An earlier exchange (I think March 2024) ‘Trust for variable service charges and expenditure’ covered a lot of ground but largely ignored the tax position of sertvice charge trusts governed by S.42 Landlord & Tenant Act 1987. IMost in England are affected. I suggest that the lessees (‘tenants’ in the Act) are all settlors of the service charge trust, to a proportional extent; which are therefore 'settlor interest’ed. Consequently, save where a lessee is a non-resident or deceased, the lessee is taxable on the appropriate proportion of any income arising tothe trust. The trust would seem to be one without an interest in possession, and theoretically subject to inheritance tax in accordance with chapter III of Part III IHTA 1984.
I think this is either ignored, misunderstood or overlooked by HMRC. What are the views of contributors to the forum?
I don’t see that paying a service charge that is legally due under a lease, and which the tenant has no choice in paying, has any element of bounty. Obviously that will be fact specific but in a normal situation (e.g. where tax avoidance is not at stake), I doubt if many tenants will believe, or would be happy paying, more than they are required to.
CIR vs Plummer is relevant as to whether there is an “element of bounty” for there to be an income tax settlement.
Your article says:
Section 42 of Landlord and Tenant Act 1987 refers to defining a gift in relation to a transfer of value, but an unintended gift is still a gift.
I know little about s42 but I can’t see it refers to a gift. I can see some deeming rules (e.g. “the contributing tenants shall be treated as entitled … to such shares in the residue of any such fund as are proportionate to their respective liabilities to pay relevant service charges”). But, as far as I can see, none of that says there is an actual or deemed gift.
So on the assumption that there is no bounty, I struggle to see how the settlements legislation can apply to tax the tenant on the s42 trust’s income.
There was a Special Commissioners decision (Retirement Care Group Ltd (as trustees) v Revenue & Customs) that said that, because the trustees of the s42 trust could accumulate income, the trustees are liable for income tax at the rate applicable to trusts. Presumably, if HMRC thought that the s42 trust was a settlor-interested trust then they would have taken that point in that case.
I agree with your article that s10 IHTA would apply to the payment of service charge.
I’ve never had to look at this point in any detail before but I had assumed that “bounty” point did not apply for s43 IHTA (e.g. Nader vs HMRC) because specific exemptions are required from the relevant property regime (e.g. for s86 trusts). As such, I could see why the exit / ten year charge might be relevant to a s42 trust.
If they were relevant, then I’d let others work out the complications. For example, a building with 1,000 flats may have, say, 1,500 tenants (sole individuals, joint individuals, estates of deceased individuals, overseas individuals, close companies, overseas companies, etc) and the s42 trust would need to be apportioned to 1,500 notional trusts. Then lots of cash would have been paid out in the first three months and so there would be no exit charge anyway. Some trusts may have big service charges and big reserves so I could see that there could be the potential for some tax. But I have no experience of that. So unless other people have ideas, as your article suggests, providing a limited exemption from the relevant property rules would make sense (e.g. exempt unless part of a scheme to avoid tax).
I don’t know much about the gifts with reservation of benefits rules that your article mentions. But I struggle to see how the payment of a compulsory service charge is a gift (and I know gift in not defined in FA1986).
Your article suggests another alternative would be to treat them as bare trusts. I personally think that would be horrible. Imagine the extra admin in trying to get a tenant’s share of the trust’s interest to include on their tax return. And trying to get a deceased’s share of the balance of the funds in trust (after accrued liabilities) on the date of their death.
I think an extra issue is what happens if the actual lease says something on top of the s42 provisions (e.g. the tenant can get a refund of an excess by asking nicely).
I am pleased to see so much attention to my Tax Adviser article.
There is no bounty requirement for IHT for a settlement. Instead, when considering someone as settlor making a transfer of value, S.10 IHTA 1985 offers an exclusion. But the settlement receiving the property - the service charge - still exists, as one without an interest in possession. S.58 et seq applies.
I agree that S.42 LTA 1987 does not refer to a gift.
Despite Plummer, the definitions of settlement and settlor in S.620 ITTOIA 2005 are wide enough for consideration to be given to S.625 ibid. However, it is convenient to accept HMRC’s view that the trustees are chargeable.
S.102 FA 1986 refers to a gift, which S.42 IHTA 1984 seems to equate with transfer of value. If a lessee’ payment of service charge is seen as made to enable the trustees to meet the costs of common parts, there isn’t an absence of gratuitous intent. Thus S.102 would apply.
I agree with you that implementing the legislation as I have suggested would be complicated.
As to the idea of bare trusts, I don’t see this as any more complicated.
As regards your final Paragraph 14, under S.42(9) LTA 1987 the provisions of a lease made before that section’s commencement will prevail, and also in the case of the ‘sole contributing tenant’ if before the commencement of Para 15, Sch 10 Commonhold and Leasehold Reform
Act 2002. Otherwise S.42 prevails in England and Wales.
Quite, Jack, the term transfer of value is a “statutory definition” which unfortunately is taken to mean and include more than it can comprehend even in any cartoon strip of deeming.