England and Wales High Court (Chancery Division) Decisions

IN THE HIGH COURT OF JUSTICE
CHANCERY DIVISION

		Royal Courts of Justice Strand, London, WC2A 2LL
		10th July 2002

Mr Justice Lightman:

INTRODUCTION

1. This is an appeal by the Appellants the Commissioners of Inland Revenue (“the CIR”) on a point of law under section 56A of the Taxes Management Act 1970 from a decision (“the Decision”) of a Special Commissioner Dr N Brice (“the Commissioner”) released on the 10th October 2001. The Decision relates to a settlement dated the 20th December 1988 (“the Settlement”) created by the late Mrs Margaret Greenstock (“the Settlor”). By the Decision the Commissioner allowed an appeal by the Respondents, the Executors of the will of the Settlor (“the Executors”), against a Notice of Determination dated the 12th January 2001. This appeal raises a number of questions of law relating to inheritance tax and most particularly as to the construction of section 102 of the Finance Act 1986 (“Section 102”).

FACTS

2. By the Settlement, the Settlor appointed herself and two others to be the trustees of the Settlement (“the Trustees”). The Settlement provided that the income of the trust fund thereby constituted (“the Trust Fund”) should be paid to the Settlor’s husband (“the Husband”) during his life, and after his death, (subject to a special power of appointment to a class of beneficiaries including the Settlor) for a specified period of eighty years on discretionary trusts for a class of beneficiaries including the Settlor, and at the end of the specified period on trust for the Settlor’s daughter Mrs Eversden and the remoter issue of the Settlor as should then be living absolutely. The Settlement conferred on the Trustees the additional powers set out in the Schedule to the Settlement (“the Additional Powers”). These included (in paragraph 3(b)) power to acquire immovable property for residence, occupation or use and enjoyment in specie by any person interested in possession in the income of the moneys used on such acquisition (including a person to whom such income may be paid in exercise of the Trustees’ discretion); and in paragraph 3(c) to acquire any reversionary interest in property or other investments not producing income or in respect of which no rent is payable.
3. By a conveyance dated the 20th December 1988 (“the 1988 Conveyance”) the Settlor conveyed a property known as Beechwood Cottage (“Beechwood”) to the Trustees to hold on trust as to 5% for the Settlor absolutely and as to 95% on the trusts of the Settlement. The Husband thereafter as life tenant occupied Beechwood (together with the Settlor) until his death.
4. The Husband died on the 6th February 1992. The Trust Fund then comprised the 95% share of Beechwood, with a value of £147,251.
5. In or about 1993 the Trustees both sold Beechwood and out of the proceeds (including the 5% to which the Settlor was entitled) purchased 6 Barn Meadows (“Meadows”) and an investment bond (“the Bond”). Thereafter the Settlor had a 5% interest in Meadows and the Bond. From the date of its purchase until her death on the 27th October 1998 the Settlor was in sole occupation of Meadows and paid all the expenses relating to it. She received no benefit from the Bond.
6. On the death of the Settlor the Trust Fund comprised the 95% interest in Meadows (valued at £171,000) and the 95% interest in the Bond (valued at £149,213,43).

THE ISSUES

7. The CIR contend that Section 102(3) deems the Trust Fund to form part of the Settlor’s estate because at the time of her death the Trust Fund was held upon discretionary trusts which included the Settlor among the class of beneficiaries and because she had occupied Meadows. The Executors challenge both those contentions, arguing that the beneficial interests of the other beneficiaries were “enjoyed to the entire exclusion or virtually to the entire exclusion” of the Settlor “and of any benefit to [her] by contract or otherwise” within the meaning of Section 102; and further and in the alternative that the initial interest in possession given to the Husband by the Settlor by operation of Section 102(5)(a) prevented any charge arising under Section 102(3).
8. The questions to be considered in turn are: (a) whether the entitlement of the Settlor under the Settlement as a discretionary beneficiary (and indeed a discretionary object of the power of appointment) constituted a reservation of interest within Section 102(3); (b) whether the occupation of Meadows and the circumstances under which it arose constituted or gave rise to such a reservation; and (c) whether the gift of the life interest to the Husband operated to exempt the Trust Fund from the provisions of Section 102 relating to reservation of interest for all time or only so long as the Husband’s life interest continued to subsist.

