Policy paper

Statement of Practice 5 (1992)

Published 21 May 1992

I. Introduction

1. Finance Act 1991 ss 83 to 92, Sch 16 to 18 introduced new rules for Capital Gains of certain offshore trusts. These are now in TCGA 1992 ss 80 to 98, Sch 5. This statement explains the practice HM Revenue and Customs (HMRC) will follow in applying the new rules in the circumstances set out below. Statutory references are to TCGA 1992 unless indicated otherwise.

II. Charge on migration - residence

2. Under TCGA 1992 s 69, a body of trustees is regarded as capable of changing its residence status part-way through a year of assessment. It must be borne in mind, however, that TCGA 1992 s 2(1) provides that the trustees are liable to tax on all chargeable gains of a tax year during any part of which they are resident or during which they are ordinarily resident in the UK.

3. Trustees who became not resident and not ordinarily resident in the UK between 6 April 1990 and 18 March 1991 (inclusive), and remain so until after 5 April 1991 are not liable to a charge under TCGA 1992 s 80, nor are they regarded as having met the condition in TCGA 1992 Sch 5 para 9(4) for 1990 to 1991.

III. Charge on migration - past trustees’ liabilities

4. TCGA 1992 ss 80 to 85 impose a Capital Gains Tax charge on the unrealised gains of a UK trust which ceases to be within the UK tax charge. The charge applies to a trust which migrates on or after 19 March 1991. Where the tax which is due under this charge is not paid by the current trustees, TCGA 1992 s 82 enables HMRC to look to certain former trustees to meet the liability. No liability can be sought from the personal representatives of a former trustee who dies before a notice of liability has been served on him. Those who can show that there was no proposal, at the time of their resignation, that the trustees might become not resident and not ordinarily resident in the UK are not liable under this section.

5. Payment can only be sought from former trustees where HMRC is unable to obtain payment from current trustees. In the first instance, payment will generally be sought from those persons who resigned as trustees immediately before the trust migrated and then from earlier trustees. Each case will, however, need to be considered in the light of the relevant facts.

6. An amount recovered from present trustees by a former trustee in respect of Capital Gains Tax under TCGA 1992 s 82 is not regarded as a capital payment under s 97. Further, such amounts do not fall within the provisions of Taxes Act 1988 Part XV, s 739 or s 740 nor are there any Inheritance Tax implications.

IV. Charge on the settlor - settlor’s right to repayment from the trustees

7. TCGA 1992 s 86, Sch 5 charge settlors to Capital Gains Tax where chargeable gains accrue within certain offshore trusts from which the settlor, members of the settlor’s immediate family, or companies which they control, can or do benefit. This goes wider than the provisions of Taxes Act 1988 Part XV eg, the settlor could be chargeable on gains realised within a trust from which his adult children could benefit even though there was no possible benefit to the settlor, his spouse or minor children.

8. The settlor’s right, under TCGA 1992 Sch 5 para 6, to reimbursement (or any payment in reimbursement) of tax paid under that Schedule is not regarded as creating an interest in a trust for the settlor under the provisions of Taxes Act 1988 Part XV where the settlor, the settlor’s spouse, and any companies in which they are participators cannot otherwise benefit from the trust, eg, where the only beneficiaries are the settlor’s children. Similarly, this statutory right to, or payment in, reimbursement is not regarded as bringing the settlor within the provisions of Taxes Act 1988 ss 677, 739, 740, nor as a capital payment for the purposes of TCGA 1992 s 97.

9. Further, this statutory right is not regarded as a reservation of benefit for Inheritance Tax purposes; nor is a provision in the trust deed either requiring the trustees to recognise the settlor’s right to reimbursement under TCGA 1992 Sch 5 para 6 or to reimburse the settlor. But where a settlor does not pursue the statutory right to reimbursement, the failure to exercise this right may give rise to an Inheritance Tax claim under IHTA 1984 s 3(3), in which case the usual rules for lifetime transfers would apply.

10. A provision written into a settlement deed requiring the trustees to recognise the settlor’s right to reimbursement under TCGA 1992 Sch 5 para 6, or to reimburse the settlor, is not, of itself, regarded as giving the settlor an interest in the settlement for the purposes of Sch 5, nor as bringing into play the provisions of Taxes Act 1988 Part XV, s 739 or s 740.

V. Charge on the settlor - certain trusts created before 17 March 1998

11. All trusts are within the scope of Schedule 5, except for those falling within the definition of ‘a protected settlement’ in paragraph 9(10A) at 6 April 1999. A protected settlement has to have been created before 19 March 1991. But a protected settlement will also be within the scope of Schedule 5 where, on or after 19 March 1991, at least one of the conditions listed below is met.

