Tax double jeopardy?

Trusts Discussion
1

Our IIP trust has moved from mandated savings income to a mix of investment and savings income disbursed by the trustees - so we’ll have to start paying tax and issuing trust income statements.

In moving to the new mix of investments, we ended up having to move the money through one of the trustees’ personal accounts. That account has received interest payments on the trust funds as well as on existing personal funds. We’re trying to work out whether both the trustee and the trust will end up paying tax on the same interest payments?

Even though the account is held in the name of an individual, is it possible to hypothesis the interest applicable to the individual and the interest applicable to the trust and only pay the respective taxes due?

The trustees currently work on a pro bono basis - so a “work around” we’re considering is to make an administrative charge to the trust. This should reduce the taxable income for the trust and we pay the trustee for their services - restoring us to an equitable position?

2

I won’t comment on the banking arrangements (!) but presumably you can make a reasonable apportionment of the interest arising based on the relative amounts of personal and trust cash in the account at any time and the prevailing interest rate (of which the bank will have told the account holder - usually as a note on the statements).

I would do a spreadsheet detailing every transaction in the period when the funds were mixed, with separate columns for personal and trust monies and a total running balance. Then apply the interest rate accordingly immediately before each balance change. You should reconcile your calculations of interest to the figures of interest paid by the bank. I see no reason why each party would/should pay tax on the other’s interest.

I would imagine that the terms of the account specifically prohibit its use for anything other than personal funds so if your financial adviser / their platform, or your stockbroker can’t manage the cash (unlikely) I would suggest you open a trust bank account. There are other very good reasons not to mix personal and trust funds /assets. I am assuming you are a lay person as you have presided over these arrangements and are asking this question. If you have not recently taken professional advice on running this trust I would suggest you do so now. I am hoping you have taken professional investment advice but if not then again I would strongly recommend you do so now, from someone who is familiar with investing for trusts.

Beneficiaries can and will go after trustees who have not fulfilled their duties properly. Taking proper trust/financial advice is pretty fundamental to being a trustee and should prove to be in the interests of all parties.

Sara Spencer | Trust Manager

www.trustandestate.co.uk

Sara Spencer Ltd, 8 Kingsway, Harrogate, HG1 5NQ

07952 651881 | 01423 524114

Sara.spencer@trustandestate.co.uk

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3

Thank you Sara - much appreciate the time you’ve spent addressing my questions!

  • re: banking arrangements - agreed (!)
  • re: spreadsheet - exactly what I’ve done, all be it a black art how FIs actually calculate interest - I can reconcile to within £1 which I thought was OK
  • re: separate account - agreed. It was only ever meant to be a short term measure to move the money from NS&I to investments via a personal account.
  • we engaged an IFA for advice and have invested through them in a balanced income portfolio actively managed by the IFA
  • we started this process in November last year and finally had the investment account opened on 16th February and started moving money to the account … on the 24th February Putin invaded Ukraine and the markets dived … we’ve held back moving the bulk of the money into investments … so it’s stayed in a personal account
  • we’re now looking at opening an instant access savings account to hold this cash while we slowly drip feed into investments hoping Putin doesn’t spring too many more surprises

Still not sure what to advise the trustee who will get a tax certificate for all the interest earned but whether to only declare a portion of the interest on their tax return?

4

The income tax position is not straightforward. The fact that the trust is IIP may simplify it a little. One analysis is that the interest is the trustee’s own income and he must pay income tax on it at his own rates. He must be under an obligation to make good the trust’s loss, What is the quantum, gross or net? If the income had arisen in a trust account it would have been taxed as the life tenant’s income. So the loss is the net amount to the life tenant (not to the trustee and they may be quite different). It is not income for tax purposes but it would surely be reasonable, indeed equitable, for the trustees to treat it as belonging to the life tenant. HMRC might not like this if the tax paid by the trustee is much less than what the life tenant would have paid. If it is the only proper analysis they can’t complain.

An alternative analysis is that the income was impressed ab initio with a constructive trust so the trustee pays the gross to the trust and the life tenant is taxed on it as income. This is a fairer result though I am really not convinced it is good law, given that it is not actual income because from a mixed fund arrived at by deduction albeit using a method which is, as it must be, reasonable plausible and logical. HMRC might go for this and the main concern for the trustees but not for HMRC is whether they might face a later challenge. My hunch is that the remainderman almost certainly can’t complain and cannot argue for the first analysis on the grounds that the trustee’s payment of compensation was capital. Depending on where the remainder lies it may be possible to get agreement to this second argument.

I do not think it wise to simply make a tax return or returns on the chosen basis and hope. I’m assuming the amount at stake is not de minimis. 50 even 30 years ago you could have phoned the DI and suggest you pop round to speak to him. One of my early mentors was an ex-DI who saw his role to extract the maximum amount of tax that was due to the Exchequer and ideally fair to the taxpayer and to settle without a long wrangle over the niceties. I fear this route belongs to what Maxine has adroitly called"a former life". You may have to put forward a proposal in a moderately but not too obsequious letter. You are at liberty to put forward initially only one analysis. Double economic taxation is perfectly possible but even in 2022 I believe HMRC will be amenable to a solution that proposes a single tax charge.

The first analysis above is much more tricky with a discretionary trust. Income taxed at the trust rate can go into the pool and frank distributions to beneficiaries, with the occasional optimum result that their personal allowances will generate total or partial refund of the trust tax, so that it is more of a prepayment than a cost. Compensation for breach of trust is not income and measuring the loss to the trust is therefore more difficult. Because the income tax liability of beneficiaries is not necessarily symmetrical with that of the trustees it is not a foregone conclusion that capital both received and distributed as such is not taxable to the beneficiary and, if it is, there is no corresponding tax in the pool to frank it. This is very messy and is a practical counter argument against the first analysis: i.e. to be correct it must surely work for any type of trust.The second analysis would work well for any type of trust. My mentor would have settled on that basis and moved on. Any challenge to the settlement would surely not be able to overturn the tax treatment which (as per s54 TMA 1970) is or can be contrived to be a matter between HMRC and the taxpayers (and that excludes the remaindermen). I doubt a Chancery judge would entertain a breach of trust argument from such a party and if he or she did exoneration under s61 TA 1925 would surely apply (but I was a non-contentious lawyer and stand to be corrected on that and the above two analyses by a litigation necromancer).

Jack Harper

5

@jack @SaraS Following your suggestions last month, I attempted to phone the HMRC Trusts section (found a number: 0300 123 1072). I tried three times and each time after navigating various menus and listening to recorded messages … I was told to phone back when they weren’t so busy and summarily cut off after 4:30 minutes. I then took Jacks suggestion and wrote to HMRC Trusts proposing we declare the interest earned suitably apportioned to the trust and the trustee.

That was a few weeks ago and as I’d received no reply I thought I’d try phoning again today. Bingo - after 45 minutes (!) on hold, I managed to speak to a real person.

I explained our predicament and they kindly advised that what we were proposing would be quite acceptable - as long as the interest declared by the trust and the trustee added up to the interest accrued in the accounts. We should explain the circumstances in each tax return (21.9 for the trust’s return) and that would be accepted by HMRC.

Many thanks for your help - thought I’d leave the outcome in TDF in case others trip over the same problem.