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United Kingdom Special Commissioners of Income Tax Decisions
You are here: BAILII >> Databases >> United Kingdom Special Commissioners of Income Tax Decisions >> Peter Clay Discretionary Trust v Revenue & Customs [2007] UKSPC SPC00595 (27 February 2007)
URL: http://www.bailii.org/uk/cases/UKSPC/2007/SPC00595.html
Cite as: [2007] STC (SCD) 362, [2007] WTLR 643, [2007] UKSPC SPC00595, (2006-07) 9 ITELR 738, [2007] STI 1060, [2007] UKSPC SPC595
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- This is an appeal by the Trustees of the Peter Clay Discretionary Trust against a closure notice dated 30 November 2005 relating to the year 2000-01 disallowing certain trustees' expenses in the computation of the rate applicable to trusts. The Appellants were represented by Mr Christopher McCall QC and the Revenue by Mr Rupert Baldry.
- The issue in this appeal is essentially whether various expenses of administering the trust can be attributed in part to income with the result that they do not suffer the higher rates of tax on the income of discretionary trusts.
- There was an agreed statement of facts and issues as follows:
- We heard evidence from Mr Ralph Stockwell FCA, one of the trustees, and expert evidence from Mr Kevin Custis, a director of Rathbone Trust Company Limited on the practice of trustees generally about attribution of expenses between income and capital. We find the following facts:
- The relevant statutory provisions are first s 686 of the Taxes Act 1988:
- Mr McCall QC, for the Appellants, contends in outline:
- Mr Baldry, for the Revenue, contends in outline:
- The main authorities relied on by both parties are first, In re Bennett [1896] 1 Ch 778 in which the deceased former partner in a partnership had left a will leaving a life interest. His partnership capital was a debt due to him (later his estate) bearing interest. The trustees of his will were authorised by the court to have an annual audit. At first instance it was held that the first audit was to be paid out of capital and future audits out of income. On appeal it was held that all audits were payable out of capital. Lindley LJ said:
- The correctness of Bennett was in issue before the House of Lords in the second main authority relied on, Carver v Duncan [1985] 1 AC 1082, in which the expenses in issue were premiums on an endowment policy, investment managers' fees, insurance premiums to insure chattels, and premiums on a term insurance against capital transfer tax on the settlor's death. It can be seen from the report in 51 TC 125 at 141 that other expenses charged to income and not then in dispute included charges for a bank nominee company, a fee for collecting interest on a Southern Rhodesian investment and paying premiums on a policy in the same currency, and solicitors' charges for preparing the accounts and other legal fees, part of which were attributed to income. Mr Robert Walker QC for the trustees had argued at p.1113 of the Appeal Cases report:
- Lord Templeman stated the general rule at p.1120 as follows:
- Mr Baldry relies particularly on the definition of outgoings in Bennett "By an 'outgoing' is generally meant some payment which must be made in order to secure the income of the property." He contends that securing can include ascertainment of the amount of the income available for distribution, so that tax and interest on tax is deductible even though the income will have arisen previously. But he contends that other dealing with the income is not allowable. Mr McCall points to the word "generally" in the quoted passage and cautions against treating the quotation as if it were statutory language. He gave an example of discretionary trustees with no power to accumulate visiting each of the beneficiaries to ascertain their financial circumstances and needs. He contended that the cost was clearly a proper income expense, although it had nothing to do with the securing of the income, however widely one defined that expression.
- The distinction made by Lord Templeman in Carver v Duncan is between expenses incurred for the benefit of the whole estate, such as the audit in Bennett and the investment managers' fee and the premiums on the term and endowment policies in Carver v Duncan, and ordinary outgoings of a recurrent nature which are charged to income. The issue in this appeal is whether one can attribute a single charge between the income and capital elements when it covers different work in relation to each element.
