We act for the trustees of a discretionary trust who own a commercial woodland. It was anticipated that the trees would be felled in about five years time, but there was significant storm damage last autumn/ winter and the windblown trees are going to be sold shortly before the end of the current tax year.
The trustees have no power to accumulate income.
As you know, any profits or gains arising from the occupation of commercial woodlands are wholly outside the scope of Income Tax, so the trustees will have no tax liability on the proceeds. So far so good.
However, as they must distribute the income and normally speaking income from a discretionary trust loses its character when paid to beneficiaries, does this mean that when the proceeds of the windblown trees are distributed to the beneficiaries, there will be a tax pool charge? This just doesnât seem right to me as the income is exempt in the hands of the trustees.
And if there is no tax pool charge, how do we report the income distribution to HMRC? If you show it in the section you would normally use for income distributions, our software will automatically generate a a charge.
I canât claim to fully understand this area, but there does seem to be a suggestion that the sale of felled trees is a capital item (albeit free from CGT/CT). In that case youâd need to consider IHT exit charges in principle - and while there is relief from IHT for commercial woodland itself, it seems that there can be occasions when IHT applies to felled trees sold for timber (under âwoodland reliefâ) but the rules are not clear to me.
This is from Cronerâs online library - para 570-450 âActivities regarded as a trade for roll-over relief purposesâ
"âŚthe commercial occupation of woodlands (although the profits of this activity are exempt from income tax, a chargeable gain may still arise on the assets used in that activity and the underlying land on which woodlands are planted (sometimes called the â solum valueâ)): growing timber is exempt from CGT when disposed of by the occupier (TCGA 1992, s. 250(1) );
I interpret that as if the trustees were selling the woodlands, only the land would be liable to CGT. In this case, they are not disposing of âgrowing timberâ, but timber which has been felled.
1 The initial question is whether the sale proceeds are income or capital in trust law. The Law Commission said in Law Comm 315 at page 30:
"Timber and trees
Generally, receipts from the sale of âtimberâ are classified as capital and receipts from the sale of other wood are income. The reason is that the income beneficiary is not usually entitled to cut timber. However, where the timber is cultivated to produce saleable timber as part of a timber estate and timber is cut periodically, the periodical cuttings can be viewed as âpart ⌠of the annual fruits of the landâ.
Honywood v Honywood (1874) LR 18 Eq 306, 310. This case also establishes the meaning of âtimberâ: a tree will be âtimberâ where it is oak, ash or elm; it is at least 20 years old; and it is ânot so old as not to have a reasonable quantity of useable wood" (per Jessel MR). Trees that do not fall within this definition may nevertheless be classified as timber according to the local custom of the county".
Sale of growing trees plus land is clearly capital, though there can be CGT on a gain from the land as stated by pjhorn. Many woodlands will comprise or include conifers with an optimum gestation before felling of less than 20 years. I am not aware of HMRC having a pop at Sitka Spruce or Douglas Fir etc but I tended to advise in step with a specialist surveyor wot knew his onions (and his trees).
2 If the proceeds are income then they are free of income tax (see BIM67701). So no input to the pool and. yes, a distribution of income from a DT must suffer 45%. Can a beneficiary be given an IIP revocable or for a fixed period before the income arises?
If the proceeds are capital they should be distributable as capital for tax purposes: see TSEM3781-3790. Stevenson v Wishart is the leading case. Critically trustees should have the power to distribute capital to the beneficiary in question and exercise that power with a prominent mention of âcapitalâ in the minutes of the resolution of instrument of appointment so clear that even a tax officer (whether or not âfully-trainedâ) cannot miss it. CGT does not apply but there is no relief for RPT IHT charges: IHTM04374 penultimate bullet. A sale can trigger an IHT charge by reference to an earlier death when deferral relief was claimed:see ss 125-130 IHTA.
Agreed - and Jack Harper has since (far more comprehensively) dealt with the capital vs income argument. Thank you, Jack.
Had it been income, the idea of a prior revocable IIP had also occurred to me as a possible way around the tax pool/trusteesâ secondary liability problem. The potential IHT issue appears more of a challenge though. Good luck!