Private client review for June 2021

25 June 2021

In this article, the June monthly update review for Tax Journal, Edward Reed and Mark Stichbury look at a number of private client developments.

In this month’s review, HMRC provides helpful clarification on the trust registration service; the Dormant Assets Bill, introduced in the Lords will potentially bring into scope a much wider range of assets; the OTS has published its second report on capital gains tax looking at practical, administrative and technical issues; a recent SDLT case arguing that mixed use rates should apply fails to convince the FTT that access to a communal garden brings a purchase within those lower rates; and the OECD reviews inheritance taxes and suggests changes to increase fairness and potentially increase revenue.

Trust registration service

In a totally different context (nuclear disarmament), President Ronald Reagan famously deployed in English the rhyming Russian proverb ‘trust, but verify’. The UK Trust Registration Service (TRS), designed to verify trusts, has recently undergone significant expansion under the EU’s Fifth Money Laundering Directive, but its full ambit is still uncertain.

The Money Laundering, Terrorist Financing and Transfer of Funds (Information on the Payer) Regulations, SI 2017/692 (the regulations) require many trusts that do not have a UK tax liability to register with the TRS. As a reminder, the TRS in the UK serves a dual purpose, to capture trusts which are taxable domestically, acting as an initial filing gateway, and to fulfil the UK’s obligations under the Fifth Directive (which go beyond issues of immediate UK tax liability).

HMRC has now published limited extracts of its new Trust Registration Service Manual, most of which is in line with industry expectations. There is one noteworthy development in relation to trusts holding pensions or life policies, addressing the difficulty of identifying what are largely dormant assets. Under a new schedule to the regulations, a trust of a life policy or retirement policy paying out only on the death, terminal or critical illness or permanent disablement of the person assured, or to meet the cost of healthcare services for the person assured, will be an ‘excluded trust’ and exempt from registration. Another new schedule provides that, where a trust is holding only benefits received on the death of the person assured under a policy falling within that definition, and less than two years has passed since the death, that trust will also be excluded.

It was also unclear whether trusts containing policies that can acquire surrender values would qualify as excluded trusts. In practice, policies taken out for life insurance typically can be easily differentiated from those taken out for investment purposes but with an insurance component effectively tacked on. These policies are the exception rather than the rule since the Retail Distribution Review in 2012. HMRC has now confirmed that ‘[the amended regulations] can be properly interpreted as including trusts holding policies which have surrender values, and that those trusts would remain excluded until such time as the policy is actually surrendered. It follows from this that pay-outs received from such policies on death would continue to benefit from the exclusion at Sch 3A(8). HMRC will include this position in the next iteration of the Trust Registration Service (TRS) manual.’ 

In other words, policies of life insurance which may acquire a surrender value qualify for exception from registration. This is a welcome development. HMRC continues to work on some of the fine detail and further guidance and an update of the TRS Manual will be issued in due course, including in relation to policies which may have hybrid features or fall into two buckets. More developments are expected around other types of policies, as well as other outstanding issues of debate. HMRC is also working on the technological support, which in its previous incarnation created many headaches for trustees (some of whom may be ‘digitally excluded’) and for trust administrators. Watch this space!

Dormant Assets Bill

The Dormant Assets Bill will expand the existing dormant assets scheme (which covers bank and building society accounts) to include other classes of investment. The current scheme works by enabling participating banks and building societies to apply monies in dormant bank accounts towards charitable purposes if they are unable to establish contact with the owner of those monies.

Under the expansion, the scheme will apply to other kinds of financial products and instruments, including insurance and certain retirement income policies, shares in collective investments and investment assets, and shares in certain publicly traded companies. As currently, scheme membership will be voluntary: a financial institution or company will need actively to opt in to apply proceeds of accounts in this way. However, the extended scheme would only capture proceeds relating to shares held by an individual, not a corporation. Most shares in publicly traded companies are held through intermediary organisations (such as, for example, CREST nominees) and so appear not to fall within the scheme.

To qualify as dormant, the asset holder must not have claimed the funds or communicated with the company for at least 12 years. The organisation must first attempt to trace the owner, verify their identity, and attempt to reunite them with their asset. Only if that fails can the assets be dealt with through the scheme, but if the owner subsequently comes to light, they are able to apply for compensation from the scheme.

The government estimates that the expanded scheme could release up to £880m of dormant value for good causes within the UK.

OTS review of capital gains tax

The Office of Tax Simplification published its second report on capital gains tax on 20 May. The report does not consider policy questions, but looks at simplifying practical, administrative and technical issues. It makes 14 recommendations, which range from the simple suggestion of increasing from 30 to 60 days the time for reporting taxable gains on UK property sales, to more detailed proposals in other areas such as reviewing whether gains or losses on foreign assets should be calculated in the relevant foreign currency.

