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Cite as: [2007] UKSPC SPC00609, [2007] UKSPC SPC609

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Herman & Anor v Revenue & Customs [2007] UKSPC SPC00609 (26 March 2007)

SPC00609

CAPITAL GAINS TAX – Non-resident settlement - Capital payment – Indirect receipt - Implementation of Mark II flip-flop scheme – Non-resident trust with stockpiled gains transfers trust fund to resident trust created by settlor of former trust – Trustees of resident trust appoint entire trust fund to settlor and wife – Whether capital payments received indirectly by settler and wife – Yes – TCGA 1992 ss 87(4)and 97(5)

THE SPECIAL COMMISSIONERS

DAVID PETER HERMAN

BARBARA HERMAN Appellants

and –

THE COMMISSIONERS FOR HER MAJESTY'S REVENUE & CUSTOMS Respondents

Special Commissioner: SIR STEPHEN OLIVER QC

Sitting in public in London on 12 and 13 March 2007

Richard Bramwell QC and John Dick, counsel, for the Appellants

Michael Gibbon, counsel, instructed by the acting counsel and solicitor for HM Revenue and Customs, for the Respondents

DECISION

Mr D P Herman appeals against an adjustment of £578,146.72 to his self-assessment return for 2001-02. Barbara Herman appeals against an assessment to tax of £557,764.60 for the same year of assessment.

Background

The appeals involve the capital gains tax provisions concerning non-resident settlements and the background to the assessments can be briefly summarised as follows:

(a) In 1990 Mr Herman created a non-resident settlement of which he and his family were beneficiaries ("the Family Settlement").

(b) By 1998 the "stockpiled gains" of the Family Settlement were some £2 million.

(c) On 4 February 2002 Mr Herman created a UK resident settlement of which he and Mrs Herman were beneficiaries and trustees; a UK solicitor was the third trustee. This is referred to as "the Personal Settlement".

(d) On 20/22 February 2002 the Trustees of the Family Settlement, having borrowed money and purchased a holding of Treasury stock, appointed the Treasury stock and the cash and the benefit of an unsecured loan from Mr Herman to the trustees of the Personal Settlement.

(e) On 23 March 2002 the Trustees of the Personal Settlement appointed all of the trust assets to Mr Herman and Mrs Herman in equal shares absolutely.

The issue is whether the "trust gains" for the year 2001/02 (which included the stockpiled gains of some £2 million) are to be treated as chargeable gains accruing to Mr Herman and Mrs Herman in that year. This depends on the application of Taxation of Chargeable Gains Act 1992 section 87(4). Sub-section (4) will apply with that effect if Mr Herman and Mrs Herman, as beneficiaries of the non-resident Family Settlement have received "capital payments"; for this purpose a capital payment is regarded as received (by section 97(5)(a)) by the person in question from the non-resident trustees "… if he receives it from them directly or indirectly". The Revenue say that the amounts received by each of Mr and Mrs Herman on 28 March 2002 (at stage (e) in paragraph 2 above) are to be regarded as received from the Trustees of the non-resident Family Settlement. Mr and Mrs Herman contend that sections 87(4) and 97(5) do not, properly construed and in the circumstances of the case, produce that result.

It is common ground that the transactions comprised in stages (c) and (d) were carried out in order to implement a capital gains tax avoidance scheme known as a "Mark II flip-flop".

The key statutory provisions and their background in the present context

The Trustees of a non-resident settlement are not within the charge to capital gains tax. Two groups of provisions apply so as to attribute the gains of the trustees to (respectively) the settlor or the beneficiaries.

As regards the settlor, the provisions of TCGA section 86 apply to "qualifying settlements" as defined by Schedule 5; and for gains realized before 1999/2000, a settlement made before March 1991 was not a qualifying settlement (Schedule 5 paragraph 9(1A). The present settlement was not qualifying settlement when the trustees realized their gains.

