The Law Commission

The Law Commission

Consultation Paper No 175

CAPITAL AND INCOME IN TRUSTS:

CLASSIFICATION AND APPORTIONMENT

A Consultation Paper

London: TSO

The Law Commission was set up by section 1 of the Law Commissions Act 1965 for the purpose of promoting the reform of the law.

The Law Commissioners are:

The Honourable Mr Justice Toulson, Chairman
Professor Hugh Beale QC, FBA
Mr Stuart Bridge
Professor Martin Partington CBE
Judge Alan Wilkie QC

The Chief Executive of the Law Commission is Steve Humphreys and its offices are at Conquest House, 37-38 John Street, Theobalds Road, London WC1N 2BQ.

This consultation paper, completed on 12 July 2004, is circulated for comment and criticism only. It does not represent the final views of the Law Commission.

The Law Commission would be grateful for comments on this consultation paper before 31 October 2004. Comments may be sent either –

By post to:

Matthew Jolley
Law Commission
Conquest House
37-38 John Street
Theobalds Road
London
WC1N 2BQ

Tel: 020-7453-1251
Fax: 020-7453-1297

By e-mail to:

matthew.jolley@lawcommission.gsi.gov.uk

It would be helpful if, where possible, comments sent by post could also be sent on disk, or by e-mail to the above address, in any commonly used format.

All responses to this consultation paper will be treated as public documents, and may be made available to third parties, unless the respondent specifically asks that the response, or a particular part of it, should be treated as confidential.

The text of this consultation paper is available on the Internet at:

http://www.lawcom.gov.uk

CONTENTS

Executive Summary	1.1
PART I: INTRODUCTION	1.1
The Trustee Act 2000	1.1
The reference to the Law Commission	1.5
Principal issues	1.10
Classification of investment returns as income or capital	1.11
Rules of apportionment	1.14
Impact on charities	1.18
Law reform initiatives to date	1.19
Summary of our provisional proposals	1.21
This Consultation Paper	1.22
Human rights	1.24
Regulatory impact	1.25
Acknowledgements	1.27
PART II: CLASSIFICATION OF TRUST RECEIPTS AND EXPENSES
Introduction	2.1
Rules governing classification of corporate receipts	2.2
The rule in Bouch v Sproule	2.3
Exceptions to the rule in Bouch v Sproule	2.18
Applying and extending the rule in Bouch v Sproule	2.19
Emergence of a judicial discretion to apportion	2.21
Problem situations	2.25
Demergers	2.25
Direct demergers	2.27
Indirect demergers	2.28
Scrip dividends	2.33
Criticisms of the current law	2.38
Perceived illogicality of rule in Bouch v Sproule	2.38
Questionable relevance of company law principles	2.40
Complexity and uncertainty in application to novel rearrangements of capital	2.45
Ignorance or disregard of the rule	2.47
Rules governing classification of non-corporate receipts	2.48
Rules relating to timber, minerals and copyright	2.48
Rules governing classification of trust expenses	2.51
PART III: EQUITABLE AND STATUTORY RULES OF APPORTIONMENT
Introduction	3.1
Rules governing the apportionment of trust receipts pending conversion of original trust assets	3.2
Trusts for sale	3.3
Express trusts for sale	3.4
Statutory trusts for sale	3.5
The first branch of the rule in Howe v Earl of Dartmouth	3.6
The second branch of the rule in Howe v Earl of Dartmouth	3.15
Issues of valuation and payment	3.19
Date of valuation	3.19
Applicable interest rate	3.21
Manner of payment	3.22
Exclusion of the general rule	3.24
Express exclusion	3.25
Implied exclusion	3.26
Exclusion by statute	3.29
The rule in Re Earl of Chesterfield's Trusts	3.31
Criticisms of the practical operation of the rules of apportionment pending conversion of original trust assets	3.36
Complex calculations affecting small amounts of money	3.36
Uncertainty over level of the "fair equivalent"	3.37
Uncertainty over exclusion of the rules	3.38
Routine exclusion of the rules in well-drafted trust instruments	3.39
Ignorance or disregard of the rules	3.40
Changing economic circumstances	3.41
Apportionment of debts and legacies of a deceased's estate	3.44
The rule in Allhusen v Whittell	3.44
Exclusion of the rule	3.52
Criticism of the rule in Allhusen v Whittell	3.53
Rules governing apportionment of deficient securities	3.54
Authorised security: the rule in Re Atkinson	3.55
Unauthorised security: the rule in Re Bird	3.60
Criticism of the rules governing the apportionment of deficient securities	3.63
Situations for which no rule of apportionment exists	3.64
Purchase and sale of shares "cum" and "ex" dividend	3.65
Authorised investments favouring one beneficiary over another	3.72
The statutory rules of apportionment	3.75
Apportionment between successive beneficiaries entitled to income	3.78
The rule in Re Joel	3.79
Exclusion of the 1870 Act	3.80
Criticisms of the 1870 Act	3.81
Inconvenience and unfairness caused by the rule	3.81
Routine exclusion of the rule	3.83
Ignorance and disregard of the rule	3.84
Specific criticisms of the rule in Re Joel	3.85
PART IV: PREVIOUS PROPOSALS FOR REFORM
Introduction	4.1
Previous proposals	4.3
The 23rd report of the Law Reform Committee (1982)	4.4
Duty of "even-handedness"	4.4
Statutory rules of apportionment	4.11
Trust Law Committee consultation paper (1999)	4.12
Classification of corporate receipts as income or capital	4.12
Reasonable return on trust capital	4.13
Trading profits during lifetime of trust	4.16
Discretion to reallocate income to capital and vice versa	4.17
Equitable and statutory rules of apportionment	4.18
Scottish Law Commission Discussion Paper (2003)	4.19
Classification of trust receipts and the equitable apportionment rules	4.21
Complete legislative replacement of existing rules	4.22
Legislative replacement for rule in Bouch v Sproule	4.23
Judicial power of classification and apportionment	4.24
Trustee power of classification and apportionment	4.25
Building a new scheme of classification and apportionment	4.27
PART V: ACHIEVING A BALANCE – A NEW APPROACH TO CLASSIFICATION AND APPORTIONMENT
Introduction	5.1
Classification	5.3
Corporate receipts	5.6
Non-corporate receipts	5.13
Trust expenses	5.16
Express modification of the rules of classification by the settlor	5.18
The duty to balance	5.19
Exclusion of the duty to balance	5.29
Achieving a balance and moving towards total return investment	5.32
Percentage trusts	5.35
Discretionary allocation trusts	5.39
A new trustee power of allocation	5.41
"Opt in" or "opt out"?	5.49
Exercising the power of allocation	5.56
Judicial control of the statutory power of allocation	5.78
The equitable rules of apportionment	5.83
The Apportionment Act 1870	5.86
Trusts for sale	5.89
Express and statutory trusts for sale	5.89
Implied trusts for sale	5.90
Scope of the provisional proposals	5.92
Transitional provisions	5.93
Tax implications of the provisional proposals	5.100
PART VI: CHARITIES
Introduction	6.1
The special position of charities with a permanent endowment	6.7
What is a "permanent endowment"?	6.7
The problems caused by permanent endowments	6.11
Charitable trusts and private trusts compared	6.14
When may a permanent endowment be distributed?	6.20
Winding up of small charities	6.21
Other powers of the Charity Commission	6.25
Proposed changes to the circumstances in which a permanent endowment may be distributed	6.31
The application of our proposed classification and apportionment scheme for private trusts to charities	6.35
Developments towards the adoption of total return investment	6.39
The then-current approach	6.40
Total freedom	6.41
Total return investment	6.43
The Charity Commission's current approach to investment by permanently endowed charities	6.45
Facilitating total return investment by permanently endowed charities: the way forward	6.50
PART VII: CONSULTATION QUESTIONS
Introduction	7.1
Consultation questions	7.1
Human rights	7.1
Regulatory Impact	7.2
Classification	7.3
The duty to balance	7.10
Percentage trusts	7.15
A new trustee power of allocation	7.16
The equitable rules of apportionment	7.28
The Apportionment Act 1870	7.29
Trusts for sale	7.31
Scope of the provisional proposals	7.33
Transitional provisions	7.35
Tax implications of the provisional proposals	7.39
Charities	7.40

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