STATUTORY SCHEME

9. Section 1 of the Inheritance Tax Act 1984 (“the 1984 Act”) provides that inheritance tax is charged on the value transferred by a chargeable transfer. Section 2 of the 1984 Act provides that a chargeable transfer is a transfer of value which is not an exempt transfer. Section 3 of the 1984 Act defines a transfer of value as a disposition where the value of a person’s estate is less than it would be but for the disposition. Section 18 of the 1984 Act provides that a transfer of value is an exempt transfer to the extent that the value transferred is attributable to property which becomes comprised in the estate of the transferor’s spouse or, so far as the value is not so attributable, to the extent that that estate is increased. As a result of sections 5 and 49 of the 1984 Act an exempt transfer can be either an outright transfer to a spouse or the creation in favour of the spouse of an interest in possession. Certain chargeable transfers are potentially exempt transfers: they will become exempt if the transferor survives the transfer seven years. A special code or overriding provision is introduced by Section 102 in respect of dispositions by way of gift whether or not the disposal is or is not an exempt transfer, but with a saving in respect of the exempt transfers enumerated in Section 102(5). The first of such savings (in subsection (a)) is transfers between spouses.
10. The first five subsections of Section 102 read as follows:

“102—(1) Subject to subsections (5) and (6) below, this section applies where, on or after 18th March 1986, an individual disposes of any property by way of gift and either—

(a) possession and enjoyment of the property is not bona fide assumed by the donee at or before the beginning of the relevant period; or

(b) at any time in the relevant period the property is not enjoyed to the entire exclusion, or virtually to the entire exclusion, of the donor and of any benefit to him by contract or otherwise;

and in this section ‘the relevant period’ means a period ending on the date of the donor’s death and beginning seven years before that date or, if it is later, on the date of the gift.

(2) If and so long as—

(a) possession and enjoyment of any property is not bona fide assumed as mentioned in subsection (1)(a) above, or

(b) any property is not enjoyed as mentioned in subsection (1)(b) above,

the property is referred to (in relation to the gift and the donor) as property subject to a reservation.

(3) If, immediately before the death of the donor, there is any property which, in relation to him, is property subject to a reservation then, to the extent that the property would not, apart from this section, form part of the donor’s estate immediately before his death, that property shall be treated for the purposes of the 1984 Act as property to which he was beneficially entitled immediately before his death.

(4) If, at a time before the end of the relevant period, any property ceases to be property subject to a reservation, the donor shall be treated for the purposes of the 1984 Act as having at that time made a disposition of the property by a disposition which is a potentially exempt transfer.

(5) This section does not apply if or, as the case may be, to the extent that the disposal of property by way of gift is an exempt transfer by virtue of any of the following provisions of Part II of the 1984 Act,—

(a) section 18 (transfers between spouses);

(b) section 20 (small gifts);

(c) section 22 (gifts in consideration of marriage);

(d) section 23 (gifts to charities);

(e) section 24 (gifts to political parties);

(f) section 25 (gifts for national purposes, etc.);

(g) section 26 (gifts for public benefit);

(h) section 27 (maintenance funds for historic buildings);

and

(i) section 28 (employee trusts).”

11. Before turning to the questions raised it is necessary to say a word about the term “property” as it appears in Section 102. The House of Lords in Ingram v. IRC [2000] AC 293 held that the term did not refer to something which had physical existence but to a specific interest which could co-exist with other interests in the same physical object. Accordingly Section 102 did not prevent donors from deriving benefit from the object in which they had given an interest so long as they did not derive benefit from that interest and the benefit could be shown to be referable to a specific proprietary interest which was retained. For this purpose it is necessary to have regard to the real nature of transactions and the beneficial interests of the parties concerned.