Moreover, a settlor is not treated as having an ‘interest’ in a trust created before 17 March 1998 under the terms of which the only ‘defined persons’ (listed in paragraph 2(3)) who can benefit are confined to the grandchildren of the settlor or of the settlor’s spouse etc, unless at least 1 of the conditions listed below is met on or after that date.

The conditions referred to above are:

• subject to certain exclusions, property or income is directly or indirectly provided for the purposes of the trust (paragraphs 2A(2) and 9(3))
• the trustees become non-resident in the UK or fall to be treated as such for the purposes of a double taxation agreement (paragraphs 2A(4) and 9(4))
• the terms of the settlement are varied to admit certain new beneficiaries (paragraphs 2A(5) and 9(5))
• a benefit is enjoyed by a defined person who is not a beneficiary under the terms of the trust (paragraphs 2A(6) and 9(6))

(Paragraphs 12 to 37 below only refer to paragraph 9, but the same principles will be followed in deciding whether any of the conditions in paragraphs 2A(2) to (6) are met).

(a) TCGA 1992 Sch 5 para 9(3): transactions entered into at arm’s length

12. The condition in TCGA 1992 Sch 5 para 9(3) is not met where the property or income is provided to the trust under a transaction entered into at arm’s length - see para 9(3)(a). This applies irrespective of whether the parties to the transaction are connected persons under TCGA 1992 s 286. Each case depends on its own facts and circumstances but a transaction is, in general, regarded as being at arm’s length where all the facts and circumstances of the transaction are such as might have been expected if the parties to the transaction had been independent persons dealing at arm’s length ie dealing with each other in a normal commercial manner unaffected by any special relationship between them.

13. Solely for the purposes of TCGA 1992 Sch 5 para 9(3)(a), a provision in the document governing the transaction for an appropriate adjustment to the consideration where the value agreed by HMRC differs from the original consideration arrived at by an independent valuer and specified in the sale document is, in general, regarded as falling within the terms of the above definition of an arm’s length transaction. The arm’s length value of the transaction is to be determined in accordance with the principles set out in para 12 above. This will usually correspond to the value for Capital Gains Tax purposes except, for example, where TCGA 1992 s 19 would apply.

14. It would also be necessary for the terms of the contract to provide for compensating interest at a commercial rate to be paid in either direction once the arm’s length value is determined. For this purpose, the official rate of interest for Taxes Act 1988 s 160 purposes will usually be regarded as equivalent to a commercial rate of interest, although a different rate may be accepted as so equivalent if the circumstances of a particular case warrant this treatment.

15. This practice is, however, subject to the consideration passing on sale being realistically based, ie, on a third party valuation by a qualified valuer, all the other terms of the transaction being at arm’s length and the compensating interest being timeously paid. The position in a particular case depends on all the facts and circumstances.

(b) TCGA 1992 Sch 5 para 9(3): close companies

16. The condition in TCGA 1992 Sch 5 para 9(3) may be satisfied where property or income is provided to a company in which the trustees are participators. Where, however, the transaction is carried out with the sole object of leaving funds within the company for the company’s purposes and it can be shown that any indirect benefit to the trust is merely incidental to that object, the transaction is disregarded for the purposes of para 9(3).

17. Examples of transactions which may be so disregarded are:

• where another shareholder waives an entitlement to all or part of a dividend or
• a director restricts withdrawals of remuneration voted

in order to assist the company’s cash flow, and no payments are made, directly or indirectly, to the trustees as a result of this. All relevant factors will be considered in determining whether it is appropriate to apply this practice in a particular case.

(c) TCGA 1992 Sch 5 para 9(3): transactions with wholly-owned companies

18. In general, transactions between trustees and companies which they, directly or indirectly, wholly own, or between such companies, are outside the scope of TCGA 1992 Sch 5 para 9(3) and are not treated as capital payments within TCGA 1992 s 97. For this purpose, a company is treated as directly wholly owned by the trustees where the whole of its issued share capital is directly owned by the trustees of the settlement for the benefit of the beneficiaries of the settlement. A company is treated as indirectly wholly owned by the trustees where the whole of its issued share capital is directly and beneficially owned by a company which is directly wholly owned by the trustees or it is the 100% subsidiary of such a company, or a chain of companies, which is indirectly wholly owned by the trustees. This approach may not, however, be taken where, on the facts of a particular case, it appears that the transaction has been entered into solely or mainly for the purposes of obtaining a UK tax advantage.