- Section 22(4) of the Trustee Act 1925 is relevant to this question. It provides:
- The Law Commission's consultation paper (No.175) on Capital and Income in Trusts: Classification and Apportionment, 2004, after referring to the decision about the investment advisers' fees in Carver v Duncan said:
- The authority relating to separate income and capital charges by a trust corporation is In re Roberts Will Trusts [1937] 1 Ch 274 in which Crossman J said:
- Underhill and Hayton on the Law Relating to Trusts and Trustees 17th edition states at article 51 (footnotes omitted):
- We find it surprising that there is no authority about attribution of a single expense. We agree with Mr McCall that the underlying general principle is to achieve fairness between beneficiaries entitled to income and capital as demonstrated by the passage quoted from Underhill. As s 22(4) of the Trustee Act 1925 illustrates, the expenses of an audit can be attributed between income and capital, presumably on the basis that different work is performed on the income and expenditure account than on the balance sheet. Bennett can be understood to be a case where only the capital was relevant; the deceased retired partner had no interest in the profits, but only an entitlement to interest on his capital. We consider that in the light of the general principle of fairness "expenses incurred for the benefit of the whole estate" should not be understood widely as meaning anything that is for the benefit of both the income and capital beneficiaries should be charged to capital and should not be attributed. We therefore prefer the approach that one should attribute unless the expense really is a capital expense where the interest of the income beneficiary is merely the consequential loss of income on the capital that goes to pay the expense. Examples of this in Carver v Duncan are the insurance premiums, whether on an endowment policy which is essentially an investment, or a term policy, which protects the capital in the event of the settlor's death, and the investment managers' fee, described by Lord Templeman at p.1120-1 "to keep under review and to advise changes in investments comprised in the trust fund"…because the advice of the investment advisers will affect the future value of the capital of the trust fund and the future level of income arising from that capital."
- Mr Baldry put forward a contention based on the wording of s 686(2AA) that in any event "the expenses of the trustees" could not include payments to the trustees themselves. We do not agree. The payments are from the trust property to the trustee as an individual in his personal capacity. They are paid to the individual because he is a trustee but he does not receive them as trustee but in his personal capacity as an individual separate from the trustees. In our view one can regard the payments as expenses of the trustees in the sense that they are expenses of the trust property (and therefore of the trustees), and it makes no difference that they are paid to one of their number rather than to a third party. The lack of any real distinction between a payment to a person who is a trustee and a payment to a third party is shown here where Mr Stockwell, as a partner in Rawlinson & Hunter, charges for his services, and by the same invoice the firm also charges for accountancy services performed by others in the firm. Accordingly we see no reason in principle why attribution should not apply to trustees' fees.
- We turn to apply those general considerations to the expenses in issue in this appeal. We do not regard ourselves as constrained by the position of the parties in negotiations (see paragraph 3(12) above). Our view on each type of expense is as follows:
- On the timing of the deduction Mr McCall contends that the expenses that are allowable are deducted on an accruals basis. Mr Baldry contends that they are deductible on a cash basis; if they are incurred in year 1 and paid in year 2 they are deductible against the income of year 2.
- For convenience we set out subs (2AA) again:
- One must start by identifying "the income arising to trustees in any year of assessment" which is done on ordinary principles relating to the type of income concerned, which may be either on an accruals basis, as for trading and property income, or on a cash basis, as for investment income. It is relevant that the first three types of income against which expenses are set in order by s 689B are types of savings income that are computed on a cash basis. Next one must identify "the expenses of any trustees in any year of assessment, so far as they are properly chargeable to income," which is determined by trust law principles Expenses could mean expenses both incurred and paid in the year, or it could mean either incurred or paid. We noted the contrast between in the year of assessment with expenses of management of investment companies in the pre-Finance Act 2004 version of s 75 of the Taxes Act 1988 referring to expenses of management for the accounting period, but we do not regard the difference as critical because of the different origins of the two provisions. Thirdly, one must identify the amount of the income previously identified which "is treated in accordance with section 689B as applied in defraying the expenses of the trustees in that year which are properly chargeable to income." The reference to s 689B is odd because that section provides for the order in which the expenses are deducted from various types of income, rather than treating income as applied in defraying expenses. But it does provide for setting expenses in any year against types of income which by s 686 is income arising in the year. One would expect a correlation between the timing of the income and expenses which is best achieved if the expenses are computed on an accruals basis and set against the income of the year in which the income accrues. If expenses are computed on a cash basis it will often happen that they are set against income of a subsequent year from that in which they are incurred, which loses the correlation and may have the effect of reducing the income of different beneficiaries, or the nature of the trusts may have changed. We do not consider that subs (2AA) is trying to be prescriptive about the timing of the expenditure since the timing of the income against which the expenditure is set depends on the nature of the income. While we consider that an accruals basis achieves a better result in terms of fairness between income and capital beneficiaries and is more suitable to larger trusts such as the one in this appeal, we do not consider that a cash basis, which may be easier to operate in practice for smaller trusts, is wrong.
- In summary, our decision in principle is that:
- In accordance with section 56A(2) of the Taxes Management Act 1970 we hereby certify that our decision involves a point of law relating wholly or mainly to the construction of an enactment that has been fully argued before us and fully considered by us. This means that if both parties consent, and if the leave of the Court of Appeal is obtained, the Appellant may appeal from our decision directly to the Court of Appeal.