DISCRETIONARY TRUSTS

12. The first issue raised is whether the entitlement of the Settlor as a discretionary beneficiary under the trusts of income and the power of appointment has the legal effect that the Trust Fund is to be treated for the purposes of Section 102 as property subject to a reservation. Section 102 (2) and (3) require the Trust Fund to be treated as subject to a reservation if the Trust Fund was not (beneficially) “enjoyed to the entire exclusion, or virtually to the entire exclusion, of the [Settlor] and of any benefit to [her] by contract or otherwise” during the last seven years of her life.
13. The starting point in answering this question must be an examination of the nature of the right or interest of a discretionary beneficiary. The nature of the right or interest of the Settlor as an object of the discretionary trust and as an object of the power of appointment for present purposes must be the same: the contrary is not suggested. The authoritative analysis is to be found in Gartside v. IRC [1968] AC 553. In that case the House of Lords held that such a beneficiary did not have an interest in the whole trust fund or any part of it within the meaning of section 43 of the Finance Act 1940. In the course of his speech Lord Wilberforce gave guidance as to the nature or interest of a discretionary beneficiary, saying (at p.61):

“No doubt in a certain sense a beneficiary under a discretionary trust has an ‘interest’: the nature of it may, sufficiently for the purpose be spelt out by saying that he has a right to be considered as a potential recipient of benefit by the trustees and a right to have his interest protected by a court of equity. Certainly that is so, and when it is said that he has a right to have the trustees exercise their discretion ‘fairly’ or ‘reasonably’ or ‘properly’ that indicates clearly enough that some objective consideration (not stated explicitly in declaring the discretionary trust, but latent in it) must be applied by the trustees and that the right is more than a mere spes.”

14. The legal nature of the right or interest is of an equity rather than an equitable proprietary interest.
15. There is no direct authority on the question raised whether the right of the Settlor as a member of a class of discretionary beneficiaries who are entitled under trusts of income or as potential objects of a special power of appointment is sufficient to give rise to a reservation for the purposes of section 102(3). The matter should accordingly be approached as a matter of principle and statutory construction.
16. The Commissioner in paragraph 79 of the Decision held that the Settlor’s entitlement to be considered as a potential recipient of benefit by the Trustees precluded a finding that the Trust Fund was enjoyed to the entire or virtually the entire exclusion of benefit to her under the Settlement.
17. I entirely agree. The insertion of the provision enabling benefit to be conferred on her creates the potential for the conferment of substantial benefit on her and the consequent diversion of benefit from others. The provision in her favour is not consistent with her entire exclusion or her virtual entire exclusion from benefit. It cannot be entirely discounted or virtually entirely discounted by evaluation of the probabilities or otherwise that occasion will arise for conferring benefits on her.
18. Support for the construction which I favour is furnished by the considerations referred to by Lord Reid in Gartside above at p.612:

“But then the respondents founded on two decisions on the meaning of the word ‘interest’ in a different provision which was obviously passed to deal with a different problem. The Customs and Inland Revenue Act, 1881, required certain property to be brought in although it had ceased to belong to the deceased at the date of his death. This included the case where a settlor in making a settlement had reserved an interest in the settled property. In Attorney-General v. Heywood the settlor had provided that the trustees had a discretion to apply the trust income for the benefit of himself his wife and children or any one or more of them. It was, I think, rightly decided that he had reserved an interest within the meaning of that provision. It is always proper to construe an ambiguous word or phrase in light of the mischief which the provision is obviously designed to prevent, and in light of the reasonableness of the consequences which follow from giving it a particular construction. Here, if ‘interest’ were given a narrow or technical meaning, it would be very easy to defeat the obvious purpose of the provision by setting up a discretionary trust and choosing trustees who might be expected to exercise their discretion in favour of the settlor. And, on the other hand, no unreasonable consequences would follow if the word were given a wider meaning so as to include possible benefit that would come to the settlor in a certain event—in the event of the trustees deciding that he should have the whole or part of the income....”