As regards beneficiaries, the gains of the trustees of a non-resident settlement are attributable to beneficiaries who receive "capital payments": see section 87. For this purpose, capital payments are defined by section 97. Such gains are taxed as the gains of the beneficiary but with the addition of a "supplement" under section 91. In the present case the supplement gives an effective tax rate of about 58%.

Section 87(4) provides:

"The trust gains for a year of assessment shall be treated as chargeable gains accruing in that year to beneficiaries who receive capital payments or who have received such payments in any earlier year."

Section 97(1) provides that for the purposes of sections 86A to 96 and Schedule 4C "capital payment" means –

"(a) Any payment which is not chargeable to income tax on the recipient."

Section 97(5) provides:

"For purposes of sections 86A to 98 and Schedule 4C a capital payment shall be regarded as received by a beneficiary from the trustees of a settlement if –

(a) he receives it from them directly or indirectly;

(b) it is directly or indirectly applied by them in payment of any debt of his or otherwise paid or applied for his benefit or

(c) it is received by a third person at the beneficiary's direction."

Prior to the introduction of amendments made by Finance Act 2000, where property was transferred from a non-resident to a resident settlement, section 90 applied to carry over the realized gains of the non-resident trustees to the resident trustees. But it did not apply to gains realized by the non-resident trustees after the transfer. This gave rise to arrangements known as "flip-flop" schemes.

The "Mark I" flip-flop scheme operated in the manner described in this example:

The trustees of a non-resident settlement hold assets worth £1 million. The assets have a capital gains tax base cost of £0.5 million. The trustees borrow £1 million and advance it by way of resettlement on the trusts of a resident settlement for the benefit of beneficiaries of the non-resident settlement. The non-resident trustees sell the assets and discharge the borrowings. Because section 90 did not apply to the post-advancement gains, they were left in the (now redundant) non-resident settlement.

Finance Act 2000 enacted two Schedules to the TCGA (Schedules 4B and 4C) which applied where there were transfers between settlements "linked to trustee borrowings". These provisions were effective to counter Mark I schemes. But at the same time a new subsection (5) was inserted in section 90 and reads:

"This section shall not apply –

(a) to a transfer to the extent that it is … linked with trustee borrowings; …".

This paved the way for Mark II flip-flop schemes designed for cases where there were pre-existing "stockpiled" gains. I once again illustrate the position with an example.

In April 2001 a Jersey Settlement had realized gains of £1 million and assets of £1 million (whose disposal would not give rise to a gain). The trustees borrowed £1 million and appointed the cash to a UK settlement. The trustees realized their assets and repaid the borrowings. The effect of section 90(5) was that the stockpiled gains remained stranded in the Jersey Settlement.

Thus, although the transfer was "linked to trustee borrowing", the link might be purely formal (unlike the Mark I schemes). Mark II flip-flop schemes were explained as follows in the Treasury Notes to Finance Act 2003:

"66. The new version of the flip-flop scheme deliberately triggers the Finance Act 2000 legislation to switch off the section 90 avoidance rule with the aim of stranding already realized gains in one settlement and potentially allowing capital payments to be made to beneficiaries from another settlement without incurring a capital gains charge.

The scheme is used where the settlement carrying out the transfer of value has already disposed of all or most of its assets, but the gains have not yet been attributed to beneficiaries. The transfer of value to another settlement triggers a deemed disposal of the settlement's assets, but the settlement has few if any unrealized assets so there are few if any gains to go into the Schedule 4C gains pool. Because the Finance Act 2000 legislation only requires gains created by the deemed disposal to go into the pool, any existing unattributed gains remain in the transferor settlement and it is claimed that the capital from the transfer of value can then be paid out to beneficiaries by the trustees of the transferee settlement without triggering a capital gains charge."

(The Amendments made by Finance Act 2003 (which included amendments to section 90(5)) had retrospective effect as regards transfers between settlements made after 21 March 2000, but only insofar as the transferred property remained within the transferee's settlement as at 9 April 2003. So, in the latter of the two examples, if the position remained unchanged on 9 April 2003, the stockpiled gains in the Jersey settlement would be treated as capable of attribution to recipients of capital payments from the UK settlement. But not, if before that date, the funds had been distributed to beneficiaries. The latter is the type of case with which the present appeals are concerned.)