SPC00595
DISCRETIONARY TRUST – whether single fee for expenses of management that relate partly to income and partly to capital can be attributed partly to each for s 686(2AA) Taxes Act 1988 – yes – attribution applied to professional trustee's fee, custodian fees, accountancy fees and bank charges but not investment management fees
THE SPECIAL COMMISSIONERS
THE TRUSTEES OF THE PETER CLAY
DISCRETIONARY TRUST Appellant
- and -
THE COMMISSIONERS FOR HER MAJESTY'S
REVENUE AND CUSTOMS Respondents
Special Commissioner: ADRIAN SHIPWRIGHT
DR JOHN F. AVERY JONES CBE
Sitting in public in London on 13 and 14 February 2007
Christopher McCall QC instructed by Rawlinson & Hunter, Chartered Accountants, for the Appellant
Rupert Baldry, counsel, instructed by the Acting Solicitor for HM Revenue and Customs for the Respondents
© CROWN COPYRIGHT 2007
DECISION
Facts
(1) This case arises out of a dispute between the Revenue and the trustees of a UK resident discretionary trust, made by one Peter Robert Clay on the 5th December 1995 and known as the Peter Clay Discretionary Trust, as to the amount properly deductible for income tax purposes under section 686(2AA) of the Taxes Act as being expenses properly chargeable to the income of the trust. The dispute arises in respect of the year of assessment ending 5th April 2001, but the resolution of the dispute is likely to have a bearing on the position for subsequent years.
(2) In essence the dispute raises the question of whether it is proper for trustees as a matter of the general law (that is to say disregarding, in accordance with the relevant statutory provisions in this behalf, any express provision in their trust) to charge part of certain annual expenses to the income of their trust on the footing that that is the proper application of the general rules as to the incidence of trustee expenses; the ambit of the dispute includes specifically the following categories of expense namely (i) trustees fees (ii) investment management fees (iii) bank charges (iv) custodian fees and (v) professional fees for accountancy and administration.
(3) The trust in issue in this case is a large trust producing an income of the order of seven figures; it is agreed that the precise amount of the income and of the capital is irrelevant. Despite the size of the trust income, the sum at issue in this appeal is not large but it is apprehended that the outcome may have a substantial bearing on the overall tax payable in relation to the trusts subsisting in the Clay family over the years (and indeed may be of some general application).
(4) So far as concerns the trustees in the case they comprise:
(i) two "non-executive" trustees by name Sir George Russell and Sir Ronald Miller who claim only limited fees for the time which they spend in preparing for and attending trustee meetings;
(ii) a family trust company Doveport Trustees (No 2) Ltd which does not charge for its time and is in post only to ensure a degree of family involvement in the debates of the trustees and;
(iii) one "executive" trustee Mr Ralph Stockwell, a former senior partner of Messrs Rawlinson & Hunter, accountants to the trustees, who is engaged in managing this and other Clay family trusts (including certain charitable trusts).
Mr Stockwell was during the year in question remunerated for his service as a consultant to his firm and, like the non-executive trustees, seeks to allocate the costs of his time as between the various trusts according to his best estimate of the amounts of time which are spent in dealing with each such trust.
(5) It is not in dispute that almost all of the income in the present trust is customarily accumulated and thus requires to be invested for the purpose of that process of accumulation; so one specific question relates to the extent, if any, to which it is proper to charge the costs of investment services relating to that process of investment, that is to say advice as to the investment of income which is resolved to be accumulated. This the Appellants say is an example of an expense which under the normal rules ought to be charged to the subject matter of the service in question (which is the income under consideration, that is to say that which it is proposed to accumulate). By contrast, the Revenue say that investment management fees are by their nature only applicable to capital and so must be charged to capital; but the Appellants' reply that it is different where, as here, it is the way in which income is to be dealt with – the fact that it is by process of accumulation to be added to capital - which requires the incurring of expenses and that there is no difference in principle between this form of expense and (say) the costs of dealing with income dealt with in any other way, for example by being allocated to a beneficiary who is resident in a foreign jurisdiction such that dealing with his income imposes particular burdens on the trustees.
