CG38527 - Tainting: further points: TCGA92/S86

TCGA92/Sch5/para9

As explained at CG38520 tainting was an important concept before FA 1998 extended the definition of qualifying settlement to apply to all settlements except protected settlements.

From 6/4/17 with the introduction of deemed domicile rules see CG38435 guidance originally incorporated in Statement of Practice 5/92 on general questions as to what amount to ‘tainting’ may need to be considered. The detailed guidance on tainting will be included in the Trusts, Estates and Settlements Manual but extracts of content from Statement of Practice 5/92 on para 9 are re-produced below:

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.