19. If Section 102 were so construed that the interest of any settlor under a discretionary trust created by him does not constitute a reservation of benefit, there would be opened up a means of totally defeating the plain object of Section 102. The alternative construction is both available and preferable.
20. Mr Thornhill for the Executors submitted that under the terms of the Settlement the Settlor was entirely excluded or virtually excluded from any benefit. For the reasons which I have given I disagree: indeed the whole purpose of her inclusion as a discretionary beneficiary was to ensure that she was not so excluded but could be benefited. Further or in the alternative Mr Thornhill submitted that the entitlement to consideration by the Trustees for benefit was (within the principles laid down in Ingram) interest retained by the Settlor when she made the Settlement: it did not therefore fall within the provisions relating to reservation of benefit. This argument is hopeless. The Settlor had no right to consideration for benefit by the Trustees before she made the Settlement. There were no Trustees and no Settlement. The right to consideration by the Trustees cannot therefore have been retained when the Settlement was created. The right was created by, and arose under, the Settlement and was a reservation of benefit in her favour.

OCCUPATION OF MEADOWS

21. Under the law as it stood until the Trusts of Land and Appointment of Trustees Act 1995 (“the TLATA”) came into force on the 1st January 1997, on execution of the 1988 Conveyance the Settlor acquired a 5% interest in possession in Beechwood and in right of this beneficial interest as tenant in common in equity the Settlor was entitled to occupy the Property in common with the Husband (who was life tenant under the Settlement) and her entitlement to occupy continued after his death. She was not entitled to sole or exclusive possession, but for all practical purposes her occupation would be and was sole and exclusive unless the Trustees made a decision and took action to dilute or (through the medium of the Court) extinguish her right of occupation.
22. This case was presented to the Commissioner on the basis that the law remained as it was prior to the 1st January 1995 (no reference was made to the TLATA) and that the Settlor’s legal position was exactly the same in respect of her occupation both of Beechwood and Meadows when purchased in its place. Not surprisingly on these twin basis the Commissioner held that there was no retention of benefit in respect of the occupation of Meadows. At paragraphs 68 to 72 she gave her reasons:

“(a) - Was the settlor’s occupation of the house the reservation of a benefit?

68. For the Appellants Mr Woolf argued that the rights of the settlor under the trust and her occupation of the property did not amount to a reservation of benefit because she had a 5% share in the house and was entitled to occupy the house for that reason; she did not entrench on the rights of the other beneficiaries. Section 102 permitted a settlor to carve out an interest. He relied upon Ingram at 41j and argued that the gift to the settlement had been subject to the settlor’s 5% interest which gave her the right of occupation and that her right to occupy had never been included in the gift. The trustees and beneficiaries had never at any time acquired the house free of the settlor’s interest. Accordingly any benefits derived by the settlor were not derived from the interests given. He adopted the decision in Oakes at page 76.

...

70. The passage relied upon by Mr Woolf in Oakes at page 76 reads:

‘If a donor reserves to himself a beneficial interest in property and only gives to the donees such beneficial interests as remain after his own reserved interest has been satisfied it is now well established that such reservation of a beneficial interest does not involve any benefit to the donor within the meaning of the section.’

71. Oakes is also authority for the view that the right of residence is not a benefit as it is a right enjoyed by a co-owner of property. Ingram is authority for the view that section 102 does not prevent people from deriving benefit from the object in which they have given away an interest but only when they derive a benefit from that interest.

72. I would therefore conclude that the settlor’s occupation of the house was a right enjoyed by her as a 5% co-owner of the property and that that benefit was not derived from the interest which was given away in the settlement. The evidence was that the settlor had in fact occupied the property alone but there was no evidence that any of the beneficiaries under the settlement had been excluded from joint occupation.”

23. The Commissioner would surely have decided the question differently if her attention had been called to the change in the law effected by the TLATA and more importantly the material difference in the legal position affecting the Meadows and Beechwood.
24. On and after the 1st January 1997 when the TLATA came into force, a tenant in common in equity (and accordingly a person in the position of the Settlor) who had made a contribution to the purchase price was no longer automatically entitled by reason of such contribution alone to occupation of the property purchased. Section 14 of the TLATA provided that he should only become so entitled if one of two alternative conditions were satisfied:

“(1) A beneficiary who is beneficially entitled to an interest in possession in land subject to a trust of land is entitled by reason of his interest to occupy the land at any time if at that time—

(a) the purpose of the trust includes making the land available for his occupation (or for the occupation of beneficiaries of a class of which he is a member or of beneficiaries in general), or

(b) the land is held by the trustees so as to be so available.”