(6) Part of the dispute revolves around the fact that it is not possible to say of any particular burden on the trust (as for example trustees' remuneration) that it is made up of individual items of expense, some of which can be shown to be attributable to activities actions or services relating to income and some of which cannot; the trustees have in these circumstances followed a pattern of allocating proportions of their expenses to income, doing the best they can to identify the extent to which the fees should be apportioned. A question therefore arises whether it is possible to apportion expenses as between income and capital on this basis. The trustees have in fact claimed half their expenses by way of trustee fees, investment management fees, bank charges, custodian fees, and professional fees by way of accountancy services. The Revenue have indicated that they would be willing to allow custodian charges and professional fees in their entirety in so far as they could be shown to relate to income; the trustees are seeking to give reality to that concept by process of appointment where it is not possible to say of any particular fee precisely how it is made up because it is not an aggregate of costs specifically chargeable in respect of specific items on account.
(7) The sums in question are (stating the full amount in each case):
| Trustee fees | |
| executive trustee | 41,712 |
| non-executive trustees | 5,000 |
| Investment managers' fees | 176,136 |
| Bank charges | 511 |
| Custodian fees | 38,024 |
| Professional fees | 33,488 |
| Total fees | £294,871 |
(8) As part of the argument, the Revenue have sought to say that trustee remuneration is in any event not an expense of the trust; in the alternative the Revenue say that remuneration is an expense incurred for the benefit of the beneficiaries of the trust as a whole and so must be charged in its entirety to capital. The Appellants say that that cannot be correct, as a matter of looking at fees which are charged for services which relate to various different types of activity, some designed exclusively for the purpose of producing the proper income from the trust and others designed for general purposes or with express regard to capital. They say on authority that it is clear that some part of the trustees' fees must properly be regarded as ordinary and recurrent expenses of the trust which should be charged to income and that here too, as in the case of the investment managers fees and bank charges, a proportion of these fees is plainly incurred as a result of the receipt of income and is chargeable to income accordingly. They say the proportion they have claimed is reasonable on the facts of the case. As far as the supposed objection that trustee remuneration is not an expense of the trust, the trustees have had difficulty in understanding how payments made to individual trustees at the expense of the bank accounts of the trust are not an expense of the trust, in just the same way as payments of the trust to "the butcher the baker and the candlestick maker" for they are, of course, received by the trustees in their individual capacity as part of their earned income; they will develop this in their skeleton argument but for the moment simply wish to record that this is a matter in dispute although recent correspondence from HMRC had led them to think that it was accepted that there was here an expense.
(9) One factual element in this dispute is that there is a substantial commitment on the part of the trustees to international investment because of the size of the Clay funds and the need to diversify on a worldwide basis. This leads to two burdens not necessarily always present in any trust namely:
(i) many double tax treaties and similar provisions have to be applied in determining the amount of the trust income;
(ii) careful attention has to be paid on a regular and recurrent basis to interest rates on the various currencies in issue to ensure that the investments are appropriate.
The Appellants say that it is clear that the former is a source of a burden of expenditure which is properly attributable to income in precisely the same way as the preparation of income accounts must inevitably be charged to income. As for the latter, they also assert that this is part of the process of making sure that the income return of the trust is appropriate and as a recurrent ordinary expense of the trust is not chargeable to capital, even though investment expenses would so far as attributable to the investment of capital normally be chargeable to capital.
(10) Another fact which requires to be explained is the substantial element of custodian fees. These are charged by custodians on behalf of the various investment managers for their services in receiving (and accounting for) cash (principally investment income); they are recurrent and ordinary fees of the trust and it is on that basis that they are said by the trustees to be properly chargeable to income. The stance of the Revenue is that that can only be the case to the extent that they can be shown to relate to income.
(11) In the circumstances the issues which arise for the determination of the tribunal are:
(i) whether any and if so what proportion of the trustees' fees is properly chargeable to income;
(ii) whether any and if so what proportion of the investment managers' fees is properly chargeable to income;
(iii) whether any and if so what proportion of the bank charges is properly chargeable to income;
(iv) whether any and if so what proportion of the custodian fees is properly chargeable to income;
(v) whether any and if so what proportion of the accountancy and administration fees charged by the accountants is properly chargeable to income.
[It was agreed between the parties at the hearing that we should give a decision in principle and not attempt quantify the proportions.]
(12) A schedule has been prepared by the Revenue showing how the trustees' claims have been presented at different stages in advance of the proceedings and how the Revenue states its position. The trustees say that the fact that different proportions have been sought at different stages in their attempt to reach an acceptable basis for computation reflects in part (of course) an anxiety to reach agreement but in the main simply the fact that there has been a process in which the trustees have been able to consider and consider again their attempts to take an accurate overview of the way time and costs need to be divided between items which have in the event attracted an aggregate charge to which specific division is not possible and which thus on their understanding of law and practice requires a process of considered appointment.