It is common ground that the Mark II flip-flop was effective in preventing the realized stockpiled gains of the non-resident Family Settlement being carried into the Personal Settlement. This brings me to the issue which, as already noted, is whether section 97(5)(a) applies to treat Mr Herman and Mrs Herman as having received capital payments from the Family Settlement indirectly.

Contentions of the Parties

Before examining the facts I shall shortly summarized the arguments. In the light of these I shall reach some conclusions on the law because these will dictate the nature of the fact-finding exercise.

For the Hermans represented by Richard Bramwell QC and John Dick, it is argued that the amounts actually received from the Personal Settlement were not indirectly received from the non-resident Family Settlement. The authorities on "indirect" payments, such as Pott's Executors v Inland Revenue Commissioners 32 TC 211 and Piratin v Inland Revenue Commissioners 54 TC 730, show that the term "received indirectly", properly construed, does not support the Revenue's contrary assertion. Instead the context of section 97(5) prevents a wide meaning being given to subsection (5)(a). This follows from the fact that a greatly enlarged meaning of payment has been given by the plain words of subsection (5)(b) and (c).

The argument for the Hermans goes on to contend that the scheme of sections 80-97 (covering non-resident settlements) is inconsistent with the notion that the same appointment may result in a direct receipt from one settlement (e.g. the Personal Settlement) and an indirect receipt from another (e.g. the Family Settlement).

Mr and Mrs Herman, through Mr Dick, pointed to a series of anomalous and unintended consequences that would ensue were the same payment to be treated as a capital payment made by the trustees of two settlements. He gave two examples of double-counting anomalies and an example of an anomaly resulting from the "matching" and "surcharge" provisions. (The Revenue did not challenge the possibilities of anomalies of those sorts. They had not, I was told, come across situations where in practice such anomalies had been thrown up.) I have summarized the anomalies in the Appendix to this decision in case the point should ever become relevant.

The Revenue point to the scheme of the relevant capital gains tax legislation within which the expression "he receives it from them directly or indirectly" in section 97(5)(a) falls to be construed. This requires the attribution of "trust gains" to beneficiaries according to any benefits they receive in a form that is not subject to income tax. See the decision of Walker LJ in Cooper v Billingham [2001] STC 1177 and [2001] EWCA Civ 1041 in paragraph 37 and, as Lord Walker, in West v Trennery [2002] UK HL 5, [2005] STC 214 in paragraphs 43 and 44. The statutory test is contained in the deeming words of section 97(5), "a capital payment shall be regarded as received by a beneficiary from the trustees of a settlement if … he receives it from them directly or indirectly". In the present situation the capital payments were received directly from the trustees of the Personal Settlement. Whether they were also receive indirectly from the trustees of the Family Settlement calls for an enquiry as to whether the receipt can be traced back to the Family Settlement as being the indirect source. On the evidence, with particular reference to the circumstances of the payments having been received in pursuance of the scheme and because, in the words of Lord Walker in paragraph 41 of West v Trennery, the Personal Settlement "served as a vehicle to receive and continue the act of bounty effected by the" non-resident Family Settlement, the receipts can properly be traced back to the capital payments made by the trustees of the Family Settlement.

Observations on the law

Drawing the threads together in the legal analysis, I am satisfied that the word "indirectly" found in the expression "a capital payment shall be regarded as received by a beneficiary from the trustees of a settlement if … he receives it from them directly or indirectly" adds significantly to the word "directly". The Pott's analysis is not in point here. The enquiry in Pott's and Piratin (and in Wachtel v Inland Revenue Commissioners 46 TC 543) was to ascertain whether sums paid to third parties were "paid directly or indirectly to" the settlor. The issue in those cases was what could be meant by "paid"; thus questions of whether a third party is "accountable" to the settlor (the Pott's analysis) are not relevant here. Here, in contrast to the Pott's line of cases, the starting point of the analysis in section 97(5)(a) is that Mr Herman and Mrs Herman are identified as the individuals to whom the amounts have been paid. The enquiry, put in train by "indirectly" in the context of the present case, is whether the amounts paid to Mr Herman and Mrs Herman, i.e. their receipts, can be traced back as having an indirect source in the Family Settlement.