25. Looking at the first alternative condition, it may be noted that the “purposes” of a trust are primarily to be found in the trust instrument, but may in appropriate cases be found outside it: such purposes may however be expected to be consistent with the contents of the trust instrument. Looking at the second alternative condition, it may likewise be noted that trustees can only hold land “so as to be available” for occupation by a beneficiary if this accords with the purposes of the trust instrument or a due exercise by them of their powers thereunder. The mere fact that the Settlement contains the Additional Powers is not of itself sufficient to satisfy either of the two conditions. I should add that Section 13(7) does not (as was suggested at one time in argument) notwithstanding non-compliance with either condition confer entitlement to occupation on the Settlor by reason of the fact that she was a tenant in common in occupation when the TLATA came into force: section 13 confers on trustees powers to exclude or restrict occupation where two or more beneficiaries are entitled to occupy land, and section 13(7) imposes limits on those powers. Section 13 (and in particular section 13(7) have no application to the facts under consideration in this case.
26. The thrust of Mr Thornhill’s submission was that both the conditions required by section 12 of the TLATA were satisfied and that accordingly the Settlor continued after the 1st January 1997 to be entitled to occupation of Meadows. This submission calls for a careful analysis of the circumstances leading to the purchase of Meadows.
27. On the sale of Beechwood, the Trustees held 5% of the net proceeds as bare trustees for the Settlor and 95% on the trusts of the Settlement. On receipt of the net proceeds of sale the Trustees were legally obliged to pay over the 5% to the Settlor. The Trustees could not unilaterally decide to invest the 5% in any other property (whether alone or together with the remaining 95%) without the agreement of the Settlor as beneficially entitled to the 5%. The Trustees invested the full net proceeds of sale in the purchase of Meadows. In the absence of any evidence to the contrary, it is common ground that the Trustees must be presumed to have acted lawfully and in accordance with their fiduciary duties: see e.g. Billingham v. Cooper [2001] STC 1177 at 1185 [2001] EWCA 1041 para 32. Accordingly it must be presumed that the Trustees and the Settlor agreed that the Trustees should invest both the Settlement’s 95% of the net proceeds of sale and the Settlor’s 5% in the purchase of Meadows and the Bond; and it must likewise be presumed (in the light of the law as it stood prior to the coming into force of the TLATA) that the Trustees and the Settlor agreed and intended that by virtue of her contribution of 5% of the purchase price the Settlor should become entitled to a like right of occupation of Meadows as she had previously enjoyed in respect of Beechwood and that the purchase was made on this basis. This scenario entirely accords with the skeletal evidence before the Commissioner, and most particularly the application of the Settlor’s money as 5% of the purchase price of Meadows (and the Bond) and the subsequent occupation by the Settlor of Meadows.
28. I accordingly fully accept Mr Thornhill’s submission. It is clearly correct.
29. In the circumstances it is plain (and common ground) that the reasoning of the Commissioner on this issue cannot stand and it is necessary to decide whether the agreement between the Trustees and the Settlor and consequent occupation by the Settlor for the remainder of her life of Meadows made the Settlement’s share of the proceeds of sale of Beechwood and 95% interest in Meadows “subject to a reservation”. In my view the answer is clear. Under the agreement with the Trustees (providing as it did for the Settlor to pay 5% of the purchase price of Meadows and acquire in consequence a right of occupation) the Trustees conferred on the Settlor the right to occupy Meadows for an indefinite period rent free. The application of the Settlement’s share of the net proceeds of sale of Beechwood in the payment of 95% of the purchase price of Meadows was made by the Trustees for this purpose (i.e. to benefit the Settlor in this way); the Settlor and Trustees entered into an agreement to confer this benefit on her; and far from the Settlor being excluded from benefit, she thereafter enjoyed this benefit effectively to the exclusion from benefit of the beneficiaries under the Settlement.

