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Income Tax Bill


 

These notes refer to the Income Tax Bill as introduced in the House of Commons on 7th December 2006 [Bill 14] Part 8: Other reliefs

Part 9: Special rules about settlements and trustees

Overview

1340.     This Part is about special rules that apply to settlements and trustees.

1341.     Most income tax rules apply to "persons" in general, which includes trustees. This Part contains additional rules specific to trustees. Some of these rules apply generally. Others apply more specifically, to particular types of settlement, to certain types of settlement income or to the treatment of income of beneficiaries.

1342.     Except for the special position of unauthorised unit trusts, the provisions in this Part do not apply to "bare trusts", ie those where the beneficiary is absolutely entitled to both the income and capital.

1343.     The provisions in this Part do not apply to personal representatives. Accordingly, the rates at which their income is taxed (the savings, dividend ordinary or basic rates depending on the income concerned) are the rates provided for in Chapter 2 of Part 2.

1344.     Rules specific to charitable trusts are in Part 10.

Chapter 1: Introduction

Overview

1345.     This Chapter contains an introduction to the Part and some basic definitions.

1346.     There is no attempt to define a settlement or particular types of settlement, although Chapter 2 defines "settled property" and "settlor".

1347.     While it is often useful in practice to categorise a settlement either as an "interest in possession settlement" (under which the beneficiaries are entitled to the settlement income as it arises) or as an "accumulation or discretionary settlement" (under which income can be accumulated or paid to beneficiaries at the trustees' discretion), some settlements are "mixed" (in that there are both sorts of beneficiary).

1348.     The rules in this Part are written so that they apply having regard to the treatment of the income rather than the type of settlement.

Clause 462: Overview of Part

1349.     This clause introduces the Part. It is new.

Bill 14—EN (II)     54/2Clause 463: Interpretation of Part

1350.     This clause provides definitions for the purpose of the Part. It is based on sections 686(6) and 687(4) of ICTA.

Clause 464: Scottish trusts

1351.     This clause concerns beneficiaries of Scottish trusts. It is based on section 118(1) of FA 1993.

1352.     For certain income tax purposes, trusts under which the beneficiaries have an equitable right in possession are treated differently to discretionary trusts. Scottish law does not recognise the concept of an equitable right in possession. So this clause provides for the law of England and Wales to be applied for the purpose of determining whether beneficiaries under a Scottish trust have an equitable right in possession for income tax purposes.

Chapter 2: General provision about settlements and trustees

Overview

1353.     This Chapter provides definitions for income tax purposes that are, as far as possible, aligned with those which apply for the purposes of capital gains tax (see sections 68A to 69 of TCGA). It is based on provisions inserted into ICTA by Schedule 13 to FA 2006.

1354.     The definitions in the ICTA provisions apply for the purpose of the Tax Acts and thus extend beyond income tax to provisions of the Corporation Tax Acts. But the extent of their application for the purposes of the Corporation Tax Acts is in fact fairly limited. Accordingly, the ICTA provisions are repealed in favour of a new section 832(2A) in ICTA applying this Chapter for those purposes (see Schedule 1).

Clause 465: Overview of Chapter and interpretation

1355.     This clause introduces the Chapter. Subsections (1) to (6) are new. Subsections (7) and (8) are based on section 685B(7) and (8) of ICTA.

Clause 466: Meaning of "settled property" etc

1356.     This clause defines "settled property". It is based on section 685A of ICTA.

1357.     The definition corresponds to that in section 68 of TCGA. It also mirrors the effect of section 60 of TCGA in relation to bare trustees and nominees.

1358.     In subsection (3), the expression "under a disability" in section 685A(1) of ICTA has been rewritten as "lacking legal capacity". This does not change the substance.

Clause 467: Meaning of "settlor" etc

1359.     This clause defines "settlor". It is based on section 685B of ICTA.

1360.     The definition corresponds to that in section 68A of TCGA.

1361.     The clause introduces a new term "disposable property", defined in clause 468.

1362.     Subsection (6) is concerned with the case where one person makes or enters into a settlement in accordance with reciprocal arrangements with another person.

1363.     As subsection (8) makes clear, a wider definition of "settlor" applies to the anti-avoidance provisions in Chapter 5 of Part 5 of ITTOIA.

Clause 468: Meaning of "disposable property"

1364.     This clause defines the new term "disposable property". It is based on section 685B(5) of ICTA.

1365.      The definition covers the same ground as section 62(10) of TCGA.

Clause 469: Person ceasing to be a settlor

1366.     This clause explains when a person ceases to be a settlor for income tax purposes. It is based on section 685B(6) of ICTA.