Unless therefore there is anything in a wider context that precludes this, it seems to me that the correct approach is to apply the statutory test contained in the words in section 97(5)(a) and work back to find the indirect source of the undisputed receipts. I can detect nothing in the statutory code that is inconsistent with that approach. The underlying aim of the particular code is to attribute trust gains to beneficiaries according to any benefits they receive in a form that is not subject to income tax: see the passages from Cooper v Billingham and West v Trennery cited by the Revenue in support of their case (see paragraph 17 above). That is the framework created by section 87 and 97. The provisions of Finance Act 2000 may have "switched off" the section 90 "avoidance rule" (to use the Treasury's expressions in the Notes set out in paragraph 11 above). But the two framework provisions remain unchanged. What is more, it must be implicit in the arguments for Mr Herman and Mrs Herman that had the relevant arrangements been entered into prior to Finance Act 2000, a charge to capital gains tax would have arisen in respect of the payments that they had received.

I acknowledge from the examples put forward by Mr Dick that double counting of gains could, at least in theory, result from this construction and application of section 97(5)(a). Rough consequences can, as Lord Walker observed in West v Trennery (paragraph 44) result. The examples put forward by Mr Dick are not, however, this case. I have already observed that the situations postulated in the examples have not arisen in the experience of the Revenue. Moreover, it is not beyond the realms of purposive construction that section 87(5) might apply to prevent the double counting problems.

The right approach, I think, is to make an enquiry, using whatever signposts appropriate to the circumstances are available, and to determine whether the receipts of Mr Herman and Mrs Herman can properly be linked to the disposition from the Family Settlement as their indirect source. An obvious signpost will be the existence of a plan, if there is one. In the present circumstances the appointment by the trustees of the Family Settlement was in pursuance of a scheme, the Mark II flip-flop scheme; it will be relevant to the enquiry to determine whether the plan as a whole envisaged that Mr Herman and Mrs Herman should receive the amounts that they did. If the relevant receipt resulted by accident or on account of circumstances not envisaged by the scheme, then the linkage may not be there. The second signpost is to analyse the trust law and determine whether the Personal Settlement "served as a vehicle to receive and continue the act of bounty effected by" the trustees of the Family Settlement (see the words of Lord Walker in paragraph 41 of West v Trennery). The precise means by which the scheme was implemented will, in addition, be relevant to the question whether there is sufficient linkage to make the payments "indirectly" receipts from the trustees of the Family Settlement.

The facts relevant to the enquiry

The Family Settlement had been created in November 1990. It gave successive life interests to Mr Herman and to his wife with an overriding power of appointment exercisable in favour of "beneficiaries" who included Mr Herman, his wife and his family. The trustees of the Family Settlement subscribed for 50,000 £1 shares in Anglia Windows (of which Mr Herman was one of the "buy-out" team in 1990). He had been finance director of that company and its successor. Between 1990 and 1998 the shares were sold, realizing substantial gains. These were "stockpiled" and not released as capital payments.

In 1997 "Orbis Management Ltd" (a Guernsey company associated with Kleinwort Benson) became trustee of the Family Settlement.

A letter of 17 July 2001 from Orbis Management put the idea to Mr Herman of a scheme to mitigate tax on the stockpiled gains. On 24 July 2001, and following a telephone conversation with Mr Herman, Orbis Taxation Services Ltd wrote to Mr Herman explaining that the scheme sought to achieve complete avoidance of tax; it pointed out that the Hermans would have to establish a new trust with settled funds of £10,000 but indicated that should the new trust "subsequently decide to distribute capital then these moneys would in effect be refunded". The proposed fee was £50,000. The potential saving of tax was said to be some £1 million.