(1) The trust arose out of a resettlement of the interests of the United Kingdom branch of an American family whose wealth derives from the 19th century entrepreneur Eben Jordan. It is one of six trusts with United Kingdom resident trustees which are invested in a similar way. It is a discretionary trust and the trustees have in the past accumulated most of the income.
(2) Mr Stockwell's role is very active. He spends about 15 hours a week on the investments and a similar amount of time on the income of the six trusts, equating to about 1½ hours a week on the income of this particular trust. The work on income includes checking that the withholding taxes are deducted at the correct tax treaty rate in about 17 countries. Investments are held in a similar number of currencies. He sees daily income records of the Custodians on each account and in each currency on his computer. The trusts have three different investment managers each with its own Custodian. This trust, but not the others, has made investments in venture capital investments.
(3) Rawlinson & Hunter bill quarterly for Mr Stockwell's services as a trustee and separately for accounting services performed by other members of the firm. The amount of each part of the fee varied from quarter to quarter (although Mr Stockwell's part is the same except for being less in one quarter) in the period under appeal from which we infer that the charges are calculated either on a time basis or on an agreed basis that was calculated in advance on the expected time. The fee is split between the six trusts on the basis of their value. The non-executive trustees are paid a fixed fee.
(4) We saw agreements with three investment managers. Each of these was based on a fee calculated by reference to capital value.
(5) Both Mr Stockwell and Mr Custis drew attention to (and we accept) the changed role of investment advisers since about 1990. Originally a stockbroker would provide periodic advice on investments while the trustees dealt with transfer forms, keeping share certificates and collecting income. Now investment managers will use their nominee company, will have discretion to vary investments in accordance with trustees' general instructions, will maintain accounts of income and capital, make payments out of each on the trustees' instructions, produce statements of such accounts and valuations of investments, prepare annual tax information with a consolidated tax deduction certificate and compute capital gains, will check and chase up missing income, including dealing with withholding taxes.
(6) Mr Custis said (and we accept) that where trustees' fees were based on the value of the funds he would expect between 50% and 70% to be attributed to income. Trustgees' expenses are generally accounted for on an accruals basis, except in very small trusts.
Statutory provisions
"(1) So far as income arising to trustees is income to which this section applies it shall be chargeable to income tax at the rate applicable in accordance with subsection (1AA) below, instead of at the basic rate or, in accordance with section 1A, at the lower rate or the Schedule F ordinary rate.
(1AA) The rate applicable in accordance with this subsection is—
(a) in the case of so much of any income to which this section applies as is Schedule F type income, the Schedule F trust rate; and
(b) in the case of any other income to which this section applies, the rate applicable to trusts.
…
(2AA) The rate at which income tax is chargeable on so much of any income arising to trustees in any year of assessment as—
(a) is income to which this section applies, and
(b) is treated in accordance with section 689B as applied in defraying the expenses of the trustees in that year which are properly chargeable to income (or would be so chargeable but for any express provisions of the trust),
shall be the rate at which it would be chargeable on that income apart from this section, instead of the rate applicable to trusts or the Schedule F trust rate (as the case may be)…."
Section 689B provides
"(1) The expenses of any trustees in any year of assessment, so far as they are properly chargeable to income (or would be so chargeable but for any express provisions of the trust), shall be treated—
(a) as set against so much (if any) of any income as is income falling within subsection (2) [Schedule F income], (2A) [Case V savings income] or (3) below [other savings income] before being set against other income; and
(b) as set against so much (if any) of any income as is income falling within subsection (2) or (2A) below before being set against income falling within subsection (3) below and
(c) as set against so much (if any) of any income as is income falling within subsection (2) below before being set against income falling within subsection (2A) below…."
Accordingly the issue is whether the income arising to the Appellant trustees has been applied in defraying the expenses of the trustees in that year which are properly chargeable to income.
Contentions of the parties
(1) The issue is essentially whether a particular management expense of a trust which relates partly to income can be attributed partly to income and partly to capital. If such attribution is not possible the result will be unfair to one or other class of beneficiaries. It is a cardinal principle of trust law that the trustees have to keep the balance between income and capital.
(2) There is no dichotomy between recurrent and ordinary expenses and expenses incurred for the benefit of the estate as a whole. As Mr Robert Walker QC argued for the trustees in Carver v Duncan [1985] 1 AC 1082, 1113 "many expenses (for instance repairs, insurance, and trustees' ordinary remuneration) are incurred for the benefit of the trust property as a whole, but are properly chargeable to income." The correct test for an expense to be attributable to income is whether the expense is an ordinary outgoing of recurrent nature which is necessary or designed to maintain use, application or enjoyment of income. Mr Baldry's contention that the only expenses attributed to income are those to secure the income is based on reading the statement in In re Bennett [1896] 1 Ch 778 that "By an 'outgoing' is generally meant some payment which must be made in order to secure the income of the property" as if were statutory wording, and ignoring that it says it "generally." Outgoings clearly include repairs but these do not secure the current income; they protect the future income. Securing in this context means protecting the income beneficiary's rights.
