Private client review for March
The government has accepted many, but not all, of recommendations made by the House of Lords Economic Affairs Committee in its recent review on additional HMRC powers. HMRC accepts STEP’s interpretation that the inheritance tax spouse exemption could be available for assets held in a trust where the settlor has reserved a benefit. An opinion of the GAAR advisory panel on loan to participator schemes serves as a cautionary tale for taxpayers seeking to avoid tax charges through contrived arrangements. In Quentin Skinner 2005 Settlement, the Upper Tribunal denied entrepreneurs’ relief to individuals with interests in possession in trusts holding shares in the family business for around four months before the trustees’ disposal of those shares.
The reaction from most private client practitioners to the Budget will be one of relief. Although we know that tax rises, primarily to corporation tax, are due in the medium term, there were no real surprises and it was pleasing to see that the chancellor has heeded the many concerns voiced about the feasibility of a UK wealth tax, making no mention of it on 3 March.
Response to concerns over additional HMRC powers
Tackling avoidance has been a top priority for HMRC for some time. Measures included in the Finance Bill 2021 are intended to give HMRC additional powers to tackle avoidance, with a particular focus on combatting disguised remuneration schemes.
In response to the earlier draft measures, the House of Lords Economic Affairs Committee undertook a review of HMRC’s proposed measures. On 19 February 2021, the government responded to that report.
The response is generally positive, with the government accepting nine of the committee’s recommendations, and partially accepting six. Several of the recommendations, and the subsequent government response, will be of particular interest. The following are some highlights, which may give a sense of the direction of travel.
In Recommendation 7, the Committee suggests that HMRC should collaborate with specialists to establish steps for preventing disguised remuneration schemes being used by employment intermediaries, and to ensure that no government or public sector body contracts with an intermediary operating such schemes. The Committee noted that both ICAS and the Law Society of Scotland suggested that agencies providing staff to government or public sector bodies should be required to give assurances that they are not involved in disguised remuneration schemes.
The government partially accepted this recommendation. However, it held off on providing a substantive response, as it has launched a call for evidence on tackling disguised remuneration. The government is analysing responses with a view to publishing a summary in due course.
Recommendation 8 relates to improving the method for reporting disguised remuneration avoidance schemes. The Committee believes that creating a dedicated tax avoidance reporting service would increase effectiveness and decrease demand for schemes. Whilst noting its acceptance of this recommendation, the government notes that such reporting channels already exist, and should be used to report any schemes.
In recommendation 9, the Committee focuses on the need for greater protection for taxpayers from unregulated tax advisers who market disguised remuneration schemes, suggesting that it might be appropriate to move to a regulated system, and to create a register of tax advisers. The government accepts the need for taxpayer protection but is wary of moving to a regulatory approach immediately. Avenues being explored include whether it might be appropriate to require tax advisers to have professional indemnity insurance before providing advice. In the government’s view, this would drive up standards by excluding riskier practices which cannot obtain insurance, as well as providing an avenue for redress for taxpayers. We will no doubt hear more on this.
Gift with reservation and IHT spouse exemption
After communicating with HMRC on the topic, STEP has published a short briefing note which has provided some clarity on the availability of the inheritance tax spouse exemption to assets held in a trust where the settlor has reserved a benefit.
The reservation of benefit rules set out in FA 1986 provide that property subject to a reservation at the donor’s death is treated as ‘property to which [the donor] was beneficially entitled immediately before his death’. In effect, the property remains in the donor’s estate.
Generally, inheritance tax on death is charged as if the deceased has made a transfer of value of their estate, with the value transferred being equal to the value of their estate immediately before their death. In this context, their estate is ‘the aggregate of all property to which he is beneficially entitled’.
However, certain transfers are exempt transfers, and they are not treated as chargeable transfers, thereby exempting them from a charge to inheritance tax. Included in the category is a transfer which is ‘attributable to property which becomes comprised in the estate of the transferor’s spouse’. Effectively, where assets are transferred to a spouse on death, those assets are not subject to inheritance tax.
How does this apply to assets transferred to a trust in respect of which the deceased had reserved a benefit? On the basis that property subject to a reservation remains in the donor’s estate as if he is beneficially entitled to it, logic dictates that spousal relief should be available, provided the settlor’s spouse becomes beneficially entitled to the property on his death. This is STEP’s view, to which HMRC has indicated its agreement.
Of course, no relief would be available if, on death, the property is held on discretionary trust for a class of beneficiaries which includes the spouse.
STEP suggests situations where the spouse exemption would be available when the deceased had reserved a benefit:
- If the settlor’s spouse becomes beneficially entitled to the property under either:
- the original terms of the settlement; or
- a subsequent appointment made thereunder and prior to the settlor’s death.
- The same would apply where the spouse’s entitlement on the settlor’s death is to a qualifying interest in possession.
