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HMRC internal manual

Trusts, Settlements and Estates Manual

Settlements legislation: settlor retains an interest

ITTOIA/S624

Where the settlor has retained an interest in property in a settlement, the income arising is treated as the settlor’s income for all tax purposes. A settlor has retained an interest if the property or income may be applied for the benefit of the settlor, a spouse or civil partner.

In general, the settlements legislation can apply where an individual enters into an arrangement to divert income to someone else and in the process tax is saved. These arrangements must be:

  • bounteous, or
  • not commercial, or
  • not at arm’s length, or
  • in the case of a gift between spouses or civil partners, wholly or substantially a right to income.

The settlements legislation most commonly applies to arrangements involving a settlor’s spouse, civil partner or minor children. However, ITTOIA/S625(1) makes it clear the settlor is treated as having an interest in property if ‘that property or any related property is, or will or may become, payable to or applicable for the benefit of the settlor or his spouse or civil partner in any circumstances whatsoever’. It is not necessary for the settlor’s spouse, civil partner or children to be the people to whom the income is transferred. If the settlor or their spouse or civil partner may benefit regardless of who else benefits then the legislation can apply. See the example below

Example 3- gifted shares with conditions attached

Mr C is a higher-rate taxpayer who owns all the 100 issued shares in C Ltd. He wants to give his brother, a basic rate taxpayer £25,000 but Mr C’s money is tied up in the company. To avoid a higher-rate charge on dividends paid out of the company, Mr C transfers 50 shares to his brother on the understanding that the shares are to be returned to him a month later. Mr C declares and the company pays a dividend of £500 per share so that £25,000 is paid to each shareholder. The plan, under which the gifted property is expected to return to the donor is an arrangement where the donor or settlor has retained an interest in the property so the income paid to the brother is deemed to be Mr C’s under ITTOIA/S624.

Settlement only partially settlor-interested

Where the settlor has retained a clearly defined interest in a distinct part of the settlement, for example in one fund forming part of a trust, only a corresponding part of the income is caught. In other cases of a settlor retaining a partial interest in a trust, you should submit the case to HMRC Trusts & Estates Technical Edinburgh for advice

Exceptions

TSEM4205, 4206 and 4207 cover the exceptions where income arising under a settlement is not treated as that of a settlor who retains an interest.

Help Sheet

Help Sheet HS270. External customers can see this guidance at http://www.hmrc.gov.uk/helpsheets/hs270.pdf gives examples of

  • settlements where the settlor has retained an interest and
  • circumstances in which a settlor is not treated as retaining an interest.