(3) Section 22(4) of the Trustee Act 1925 in requiring attribution of audit fees between capital and income as the default provision recognises that such attribution is permitted.
(4) Trustees' fees are an expense of the trustees. They are payments out of the trustees' account to an individual trustee in his personal capacity. Trustees' fees are normally chargeable to income. Walton J said in In re Duke of Norfolk's Settlement Trusts [1979] Ch 37, 62 as a general reflection of the court's inherent jurisdiction:
"In those cases in which the inherent jurisdiction is exercised, it appears to me that any remuneration allowed ought to come out of income, if it be remuneration for running the affairs of the trust pure and simple - general remuneration. This, I have been informed by Chief Master Ball, was the invariable practice in those cases decided by the former Chancery judges whom he has served, and it accords with my own impressions. This would seem only logical. But in those cases such as the present where the special services rendered by the trustees have been, in substance, the development of the capital assets of their trust, it would be appropriate that any special remuneration should be paid out of capital."
Contrary to Mr Baldry's contention, Carver v Duncan had not affected this treatment; the Duke of Norfolk case was cited in Carver v Duncan and no criticism was made of it.
(5) Before accumulation income is still income and the expenses of dealing with it, including a proportion of the investment managers' fees on how to invest the accumulations is allowable as an income expense just as are the expenses of deciding how to distribute income.
(6) The Custodian fees are largely attributable to income as the bulk of the transactions relate to income.
(7) The bank charges relate predominantly to income, save for the second account which related to an overdraft on capital account.
(8) On timing, subs (2AA) dealt with income "treated in accordance with section 689B as applied in defraying the expenses of the trustees" which was a notional process not connected with timing.
(1) In Carver v Duncan Lord Templeman said "The trustees must then debit each item of expenditure either against income or against capital." Attribution of part of a single expense is not normally appropriate. Expenses that benefit both capital and income beneficiaries are not attributable between income and capital but are to be charged wholly to capital. The only expenses attributable to income are those paid in order to secure the income, see the definition of "outgoing" in In re Bennett. Securing can include everything up to determining the net income available for distribution.
(2) Section 22(4) of the Trustee Act 1925 is a specific statutory provision dealing with audit fees, which did not relate to securing the income, and not a statement of any general principle.
(3) Investment management fees are charged to capital as in Carver v Duncan. Costs relating to the investment of accumulated income relate to an accretion to capital and are a capital expense.
(4) Even though trustees' remuneration may have been allowed against income in the past Carver v Duncan should now be applied. Such fees are not ordinary outgoings and are incurred for the trust as a whole and are accordingly capital. In any event income applied in paying trustees' fees is not applied "in defraying the expenses of the trustees" within s 686(2AA), which implies liabilities incurred by the trustees.
(5) Bank charges are for the benefit of the trust as a whole and are capital.
(6) Accountancy expenses so far as they relate to income, including the tax return so far as relating to income, do not benefit the trust as a whole and are allowable as a deduction.
(7) Custodian charges so far as relating to income do not relate to the trust as a whole and are allowable as being for the securing of the income.
(8) On timing, the usual meaning of expenses means liabilities incurred and paid. Income cannot be treated in accordance with s 689B as applied in defraying the expenses of the trustees until the expense has been paid, when it is allowable against the income of that year. There was a distinction between the trustees' expenses in the year of assessment, and expenses of management of an investment company for the accounting period in the former version of s 75 of the Taxes Act 1988.
Reasons for our decision
"Then the trustee says that in order to make that investigation he will have to employ an accountant at a cost of about £213. The question is, who is to pay for that? In the first place, as between the testator's estate and the surviving partners the expense cannot be thrown upon them: it must be borne by the testator's estate. It does not exactly come under the head of debts or testamentary expenses, but it is much more akin to testamentary expenses than anything else that can be suggested. I think the suggestion made by Mr. Cozens-Hardy was the true one - namely, that an expense of this kind is part of the costs, charges and expenses properly incurred by the executor and trustee in the performance of his duty. Why is this expense to be thrown upon the tenant for life? For whose benefit is it incurred? It is really for the benefit of the whole estate, though the practical effect of throwing it upon the whole estate will be that the tenant for life will lose the income of the sums expended.