Clause 470: Transfers between settlements

1367.     This clause and clause 471 provide rules for identifying the settlor(s) of property in a settlement where property is transferred from one settlement to another for less than full consideration. The rules are the same as those that apply in section 68B of TCGA.

1368.     This clause explains when a relevant transfer occurs. It is based on section 685C of ICTA.

Clause 471: Identification of settlor following transfer covered by section 470

1369.     This clause identifies the settlor(s) in circumstances where a transfer of property within clause 470 takes place. It is based on section 685C of ICTA.

Clause 472: Settlor where property becomes settled because of variation of will etc

1370.     This clause identifies the settlor in certain cases where a will is varied after a person dies. It is based on section 685D of ICTA.

1371.     The rules are the same as those that apply in section 68C of TCGA.

1372.     Subsection (2) applies when property becomes settled property in consequence of the variation, but would not otherwise have become settled property. In that case a person specified in subsection (3) is treated as the settlor.

1373.     In subsection (3), the expression "under a disability" in section 685D(3) of ICTA has been rewritten as "lacking legal capacity". This does not change the substance.

1374.     In subsection (4), the expression "donatio mortis causa" has been retained, in the absence of any simple English expression that adequately summarises its meaning.

Clause 473: Deceased person as settlor where variation of will etc

1375.     This clause deems the deceased person to be the settlor in certain cases where a will is varied after a person dies or that person dies intestate. It is based on section 685D of ICTA.

1376.     The rules are the same as those that apply in section 68C of TCGA.

Clause 474: Trustees of settlement to be treated as a single and distinct person

1377.     This clause provides that the trustees of a settlement are collectively regarded as a single person distinct from the persons who are the trustees from time to time. It is based on section 685E(1) and (8) of ICTA.

1378.     The rule is the same rule as in section 69 of TCGA.

1379.     This rule is of particular significance in relation to the determination of the trustees' residence for income tax purposes.

Clause 475: Residence of trustees

1380.     This clause sets out rules for determining whether trustees (treated as a single person under clause 474) are resident and ordinarily resident in the United Kingdom. It is based on section 685E(2), (3), (4), (6) and (7) of ICTA.

1381.     If all the persons who are trustees are UK resident then the single person is UK resident and ordinarily UK resident. If all those persons are non-UK resident then the single person is non-UK resident and not ordinarily UK resident. If the trustees have mixed residence then a tie-breaker applies and the residence of the single person is determined by reference to whether there is a settlor who meets condition C (see subsection (5)(b) and clause 476).

Clause 476: How to work out whether settlor meets condition C

1382.     This clause applies for the purposes of working out whether a settlor in relation to the settlement meets condition C. It is based on section 685E(4) and (5) of ICTA.

1383.     Subsections (2) and (3) each provide that a person who is a settlor in relation to a settlement meets condition C if the person was UK resident, ordinarily UK resident or domiciled in the United Kingdom at the time specified in the subsection.

1384.     Subsection (2) applies if the settlement arose on the death of the settlor and requires the settlor's residence and domicile to be determined immediately before the settlor's death.

1385.     Subsection (3) applies in all other cases and requires the settlor's residence and domicile to be determined at every time when a settlor makes, or is treated as making, the settlement (see, in particular, clause 467(3)).

1386.     Subsections (2) and (3) also each provide that a person who meets condition C in relation to a settlement at the time specified in the subsection continues to meet condition C at all subsequent times until the person ceases to be a settlor in relation to the settlement.

1387.     Accordingly, the single person mentioned in clause 474(1) will be treated as UK resident and ordinarily UK resident for as long as the settlement has mixed residence trustees and there continues to be a settlor who meets condition C in relation to the settlement.

Clause 477: Sub-fund elections under Schedule 4ZA to TCGA 1992

1388.     This clause sets out the income tax position where the trustees of a settlement have made a sub-fund election under Schedule 4ZA to TCGA. It is based on section 685G of ICTA.

1389.     The broad effect is that each sub-fund is treated as a separate settlement distinct from the principal settlement and with its own deemed single person trustees.

Clause 478: References to settled property etc in regulations

1390.     This clause provides rules for interpreting terms in regulations. It is based on paragraph 37(1) of Schedule 13 to FA 2006.

Chapter 3: Special rates for trustees' income

Overview

1391.     This Chapter provides the main rules about which income is to be charged at either the trust rate or the dividend trust rate.

1392.     The main category is "accumulated or discretionary income" which, broadly, is income which is income of trustees under trust law and which is not assessable as income of any beneficiary.

1393.     The Chapter also deals with other specific types of receipt to which one or other of the special trust rates apply.

