Mandy Connolly
Tax Manager
Praxis Fiduciaries Limited

Judicial authority for the deductibility of trustee management expenses

The amount of trustee management expenses (“TMEs”) chargeable against income is of relevance to discretionary trusts with a view to calculating the trustee’s tax liability and to interest in possession trusts in respect of the amount of income taxable on the life tenant.

Back in 2006, HMRC published some controversial guidance notes outlining their views on the deductibility of TMEs. A particular point of contention was HMRC’s position on trustee fees which they considered to be wholly chargeable to capital.

Earlier this year, the case of HMRC v Trustees of the Peter Clay Discretionary Trust was settled by the Court of Appeal. As a result of the case, there is now judicial authority for trustees to claim an apportionment of expenses against income. Whilst this has clearly improved the position, trustees must consider carefully the justification for any apportionment made (e.g. by reviewing time records etc.).

It was also held that any expenses incurred for the benefit of both income and capital beneficiaries (i.e. “for the benefit of the whole estate”) could not, as a point of law, be apportioned. This would apply for example, to any “responsibility fees” charged for the provision of trustee services.

The case also highlighted the position regarding investment management fees. Such fees would be considered to be capital expenses unless they related to the temporary investment of income prior to a decision being made by the trustees as to whether the income should be distributed or accumulated.

Whilst the Peter Clay case related to a discretionary trust, it is likely that the principles will also be followed in relation to interest in possession trusts. The issue will not affect settlor-interested life interest trusts as no account is taken of trustee expenses in calculating the income of the settlor. However, it is of relevance to settlor-interested discretionary trusts as the trustees are now required to pay tax at the Rate Applicable to Trustees and make the necessary entry regarding TMEs on the trust tax return (albeit that the tax payable by the trustees is available as a credit to the settlor).

Loan Benefits Arising from the Drop in Base Rates

The last year has seen a dramatic drop in base rates, however the HM Revenue & Custom’s Official Rate of Interest has been slow to follow, only moving from 6.25% to 4.75% on 1 March 2009.

Where loans have been made to UK-resident beneficiaries from an offshore trust structure on commercial interest-bearing terms a capital benefit should previously have been avoided. However, the position should now be reviewed to establish whether the interest payable under the terms of the loan agreement is less than the interest calculated at the HMRC official rate. If so, a taxable benefit will be in point in respect of the difference which may be chargeable to income tax under the offshore anti avoidance provisions of section 731 ITA 2007 or to capital gains tax under section 87 of TCGA 1992.

It should also be noted that if a loan benefit does arise in this manner, it would be treated as a capital payment for the purpose of triggering the time limit for the trustees to make a rebasing election – a deadline not to be missed for trusts with UK resident but non UK domiciled beneficiaries. An election triggered by a capital payment in 2008/09 would need to be made by 31 January 2010.

Employment-Related Trusts – Loan Benefits Arising from Non-Payment of Interest

As outlined in section 175 of ITEPA 2003, a taxable cheap loan is one on which either no interest is paid or the interest paid is less than the interest that would have been payable at the HMRC official rate.

The legislation makes reference to the fact that interest must actually be paid on the loan for the tax year in question in order for it to be taken into account when calculating the taxable benefit. An obligation to pay the interest must also have existed in the tax year. This notwithstanding, it is probably considered by many practitioners that, providing the interest payable under the terms of the loan agreement is in excess of that payable at the HMRC official rate, no loan benefit would need to be reported by the sponsoring company on the employee/beneficiary’s form P11D. It is often the case that loan interest is not paid annually but rolled up, possibly with a view to settlement from the beneficiary’s estate or waiver by the trustees on death.

Previously, H M Revenue & Customs may not have actively pursued the point regarding the payment of interest although it is understood that they may now be considering the position more closely.

With this in mind, beneficiaries should consider the timing of their interest payments. As interest needs to be paid for a particular tax year it would be reasonable for any payment made before the beneficiary’s assessment becomes final to be taken into account when calculating whether a benefit arises for the year. Strictly, this timeframe may extend to the closure date of HMRC’s window of enquiry for the year although practically speaking it may be simpler to consider whether the interest is likely to be paid by 31 January following the end of the tax year.

If the interest is paid at a later date, relief for the tax paid on the benefit is available under section 191 of ITEPA 2003, although this would need to be claimed within the specified time limit of currently 5 years and 10 months from the end of the tax year in question. As outlined in this year’s Budget (BN 87), the time limit will be reduced to 4 years for claims made on or after 1 April 2010.

Capital Payment Planning for UK-Resident Non-Domiciled Beneficiaries

In order to ensure that trusts with UK-resident non-domiciled beneficiaries are administered in the most tax-efficient manner following the new rules introduced by Finance Act 2008, it is useful to be aware of the trust’s previous capital gains and capital payments history (even though they may not give rise to any direct tax implications to the extent they relate to the period prior to 6 April 2008). It is also important for trustees to be pro active and consider the position of the current tax year before the year end to avoid any unwelcome surprises at a later date.

It may be the case that relatively few gains are likely to be realised by trustees in the current tax year, although it should be borne in mind that significant exchange gains could arise due to the drop in sterling compared to both the Euro and the US Dollar.

If a gain with a significant taxable element (i.e. post 5 April 2008 element where a rebasing election is made) is to be realised in the current tax year, trustees should consider the timing and location of capital payments. For example:

If there were unmatched capital payments made to beneficiaries in the UK in 2008/09, it may be worthwhile making an offshore capital payment in the current year to a UK-resident non-domiciled beneficiary (providing they are claiming the remittance basis for the year). Current year capital payments match to gains in priority to those brought forward from an earlier year and as such the tax on the attributed 2009/10 gain can be deferred until such time as the capital payment is remitted. It would otherwise be immediately taxable by reference to the previous year’s UK capital payment.

In addition, if any offshore income gains are to be realised in the current tax year, trustees may wish to consider making an equivalent capital payment to a UK-resident beneficiary before the year end. This ensures that the gain is matched under the capital payment regime of section 87 TCGA 1992 (rather than the income tax rules of section 720 and 731 ITA 2007) and as such, the gain is eligible for rebasing, thus exempting the pre 6 April 2008 portion of the gain from tax.

Trustees should always consider whether there is any undistributed stored-up income or earlier year’s offshore income gains in the structure as capital payments match to these in priority to trust capital gains.

To Stay or Go….?
UK-resident trustees should review the merits of moving trusts offshore to access the capital gains tax deferral environment. A common obstacle has often been the deemed disposal on export. However, given the recent economic climate, it may be that some of the trust’s assets are currently yielding losses which would reduce if not negate the capital gains tax liability. There’s no time like the present.