It has been suggested that such expenses are like annual outgoings. I do not think they are. By an 'outgoing' is generally meant some payment which must be made in order to secure the income of the property."
"In re Bennett [1896] 1 Ch 778 was a special case on unusual facts; the risky loan made by the testator was not an authorised investment. The principle which it states is too wide: many expenses (for instance repairs, insurance, and trustees' ordinary remuneration) are incurred for the benefit of the trust property as a whole, but are properly chargeable to income."
"Trustees are entitled to be indemnified out of the capital and income of their trust fund against all obligations incurred by the trustees in the due performance of their duties and the due exercise of their powers. The trustees must then debit each item of expenditure either against income or against capital. The general rule is that income must bear all ordinary outgoings of a recurrent nature, such as rates and taxes, and interest on charges and incumbrances. Capital must bear all costs, charges and expenses incurred for the benefit of the whole estate."
He said this of the investment managers' fees at p.1120-1:
"The Devonshire settlement trustees also paid annual fees to a firm of investment advisers to keep under review and to advise changes in investments comprised in the trust fund. This was a recurrent charge but not an ordinary outgoing and was incurred for the benefit of the estate as a whole because the advice of the investment advisers will affect the future value of the capital of the trust fund and the future level of income arising from that capital."
Of In re Bennett, he said at p.1121:
"In re Bennett [1896] 1 Ch 778 which has been accepted law for nearly 90 years affirms the trust principle that expenditure incurred for the benefit of the whole estate is a capital expense. In accordance with the authorities and in accordance with principle, the premiums paid by the Paul and Devonshire settlement trustees in respect of capital transfer tax protection and on endowment policies and the fees paid to investment advisers were capital expenses and not income expenses."
"(4) Trustees may, in their absolute discretion, from time to time, but not more than once in every three years unless the nature of the trust or any special dealings with the trust property make a more frequent exercise of the right reasonable, cause the accounts of the trust property to be examined or audited by an independent accountant, and shall, for that purpose, produce such vouchers and give such information to him as he may require; and the costs of such examination or audit, including the fee of the auditor, shall be paid out of the capital or income of the trust property, or partly in one way and partly in the other as the trustees, in their absolute discretion, think fit, but, in default of any direction by the trustees to the contrary in any special case, costs attributable to capital shall be borne by capital and those attributable to income by income."
Mr McCall contends that this is an example of the general principle; he points out that the sections does not authorise trustees to allocate the costs between income and capital but states that the default position is that the trustees must allocate. Mr Baldry contends that this is a special statutory provision.
"2.53 This last example illustrates the difficulties in applying what seems, in principle, to be a sensible rule. In Re Bennett, Lindley LJ said: 'by an 'outgoing' [ie an ordinary expense chargeable to income] is generally meant some payment which must be made in order to secure the income of the property.' Many fees charged to trustees or their advisers will not meet this requirement, although they have 'an income character in so far as [they] may be connected with an income benefit.' Moreover when a trust corporation charges an annual fee which is calculated by reference to the level of trust income it should be treated as an income expense, at least in cases where a separate capital charge is made on acceptance and/or withdrawal. Where there is no separate capital fee against which the annual fee can be contrasted the situation is less clear. The irresistible conclusion is that the annual fee reflects work done on behalf of both income and capital. Since the work is for the benefit of the whole estate, the fee should be charged to capital. There is, however, no authority on this question.
The sentence beginning "Many fees charged to trustees…" seems to show that the Law Commission did not regard the Bennett test of ordinary outgoings as the only category of allowable expenses.
"On the whole I have come to the conclusion that both the income fee on the income of the settled legacies, and the withdrawal fee on the capital when withdrawn, ought to be borne by the settled legacies. The income fee must come out of the income of each settled legacy, and the withdrawal fee out of the capital of each settled legacy."
It seems therefore that where the trustee has done the allocation in charging the fees, that allocation is to be used.
"Subject to particular statutes a trustee has a general discretion to allocate outgoings out of income or capital as he sees fit, but using his powers to effectuate the settlor's purposes and in accordance with his duty to keep a fair balance between the interests of income beneficiaries and capital beneficiaries, and so taking account of the following traditional principles governing the incidence of outgoings (after the trustees have taken advantage of their initial right to resort to capital or income as they find easiest to discharge outgoings):
(a) the corpus bears capital charges incurred for the benefit of the whole trust estate, and income bears the interest on them, while if the current income is insufficient, arrears of interest on capital charges must be paid out of subsequent income;
(b) the income usually bears current expenses, including the entire cost of keeping leaseholds in repair;
(c) where repairs to trust freeholds are necessary to save them from destruction, or fines become payable for the renewal of leases, or for putting in repair leasehold property which was out of repair at the date of the creation of the trust, the court may empower the trustees to raise the necessary amount in such a way as will be equitable between income and corpus;
(d) all costs incident to the administration and protection of the trust property, including legal proceedings, are borne by corpus, unless they relate exclusively to the tenant for life, the corpus bearing all costs, charges and expenses incurred for the benefit of the whole estate."