Clause 479: Trustees' accumulated or discretionary income to be charged at special rates

1394.     This clause applies one of two special trust rates to trustees' accumulated or discretionary income. It is based on section 686(1), (1AA), (2) and (5A) of ICTA.

1395.     The special rates apply to the trustees even where the receipt will be taxed as the income of the settlor. The settlor will receive credit for the full amount of tax paid by the trustees.

1396.     Subsection (1) introduces the term "accumulated or discretionary income" which is defined in clause 480. The fact that this clause does not apply to charitable trusts is given greater prominence than in the source legislation.

1397.     Subsections (2) to (4) provide that accumulated or discretionary income is charged at either the dividend trust rate or the trust rate instead of the rates that would otherwise apply to that income.

Clause 480: Meaning of "accumulated or discretionary income"

1398.     This clause defines "accumulated or discretionary income". It is based on section 686(2), (6ZA), (6ZB) and (6A) of ICTA.

1399.     "Accumulated or discretionary income" is a single concept rather than the sum of two separate elements.

1400.     Subsection (2) is based on section 686(2)(a) of ICTA. This provision spells out the nature and extent of the discretion concerned in more detail than in the source legislation.

1401.     Income is not included within "accumulated or discretionary income" simply because trustees have discretion over what expenses to incur or how those expenses are to be charged.

1402.     Subsection (3)(a) excludes from the meaning of "accumulated or discretionary income" any income to which a beneficiary is entitled as it arises. This is the case where a beneficiary has an interest in possession.

1403.     Subsection (3)(b) and subsection (4) exclude income that arises to certain pension funds, provided that the property giving rise to the income is not held as a member of a property investment LLP (see the definition in clause 938).

1404.     Subsection (3)(c) and subsections (5) and (6) exclude income from service charges held on trust by certain bodies.

Clause 481: Other amounts to be charged at special rates for trustees

1405.     This clause applies one of the special trust rates to certain receipts of trustees that are taxed as income. It is based on sections 686 and 686A of ICTA.

1406.     The special rates apply to the trustees even where the receipt will be taxed as the income of the settlor. The settlor will receive credit for the full amount of tax paid by the trustees.

1407.     Subsection (1) sets out the circumstances in which the clause applies. The exemption for charitable trusts, which was in section 686A(4)(c) of ICTA before it was amended by FA 2006, has been reinstated. See Change 85 in Annex 1.

1408.     Subsections (2) to (4) apply the trust rate or dividend trust rate to the receipt arising to the trustees instead of the rate that would otherwise apply to that income. The only receipt to which the dividend trust rate applies is Type 1 within clause 482.

1409.     Subsection (5)(a) and (b) ensure that receipts are not caught by this clause if they are accumulated or discretionary income (and so within clause 480) or would be but for the exceptions in clause 480(3)(a) or (c). This exemption, which was in section 686A(4)(a) before it was amended by FA 2006, has been reinstated. See Change 85 in Annex 1.

1410.     Subsection (5)(c) and subsection (6) correspond to the exception in clause 480(4)(a). That exemption, which was in section 686A(4)(d) before it was amended by FA 2006, has been reinstated. See Change 85 in Annex 1.

Clause 482: Types of amount to be charged at special rates for trustees

1411.     This clause lists the types of receipts arising to trustees that are taxed at one of the special trust rates under clause 481. It is based on section 686A(2) of ICTA.

1412.     Section 686A(2) did not include amounts taxed on trustees under the accrued income scheme and liable at the trust rate by virtue of section 720(5) of ICTA. As it is intended that all amounts that are always liable at the trust rate are treated in the same way, those amounts are included here as Type 2 income. See Change 86 in Annex 1.

Clause 483: Sums paid by personal representatives to trustees

1413.     This clause concerns the treatment of sums paid by personal representatives to trustees. It is based on section 686(6) of ICTA.

1414.     The clause applies if personal representatives have received income or other amounts which would have been liable at the special trust rates had they been trustees, and they pay a sum to trustees representing income. In such a case, the sum is treated as income of the trustees and as having borne tax at the rate referred to in section 663(1) of ITTOIA.

1415.     Following its substitution by FA 2006, section 686A of ICTA no longer includes the provision that specifically applied this rule to receipts within section 686A. But the reference in section 686(6) of ICTA to income to which section 686 applies includes receipts deemed to be such income as a result of section 686A. Accordingly, it is made explicit that this rule applies to all receipts within this Chapter.

Chapter 4: Trustees' expenses and special rates for trustees

Overview

1416.     This Chapter provides for expenses incurred by trustees to reduce the amount of income chargeable at the special trust rates.

1417.     Beyond a few basic rules, it is left to trust law to determine what expenses may be taken into account. Generally, it is only expenses incurred in the course of exercising the trustees' duties and powers and solely in managing the trust assets to produce or maintain an income flow which are allowable.