SECTION 102(5)

30. The real difficulty in this case arises on the construction of this provision. If the Executors are correct in the submissions which they make on this subsection, the subsection will preclude the application of Section 102(3) which is otherwise triggered by the answers to the two questions which I have already given.
31. The case made by the Executors is very simple. Section 102(5) provides in terms that, where there is a disposal by way of gift which constitutes an exempt transfer by virtue of section 18 of the 1994 Act, Section 102 has no application and there is no scope for the consequences provided in Section 102(3) in case of any reservation of benefit to the Settlor: they are excepted from application. The question whether the gift constitutes an exempt transfer must be determined once and for all at the date of the gift. The size of the gift to the spouse in the sense of the length of the term during which it can be enjoyed is irrelevant: even if the spouse is given an interest in possession for six months only and the Trustees thereafter hold the gifted trust fund (for example) on discretionary trusts for both spouses for their lives is irrelevant: the donor cannot be penalised in respect of any reservation of benefit under Section 102.
32. On the other hand the CIR argue that the exception conferred is intended to be temporary only and is confined to the period that the subject matter of the gift is vested in the spouse; whether there is a disposition which constitutes an exempt transfer is to be determined at the date of death of the donor; and if by that date the spouse has died and the spouse’ interest has expired, Section 102 has full application.
33. The Commissioner dealt with this question shortly in paragraphs 53-56 of the Decision. She said:

“53. The third question arising out of the issue as to whether section 102(5) applied was whether one should consider that date of the settlement or the date of the death of the settlor.

54. Mr Twiddy [for the CIR] argued that one should consider the date of death of the settlor rather than the date of the settlement. Under section 102(1) it was the date of death which defined the relevant period. At the date of the settlement there was no need to consider tax but at the date of the settlor’s death it was necessary to identify if there had been a disposal of property by way of gift with reservation.

55. I agree with Mr Twiddy that the date of the death of a donor establishes the relevant period for the purposes of section 102 and that section 102(3) also refers to the date of death of the donor. However, section 102(5) refers to the disposal of property by way of gift and reflects the same words in section 102(1). If section 102(5) applies then the other provisions of section 102 do not and so the date of death of the settlor will not be relevant. It seems to me that section 102(5) is quite specific and requires a reference only to the disposal of property by way of gift which in this appeal is the creation of the settlement.

56. I conclude therefore that, for the purposes of section 102(5), the relevant date is the date of the settlement.”

34. After anxious consideration I have concluded that the Commissioner is correct. The starting point on any consideration of the application of Section 102 must be Section 102(5); this is implicit in the provision of Section 102(1) that Section 102 only applies “subject to Section 102(5)”. The first question is accordingly whether the relevant disposal of property by way of gift (in this case the Settlement) was an exempt transfer between spouses. The language of Section 102(5) looks at the disposal at the date on which it is made and its character (as a transfer between spouses) must, as it seems to me, be determined as at that date. If the gift answers that character at that date, the provisions of Section 102 relating to property subject to a reservation have no application. For the purposes of section 18 of the 1984 Act the duration of the proprietary interest gifted to the spouse is irrelevant even as it is irrelevant how long the spouse retains the proprietary interest and whether the spouse gifts the proprietary interest on to someone else e.g. the children of the donor and donee. Likewise the duration of the proprietary interest is irrelevant for the purposes of Section 102(5). It is true that the words “to the extent that” in Section 102(5) are capable of being construed as indicating that the exception is to be co-extensive in time period with the period or duration of the gift to the spouse, but that would involve a construction of the term at odds with its construction elsewhere in Section 102 and the sections in Part II of the 1984 Act enumerated to in Section 102(5).

CONCLUSION

35. For the reasons given I shall dismiss this appeal. I must record my debt to Counsel for the help which they have afforded me on all the issues on this appeal.