The authors emphasise that the attribution is based on the trustee's duty to keep a fair balance between classes of beneficiaries.
(1) The accountancy fees relate in part to the separate work on checking and recording the income and that part is properly attributed to income.
(2) The custodian fees relate in large part to the collection of income on foreign investments. We consider that an attribution should be made between income and capital.
(3) Mr Stockwell's fee based on the time spent can be attributed in part to income in exactly the same way as if a bank trustee had charged separate income and capital fees, as in In re Roberts Will Trusts. We do not consider that the fixed fee paid to the non-executive trustees should be attributed partly to income. The distinction is that the fee of the non-executive trustees does not vary according to the amount of work attributed to income, as does Mr Stockwell's fee, and it should therefore properly be treated as expenses incurred for the benefit of the whole estate which should be charged to capital.
(4) The bank charges relate in part to the ordinary receipts and payments the majority in number of which are likely to be of an income nature, while another account relates to an overdraft on capital account. We consider that part of the charges for the former account should be attributed to income.
(5) The work of the investment managers is wider than that described by Lord Templeman in Carver v Duncan as being "to keep under review and to advise changes in investments comprised in the trust fund," reflecting the evidence from both witnesses about the change in the nature of the role of investment managers in the 1990s. We do not therefore consider that the position is conclusively determined by Carver v Duncan. However, the work is predominantly attributable to capital, particularly when, as here, the Custodian does the bulk of the work relating to the income. The only part seriously contended for attribution to income is the investment of accumulated income. If the accumulation were for a particular child then it would be proper to attribute the cost of investment of those accumulations to that fund, as opposed to the capital generally. Here since accumulations of income can be paid as income of a future year they are held on different trusts from the original capital and it would be proper to charge the fund with its investment rather than the whole capital. But the real question is whether because we are dealing with income until the accumulation takes place this is to be attributed to income. In our view accumulation of income takes one beyond the point at which the expenses are "properly chargeable to income." The trustees will have resolved to accumulate the income at which point it become capital and the expenses of investing it are capital. The position might well be different if the trustees are temporarily investing income while deciding whether to accumulate it.
Timing
"(2AA) The rate at which income tax is chargeable on so much of any income arising to trustees in any year of assessment as—
(a) is income to which this section applies, and
(b) is treated in accordance with section 689B as applied in defraying the expenses of the trustees in that year which are properly chargeable to income (or would be so chargeable but for any express provisions of the trust),
shall be the rate at which it would be chargeable on that income apart from this section, instead of the rate applicable to trusts or the Schedule F trust rate (as the case may be)."
Section 689B provides
"(1) The expenses of any trustees in any year of assessment, so far as they are properly chargeable to income (or would be so chargeable but for any express provisions of the trust), shall be treated—
(a) as set against so much (if any) of any income as is income falling within subsection (2) [Schedule F income], (2A) [Case V savings income] or (3) below [other savings income] before being set against other income…."
(1) In accordance with the requirement to achieve a fair balance between income and capital beneficiaries, a proportion of all the expenses in issue, with the exception of the investment management fees, is attributable to income and is properly chargeable to income for the purposes of s 686(2AA).
(2) We adjourn to enable the parties to endeavour to agree the correct proportion, failing which either party may apply for a resumed hearing for us to determine this.
(3) The accruals basis adopted here is a proper way of allocating expenses to a particular year of assessment.
ADRIAN SHIPWRIGHT
JOHN F. AVERY JONES
SPECIAL COMMISSIONER
RELEASE DATE: 27 February 2007
SC 3047/06
Authorities referred to in skeletons and not referred to in the decision:
Heather v PE Consulting (1973) 48 TC 293
Macdonald v Irving (1978) 8 Ch D 101
Re McClure (1906) 76 LJ Ch 52
Lloyds Bank v Duker [1987] 1 WLR 1324
Howe v Earl of Dartmouth (1802) 7 Ves Jun 137
Earl of Chesterfield's Trusts (1883) 24 ChD 643
Schmidt v Rosewood [2003] 2 AC 709
Re Gjers [1899] 2 Ch 54