Trust Law in Practice

In a slight departure from his series on Trusts and their uses, Bob Trunchion switches to look at a couple of recent cases where practitioners have come unstuck due to either poorly worded Trust documentation or lack of knowledge of how the schemes work

The first case (Figg-v-Clark 1996 STI 232) gave rise to an unexpected tax charge. A gentlemen had four children (the youngest born in January 1956). This person's father created a Settlement in 1963 into which a number of shares were put for the benefit of the gentleman and his issue. On 31st May 1963, the trustees of the Settlement executed a Deed of Appointment by which they revocably appointed that specified investments and the income thereof should be held thereafter in Trust in equal shares for such children of the man as were then living or should thereafter be born as should attain the age of 21 years. In November 1964 the gentleman suffered an accident as a result of which he was unfortunately paralysed. There was little realistic prospect of having further children. In March 1976 the revocable appointment was declared irrevocable. Unfortunately, the gentlemen died in July 1990 and the Trustee of the Settlement at that date was assessed to Capital Gains Tax on the deemed disposal of all the assets held for the benefit of the children at that date. The Revenue contended that the charge arose under Section 71 of the TCGA 1992 because at that point the beneficiaries had become absolutely entitled to the settled property as there could be no further beneficiaries added to the class of beneficiaries. The Trustee appealed on the grounds that the gentleman had been incapable of having further children since his accident and therefore the children alive at the date of his accident became absolutely entitled to the assets of the Settlement at the date of the 1976 release or at their 21st birthday.

Mr Justice Blackburn upheld the Revenue's argument. First he suggested that it was common ground that the Court had to proceed on the basis that every individual remains capable of having a child until death. With the rapid evolution of technology in the area of fertility etc. this maybe does not seem an unreasonable proposition! He suggested that the Court could have authorised the Trustees in this situation to distribute the fund on the footing that a given individual would not have any further children. Unfortunately only on the occasion when the Trustees have properly resolved that they should depart from the terms of the Trust and then distributed the Trust assets would the beneficiaries be in a position to direct the Trustees as to the application of those assets and to give good receipt for them (and thus bring the Trust to an end) and this had obviously not happened.

Whilst much of the case turned on detailed arguments the important point for practitioners to take on board is that the problem could have been avoided by a more sensible drafting of the Trust documentation. Whilst the wish to maintain maximum flexibility must always be paramount, it does make sense to limit that flexibility in certain areas. One of the areas where flexibility may be limited should be on not having open-ended classes of primary beneficiaries such as was the position here. The rule in Andrews-v-Partington would have been sensible addition so that the class of beneficiaries was closed when the eldest child took their entitlement removing this problem.

Obviously the consequence of this case was that a substantial charge to Capital Gains Tax arose at a time of the father's death which was entirely inappropriate in that it had not been anticipated and little or no tax planning could be done to mitigate the charge. The case reminds the author of a recent actual example. The case was referred to in the opening article of this series but bears repetition. In the middle 1970's a successful businessman identified an area of land which could have development potential in the long term. The land was landlocked and had little or no value at the time. Accordingly it was placed within an Accumulation and Maintenance settlement which turned out to be highly restrictive in its powers. The Deed required that when the youngest achieved age 25 the assets devolved on the beneficiaries absolutely. Obviously at the time that the Settlement was created no knowledge of time scales for the development of the land could be contemplated.

At the time the children were all very young. The youngest child reached 25 last year. Under similar legislation to the above case (Figg-v-Clark) the Trustees were deemed to have sold the assets in the Trust for their market value and re-acquired them as Bare Trustees for the beneficiaries. Obviously this would have been no problem had the assets in the Trust remained of negligible value but unfortunately the land is no longer land-locked and a retail development let out as investments has been completed on site. The Capital Gains Tax arising on this deemed disposal is substantial and could easily have been avoided had the Trust Deed incorporated slightly more flexibility to enable an effective extension to the Trust's life.

The second case shows how important it is when dealing with, and advising upon Trusts to understand their taxation consequences. Mrs Rawlinson died on 26th September 1987. Her Estate included about 16,500 shares in a company Auto-Dunnage Limited. Her Will settled the majority of her Estate on Discretionary Trusts for the benefit of a class of beneficiaries including the surviving spouse, his issue and their spouses. On 22nd December 1987 (23/4 months later) an appointment of the shares in the above company was made in favour of the surviving spouses. The objective of the appointment was to take advantage of the surviving spouse exemption and avoid Inheritance Tax of some £2m on the above shares. The use of Discretionary Settlement is common in Wills where the Testator is "undecided". They may be undecided as to where to leave their assets or they may even be uncertain as to what the value of their assets will be at their death or what the tax legislation would be. Accordingly, therefore it is simple to draft a Will which leaves all the assets in the estate on Discretionary Settlements for a very wide range of beneficiaries and so long as appointments are made within two years from the date of death for Inheritance Tax purposes the disposition is treated as though it were done by the Testator. The Trustees may hold letters of wishes from the deceased indicating the type of appointments that the Trustees should contemplate. As an aside, this beneficial treatment does not extend to Capital Gains Tax unlike a Deed of Family Arrangement. Appointments from a "two year" Discretionary Settlement will have Capital Gains Tax consequences from the date of death to the date of appointment.

Unfortunately, the Executors (being Mr Frankland and the surviving spouse) were unaware that an asset falls within the appropriate "two year" regime if it falls within the Discretionary Trust definition. Until an asset has been retained within a Trust for three months which it just had not, it does fall within the taxation definition of such a Settlement and therefore under the legislative rules which even now apply, the surviving spouse exemption was not available. Rattee (J) accepted that whilst the rules were stupid, until Parliament removes them, they have to be enforced.

One would have say however that the chances of the average family estate being in a position to deal with distributions of assets from an Estate and possibly more likely the average practitioner being in a position to have sufficient confidence to be able to distribute the assets of an Estate within three months is unlikely. One would have to say that where a terminal disease is in point such a scenario could be envisaged. Case Reference Frankland -v- Inland Revenue Commissioners 1996 STC 735.

Bob Truchion, MacIntyre Hudson