(d) TCGA 1992 Sch 5 para 9(3): loans made to settlements

(i) Loans made before 19 March 1991

19. A fixed-period loan made, directly or indirectly, to a relevant settlement prior to 19 March 1991 on non-commercial terms, eg, at a low or nil rate of interest is, generally, regarded as a provision of property in pursuance of a liability incurred before 19 March 1991, provided the loan remains outstanding on the same terms. As such, it falls within the terms of TCGA 1992 Sch 5 para 9(3)(b) and the first condition set out in para 9(3) is not met.

20. There would, however, be a direct or indirect provision of property for the purposes of the settlement where a fixed-period loan falls to be repaid after 18 March 1991 but repayment is not made and so becomes a repayable on demand loan.

21. An extra-statutory concession D41, which is being published at the same time as this statement, sets out the position in the case of non-commercial, repayable on demand, loans for the purposes of applying TCGA 1992 Sch 5 para 9(3).

(ii) Loans made after 19 March 1991

22. A loan made, directly or indirectly to a relevant settlement after 19 March 1991 on non-commercial terms, eg, at a low or nil rate of interest is regarded as a provision of funds for the purposes of TCGA 1992 Sch 5 para 9(3). This is the case whether the loan is for a fixed period or repayable on demand.

(e) TCGA 1992 Sch 5 para 9(3): loans made by trustees

23. The repayment of any loan made, directly or indirectly, to any person by the trustees is not generally regarded as the provision of funds for the purposes of the settlement under TCGA 1992 Sch 5 para 9(3). This does not, however, apply where more is repaid than is due under the original terms of the loan or, in the case of loans made after 19 March 1991, where the interest charged under the terms of the loan exceeds a commercial rate.

(f) TCGA 1992 Sch 5 para 9(3): failure to exercise rights to reimbursement

24. Failure, by or on behalf of any relevant person, to exercise statutory rights to reimbursement, eg, under Taxes Act 1988 Part XV may be regarded as the provision of funds for the purposes of the settlement under TCGA 1992 Sch 5 para 9(3). The settlement could remain outside the terms of para 9(3) where the exercise of the right to reimbursement is unsuccessful, provided it could be shown that there had been a genuine attempt to enforce rights to reimbursement.

(g) TCGA 1992 Sch 5 para 9(3): administrative expenses

25. As provided by TCGA 1992 Sch 5 para 9(3), a trust may remain outside the scope of Sch 5 where funds are provided to pay certain expenses which exceed the income of the trust. These expenses are defined as ‘expenses relating to administration and taxation’ and could be chargeable either to the income or to the capital of the trust. Only sums provided to meet genuine expenses of administration fall within the terms of the proviso: any payments which exceed such expenses are regarded as meeting the condition in para 9(3) and so bringing the trust within the scope of Sch 5.

26. The following items are not regarded as ‘expenses relating to administration’ within the terms of the proviso to TCGA 1992 Sch 5 para 9(3):

• loan interest (other than interest on a loan taken out to meet expenses of administration within the terms of the proviso)
• the costs of acquiring, enhancing or disposing of an asset
• expenses incurred in connection with a particular trust asset to the extent that such expenditure can be set against income arising from that asset

for the purpose of the proviso to para 9(3), the measure of the gross income from such a source is net of expenses

27. The term ‘expenses relating to taxation’ in TCGA 1992 Sch 5 para 9(3) is regarded as encompassing UK or foreign taxes to which the trustees are liable, along with any interest and penalties due on that tax. It could also include certain costs incurred by the trustees under the terms of the trust in obtaining information regarding the beneficiaries’ tax liabilities. One example might be where the trustees, in order to ensure they were acting in a beneficiary’s best interests, had to ascertain the tax implications for the beneficiary in adopting a particular course of action.

28. It is only the settlement’s expenses relating to administration or taxation which are within the terms of the proviso to TCGA 1992 Sch 5 para 9(3). Expenses of, for example, a company wholly owned by the trustees fall outside its scope.

29. An expense on capital account paid out of trust income is not treated as a provision of income by a beneficiary for the purposes of TCGA 1992 Sch 5 para 9(3) provided that either:

• the trust deed permits payment of capital expenses from income and the beneficiary is entitled only to net income after such payments or
• the trustees borrow money from the income account which is subsequently restored, along with interest over the period of the loan. The appropriate rate of interest is considered to be that which a Court of Equity would order on the replacement of trust income

30. Normally the specific date on which the liability to an expense relating to administration or taxation was incurred determines the year into which it falls for the purpose of applying the proviso to TCGA 1992 Sch 5 para 9(3). Where, however, the expense is incurred for a period rather than on a specific date, the basis of allocating expenses adopted by the trustees in preparing trust accounts or returns is, generally, regarded as acceptable provided that this basis is consistently adopted and is in accordance with conventional trust accounting practice.