One particularly welcome suggestion relates to transfers of assets on separation. Married couples are able to transfer assets to each other on a ‘no gain, no loss’ basis, meaning that any transfer of an asset standing at a gain does not trigger an immediate CGT charge (although the recipient inherits the transferor’s base cost). Currently, separating couples benefit from the same system for the rest of the tax year in which they separate, leading to the obvious issue that a couple who separate late in a tax year may not be able to agree and carry out asset transfers within that limited window. The position is complicated by the fact that the date of separation is not always clear.

An additional challenge arises in respect of the family home: where the home is owned by both of the couple, if one moves out, but the home is kept pending either a sale, or the children growing up, the taxpayer who moved out will lose the ability to benefit from private residence relief (PRR) in respect of any period of ownership from nine months after the date of departure. The only way to avoid that currently is to sell the property to either a third party, or their former spouse, within nine months of moving out.

With over 90,000 divorcing couples a year, and tax being some way down the priority list, many taxpayers may not realise the urgency with which they need to reach agreement and transfer assets. The OTS suggests that the period where the no gain, no loss rules apply should be extended to the end of the tax year at least two years after the separation event, or at any reasonable time after separation if the transfer is accordance with a financial agreement approved by a court.

The report also considers reforms around other aspects of PRR, including the unexpected CGT results where a taxpayer builds a house in their garden, which they move in to after selling their original home.

It remains to be seen how many of the recommendations are taken up by the government.

SDLT: access to communal garden held not to constitute mixed-use property

Khatoun v HMRC [2021] UKFTT 104 (TC) is one of the more interesting tribunal decisions on SDLT in recent months. In this case, the FTT upheld an HMRC decision that the purchase of a residential property where the purchaser also acquired the right to use a communal garden, was subject to residential rates of SDLT rather than mixed-use rates.

The taxpayer (T) purchased a freehold property in London for £9.375m. On the same day, he signed a form with a third party freeholder granting access to the communal garden and received a key. His ability to use the communal garden was formalised some months later through a deed of agreement with the garden freeholder, who could terminate T’s right of access on three months’ notice.

T submitted an SDLT return on the basis that residential SDLT rates applied to the property, which gave a total SDLT charge of £1,320,000. Shortly after that, he submitted an amended SDLT return claiming a refund of £861,750 on the basis that the rates for mixed-use property applied due to the equitable interest he claimed he had acquired in the communal garden.

HMRC enquired into the amended return and then issued a closure notice on the basis that the mixed-use rate SDLT did not apply. T appealed but this review upheld HMRC’s original decision. T then appealed to the tribunal.

T’s argument was that the right to use the communal garden was a proprietary equitable right he enjoyed in person, the benefit and burden of which bound the freeholder of the garden, which passed from owner to owner of the property, on the basis of a vague reference to the right to use the garden in a historic lease of the property. As such, it was a separate chargeable interest to the property acquired at the same time, and so mixed rates should apply.

HMRC argued that the right to use the garden was not a chargeable interest and in any event was a residential interest. The FTT agreed with HMRC and dismissed T’s appeal. The right to use the communal garden was held to be a newly granted and revocable right by virtue of the form and deed of agreement akin to a licence. It was not therefore a chargeable interest. In any event, the FTT held that, as the right to the garden was only granted because T owned the property, residential rates would have applied in any event.

Inheritance taxes across the OECD

The OECD recently published a report on inheritance taxes, looking at taxes on wealth transfers in 36 countries. The report is set firmly in the context of wealth inequality, and points out that in most countries, wealth is much more highly concentrated at the top of the distribution than is the case with income. Whilst wealth transfer taxes in many countries raise only a small fraction of total tax revenues, the report explores the role that inheritance taxation could play not only in raising revenues, but addressing inequalities and improving efficiencies.

Highlights of the report’s suggestions include:

  • a strong case for a tax levied on recipients of wealth transfers, rather than on donors (or their estates), with only a low tax-free threshold and limiting renewable gift tax exemptions such as the UK’s nil rate band;
  • progressive tax rates taking into account the total wealth received over an individual’s lifetime;
  • scaling back reliefs with what the OECD views as no obvious policy imperative, such as reliefs on private pension savings and life assurance policy payments;
  • reconsidering the scope of reliefs for business assets; and
  • allowing payment in instalments or deferred payments to overcome concerns about liquidity to pay the tax.

The report also suggests ways to address the political obstacles often associated with inheritance tax reform: providing more information on inherited wealth and inequality, as well as how many people currently pay these taxes can increase public support, and it suggests linking reform to fairness, equality of opportunity and addressing popular concerns such as tax avoidance.

Interestingly the UK was singled out as one of the better performing countries in terms of wealth redistribution: we had the most substantial fall across the countries reviewed by the OECD in the share of wealth held by the top 10% of wealthiest households. Between 1914 and 1991 the share of wealth of those households fell from 93% to 46%, although that trend has now slightly reversed.

Given the OECD’s success in improving the international exchange of information between tax authorities, the anticipated global minimum corporate tax rate and steps to ensure the world’s largest companies reallocate their profits to the countries where sales took place, we might expect more developments in this area. 

This article was first published by Tax Journal.