Helpfully, HMRC has indicated its agreement with this analysis, and it has updated its Inheritance Tax Manual (at IHTM14303) to reflect that the spouse exemption could be available in certain circumstances in relation to property subject to a reservation.
One final point to note: spousal relief does not apply if the reservation of benefit ceases inter vivos. This is because the rules operate to treat this as a potentially exempt transfer by the donor, and not by deeming the donor to be beneficially entitled to the gifted property.
Loan to participator schemes: keep off the grass...
The GAAR advisory panel has kept a low profile of late. However, a recent opinion warns that anti-avoidance legislation concerning loan to participator schemes is ‘keep off the grass’ legislation and serves as a cautionary tale for taxpayers seeking to avoid tax charges through contrived arrangements.
The purpose behind the legislation is to prevent taxpayers avoiding tax on a distribution of profits from a company where, instead of paying a dividend or salary, a company loans funds to a shareholder and does not require repayment. A tax charge arises where a participator receives a loan from a close company, although relief is given where the loan is repaid or released.
In brief, the taxpayer in this case incorporated Newco with an initial subscribed share capital of £1,000. Newco then issued a further 1.9m of shares on which no call was made. The taxpayer then transferred the shares in Newco with their uncalled capital to a company (in which they held 95% of the shares) for a value equal to the amount of their £2m loan owed to that company. This transfer was accepted by the company as a repayment of the loan balance. The taxpayer personally guaranteed to contribute the £1.9m to Newco when called, so giving Newco a value of £2m. The idea was that Newco would provide consultancy services to the taxpayer, in return for an option to acquire an annuity.
In fact, the panel found that Newco had no apparent commercial purpose or substance and the asset transferred was created specifically to be transferred in satisfaction of a debt. It also felt bound to conclude that arrangements put in place in a matter of ten days but apparently creating value of £2m were contrived.
Ultimately, the panel concluded the taxpayer had attempted to achieve a technical repayment (not an effective repayment, which the legislation might be expected to require) and qualify for relief without triggering the anti-avoidance legislation. The loan repayment was artificial. Parliament cannot have intended a taxpayer to extract cash and remain effectively indebted whilst the debt owed is treated as repaid.
A further word of warning: HMRC had made a referral to the panel before the advisers to the company conceded that the arrangements were ineffective and a tax liability arose. As the referral was made, the panel was obliged to proceed. We have the benefit of the opinion, but the taxpayer may not feel the same way.
Entrepreneurs’ relief: the gift that doesn’t keep on giving
The recent Upper Tribunal (UT) decision in HMRC v Quentin Skinner 2005 Settlement  UKUT 29 (TCC) continues the trend of slowly chipping away at entrepreneurs’ relief. Renaming this business asset disposal relief or ‘BAD’ relief may have been a prescient move.
The case concerned three family members with interests in possession in trusts holding shares in the family business and the trustees’ disposal of those shares. There was no dispute that the conditions for the relief in TCGA 1992 s 169J were met; the question was whether it was enough that the family members had only held interests in possession for around four months before the disposal. This required a deep dive into the interpretation of s 169J(4) in particular.
Under s 169J(4), throughout a one-year period ending not earlier than three years before the disposal date, in essence the family business must have been the qualifying beneficiary’s personal company as well as a trading company and the qualifying beneficiary must have been an officer or employee of the company. A company in which the individual held at least 5% of the ordinary share capital and so at least 5% of the voting rights is a personal company. A qualifying beneficiary is an individual with an interest in possession under the relevant trust (otherwise than for a fixed term).
So far so good, but does the family member also need to satisfy the definition of a qualifying beneficiary throughout the same one-year period that these conditions are met, or is it enough that they have an interest in possession at the time of disposal?
The First-tier Tribunal (FTT) concluded an interest in possession at the time of disposal was enough, with persuasive reasoning. In its view, Parliament had intended to extend the ‘entrepreneurial connection’ for individuals to situations where a qualifying beneficiary holds an interest in possession in shares through a trust. If an individual can claim relief on business assets held for less than a day and sold as part of the disposal of a business, why should this not be the case here?
The UT, equally persuasively, disagreed. The trustees receive relief by setting the amount of the gain against the qualifying beneficiary’s lifetime limit, even though the gain on disposal is not the qualifying beneficiary’s gain and they may not be affected by any capital gains tax payable. The qualifying beneficiary effectively transfers their lifetime allowance to the trustees. Parliament must have intended this to be premised on an enduring link between the qualifying beneficiary’s interest and the interest in possession they enjoy. That link is provided if there is a requirement for the beneficiary to be a qualifying beneficiary throughout the one-year period.
Otherwise, a family trust for example could obtain relief on any share disposal by appointing an interest in possession for a qualifying beneficiary on the day of disposal. The interest could be terminated shortly afterwards, and the legislation would become a tick-box exercise. Perhaps the lesson here is this: always read legislation in its wider context.
This article was first published by Tax Journal.