31. Additions to meet the difference between expenses relating to administration and taxation and any income arising to the trust do not have to be made by 5 April in the relevant year of assessment. There must, however, be a clear connection between the amount added and the computed shortfall. Additions should, therefore, be made as soon as the relevant figures are available.

32. Income, for the purposes of the proviso to TCGA 1992 Sch 5 para 9(3), is the total income which arises to the trustees in the relevant year, rather than the income which is (or would be if the trust were resident in the UK) subject to UK tax. Usually, items of income will need to be allocated to the year in which they arise for the purposes of the proviso, but, in practice, income arising from a trade carried on by the trustees may be apportioned on a time basis, provided that this basis is consistently followed.

(h) TCGA 1992 Sch 5 para 9(3): life tenants

33. A life tenant is not regarded as having provided income or property for the purposes of the settlement merely because there is an administrative delay in paying out the income that has vested in that beneficiary. If, however, the beneficiary directs the trustees to retain this income on the terms of the settlement, this is regarded as a provision of funds within TCGA 1992 Sch 5 para 9(3).

(i) TCGA 1992 Sch 5 para 9(3): indemnities and guarantees

34. An indemnity given by the new trustees to retiring trustees is not considered as the provision of funds for the purposes of the settlement under TCGA 1992 Sch 5 para 9(3). Other types of indemnity are considered in light of the facts of a particular case.

35. The giving of a guarantee is regarded as an indirect provision of funds under the terms of TCGA 1992 Sch 5 para 9(3). Payment of an obligation under a guarantee given before 19 March 1991 is, in general, regarded as a payment in pursuance of a liability incurred before 19 March 1991 and within para 9(3)(b). This may not, however, apply where:

• the contingent liability under the guarantee cannot be quantified with a sufficient degree of accuracy, eg where the guarantee is open-ended or the contingency is remote or
• the guarantor does not take reasonable steps to pursue his rights against the debtor

(j) TCGA 1992 Sch 5 para 9(5): variations

36. This provision is concerned with situations where the terms of the settlement are varied by the beneficiaries or a court to admit new beneficiaries within the class of persons defined at TCGA 1992 Sch 5 para 9(7) without thereby bringing the settlement to an end and creating a new one. For example, where the terms of the trust include a power to appoint anyone within a specified range to be a beneficiary, exercise of that power after 19 March 1991 will not be regarded as a variation of the settlement. The term ‘spouse’ in para 9(7) is not considered to include a widow or a widower.

(k) TCGA 1992 Sch 5 para 9(6): ‘ultra vires’ payments

37. For the purposes of clarification, this condition deals with ‘ultra vires’ payments, ie, cases where one of the persons defined at TCGA 1992 Sch 5 para 9(7) receives a benefit from the trust for the first time and that person is not a beneficiary under the terms of the trust deed. It may also apply where such a person benefits from a transaction with the settlement carried out, for example, under the trustees’ investment powers.

VI. Charge on beneficiaries: intragroup transfers

38. TCGA 1992 ss 87 to 89 charge UK resident beneficiaries to Capital Gains Tax on certain capital payments received from non-resident settlements. TCGA 1992 s 96 is concerned with the application of these provisions to capital payments made by companies which are controlled by the trustees and capital payments received by certain non-resident companies.

39. TCGA 1992 s 96 provides that, where the trustees (or a company which they control) make a payment to a closely-controlled non-resident company, the payment is, broadly, treated as made to those who control the company. This may, for example, mean that a payment made by a wholly-owned subsidiary to its holding company (in which the shares are, say, held 50% by the settlor and 50% by the trustees of a non-resident trust) can be treated as being made by the trustees to the settlor.

40. The payment must, however, be a capital payment within TCGA 1992 s 97(1) - ie, it must not be chargeable to Income Tax on the recipient nor be made under a transaction entered into at arm’s length. Intragroup payments which are not capital payments, for example a capital distribution on winding up which represents merely a repayment of capital on shares, or a distribution chargeable to Corporation Tax, do not fall within the ambit of TCGA 1992 s 96.

Concession D40

Non-resident trusts: definition of participators.

Press releases etc

ICAEW TAX 20/92 14 December 1992 (Guidance note - non-resident settlements. HMRC comment in respect of this statement).

Note: this statement was revised in IR 131 (August 2002).