1418.     The label "management expenses" has not been used. It does not carry any weight and omitting it avoids giving the impression that all expenses incurred in the course of managing a trust will necessarily be allowable.

Clause 484: Trustees' expenses to be set against trustees' trust rate income

1419.     This clause concerns the trustees' expenses which are to be taken into account in calculating the extent of the income chargeable at the special trust rates. It is based on sections 686(2AA) and 689B(1) of ICTA.

1420.     Subsection (1) provides that the clause applies where the trustees incur allowable expenses. This is in contrast to the source legislation which requires the expenses to have been defrayed. See Change 87 in Annex 1.

1421.     Subsection (4) provides that where allowable expenses are set against income chargeable at the special rates, the income is instead charged at the rate that would normally apply to that type of income.

1422.     Subsection (5) provides basic rules regarding what constitute allowable expenses.

1423.     Subsection (6) makes it explicit that expenses are not allowable if they are taken into account (otherwise than under this clause) in calculating the trustees' liability for any tax year.

Clause 485: Carry forward of unused expenses

1424.     This clause specifies how expenses are relieved if the amount paid exceeds the income of the year taxable at the special trust rates. It is new.

1425.     In essence, if expenses incurred exceed income they are carried forward and allowed as soon as there is sufficient trust rate income. See Change 87 in Annex 1.

Clause 486: How allowable expenses are to be set against trust rate income

1426.     This clause explains in step terms how allowable expenses are to be set against the trust rate income. It is based on sections 686(2AA) and 689B of ICTA.

1427.     The clause makes it explicit that it is the grossed up amount of expenses that is set against income charged at the special rates. (The meaning of "grossing up" is given in clause 932.) See Change 88 in Annex 1.

1428.     Before the grossing up process, Step 1 eliminates a proportion of expenses in the case of non-UK resident trustees in receipt of untaxed income (see clause 487).

1429.     Steps 2 to 6 require dividend, savings and other income to be considered in turn.

1430.     Dividend income not within subsection (2) corresponds to foreign income within section 689B(2A) of ICTA.

Clause 487: Non-UK resident trustees

1431.     This clause specifies that a proportion of the allowable expenses of the trustees is ignored if a proportion of their income is not liable to income tax ("untaxed income"). It is based on section 686(2A) and (2B) of ICTA.

Chapter 5: Share incentive plans

Overview

1432.     This Chapter is based on sections 686B and 686C of ICTA.

1433.     Under a share incentive plan, shares which are not "plan shares" (see paragraph 99(1) of Schedule 2 to ITEPA) are held on accumulation or discretionary trusts. So the trustees' dividend income arising from such shares is potentially chargeable at the dividend trust rate under clause 479. But this Chapter provides that such a charge on approved plans does not arise if the shares are awarded to participants in the plan within an "applicable period" (defined in clause 489).

Clause 488: Application of section 479 to trustees of approved share incentive plans

1434.     This clause sets out the circumstances in which clause 479 applies to approved share incentive plans. It is based on sections 686B(1), (2) and (6) and 686C(3) of ICTA.

1435.     Subsection (1) gives the basic condition that the clause applies to dividends or other distributions received by the trustees of approved share incentive plans.

1436.     Subsections (2) to (4) provide that the charge at the dividend trust rate under clause 479 arises only if and when the shares are disposed of or the "applicable period" comes to an end without the shares having been awarded to participants in accordance with the plan.

1437.     Subsection (5) provides that, if shares of the same class are acquired by the trustees at different times, they are treated as awarding shares acquired earlier before shares acquired later.

1438.     Subsection (6) explains that, for the purposes of this clause, shares are also treated as awarded when they are acquired on behalf of a participant as dividend shares.

Clause 489: "The applicable period" in relation to shares

1439.     This clause explains the meaning of "the applicable period". It is based on sections 686B(3) to (5) and 686C(4) and (5) of ICTA.

1440.     Subsections (2) to (4) state the basic rule that the applicable period ends at the earliest of:

  • five years from the acquisition of the shares;

  • two years from the acquisition of the shares if any shares in the company were readily convertible assets at that time; and

  • two years from the date that any shares in the company became readily convertible assets.

1441.     Subsections (5) and (6) provide that the basic rule is varied in a case where the shares were acquired in consequence of a contribution to the plan by the company for which it is allowed a deduction under paragraph 9 of Schedule 4AA to ICTA. In such a case the applicable period ends ten years after the shares were acquired.

Clause 490: Interpretation of Chapter

1442.     This clause makes provision about the interpretation of the Chapter. It is based on sections 686B(7) and 686C(1) and (2) of ICTA.

 
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