await the outcome.
3 Here H and W have moved out so no possession order is required. As they are not beneficiaries allowing them to occupy was outside the trustees’ powers and so void. HMRC can surely tax as if it was valid until a court declares otherwise. They might accept the point in a contract settlement.
4 There seems to be no authority on the tax consequences of an act that is in breach of trust. It seems likely to me that the possibility of such an act is too remote to engage settlor-interested provisions based on what "may " or “will” happen. But they may be if one actually happens. The actual receipt of a “benefit” is clearly caught for CGT (and for income tax under s732 ITA 2007) but apparently not for the Settlement rules. Unless it is a “capital sum” within s634(1)(b) ITTOIA 2005 and rent-free occupation is not a “sum”. The definitions of a settlor being “interested” are simply not aligned across the entire tax code. Nor its effects. Only s86 TCGA taxes a gain on the settlor as s77 has been repealed. Sch 4A deems the trustees to make a disposal and be taxed on the gain, not the settlor though he may be taxed the gain from his own actual disposal.
5 I therefore disagree with Malcolm. I accept that the GROB rules are not engaged on the basis that a reservation might arise by a breach of trust. But if it does arise HMRC are entitled to regard those rules as engaged unless a court declares that the triggering event was void from its inception.