On 23 August 2001 Mr Herman told Orbis Management that he was keen to proceed with the capital gains tax scheme. The next day Orbis Taxation Services wrote "strongly" recommending that a lawyer or accountant be appointed as third trustee of the new trust in addition to Mr and Mrs Herman. The letter explains - "This is mainly so it can be demonstrated, if necessary, that proper independent consideration is given to future decisions which the trustees of the new settlement(s) may make".

Mr Herman wrote to Orbis Management on 22 October 2001 stating that he would go ahead if Orbis were still confident about the effectiveness of the scheme. Orbis's reply of 5 November 2001 was that – "Nothing has changed". On 4 December 2001 Mr Herman wrote to Ms Hawdon of his solicitors, Rogers & Norton, shortly summarizing his advice from Orbis and stating that (according to the file note) – "If the trust were brought ashore without the protection of the … scheme, the capital gains tax liability might be about £1 million". It was not in dispute that oral discussions had taken place between Mr Herman and Orbis.

On 14 December 2001 Orbis Taxation Services wrote to Ms Hawdon. The letter contains the following passages:

"With advice from leading UK tax counsel we have developed the arrangement outlined (very broadly) below aimed at removing the potential tax liability".

The letter goes on to say that after UK gilts had been appointed to the new UK settlement – "… we will then provide a letter setting out the UK tax position and tax counsel's comments relating thereto in order that the trustees of the new settlements may be in a position to properly consider the future administration etc. of those settlements".

At the start of 2002 Mr Herman telephoned Ms Hawdon telling her that his tax advisers were concerned to get everything set up before the Budget. The same day Orbis Taxation services telephoned Ms Hawdon. Her file note reads:

"He said that Orbis would be appointing gilts into the Hermans' settlement to a value of about £2 million. Thereafter, they would need the Trustees' instructions for the sale or transfer of gilts and if sale, they would need instructions to send the proceeds to a trust bank account. Mr Herman has been told that he needs to set up such an account. Once the gilts had been appointed into the Settlement, a further letter would be sent out setting out the tax situation and the Trustees would then have to decide whether to close the trusts and take the money out. At this stage,, the trustees would be given an indemnity to cover them against any liability to tax and any costs which might arise. It was envisaged that the money would go to Mr and Mrs Herman …".

(I have inferred from this is that Orbis expected that the Personal Settlement would be closed and that the money would go to Mr Herman and Mrs Herman.)

On 7 January 2001 Orbis Taxation Services wrote to Ms Hawdon stating that if the decision were taken to distribute funds from the Personal Settlement, they would expect the trustees to obtain a full indemnity from the recipients against taxation, costs etc; Orbis Taxation services offered to provide an appropriate deed for consideration.

Ms Hawdon wrote to Orbis and to Mr Herman on 16 January 2002. The letter to Mr Herman contained a comprehensive disclaimer on the part of Rogers & Norton stating that they were "completely reliant upon Orbis "to advise on and deal with all the taxation aspects of the entire scheme from the outset, including stamping of documents, reporting to the Inland Revenue etc as appropriate, to its conclusion." Mr Herman and Mrs Herman were sent copies of the Personal Settlement for signature by Ms Hawdon on 18 January 2002.

Then followed a telephone call from Orbis to Ms Hawdon on 29 January 2002. Her file note records among other things, that the "end game" was "that the trusts were not intended to last long and that once the funds had been transferred to them, they would be appointed out to the beneficiaries. … The whole scheme for tax planning was to avoid the existence of any trust, hence the need to appoint out reasonably quickly."

Mr Herman had been somewhat delayed on account of his wife's ill health. But when he attended Ms Hawdon's office on 31 January 2002 with the signed Personal Settlement, the attendance note records that:

"Mr Herman said that, having spoken to [Orbis], he now discovered that Orbis want the whole scheme pushed through before 5 April, i.e. all money to be moved round by then."

The signed Personal Settlement is dated 4 February 2002.

On 14 February 2002 Orbis drew down £1.98 million from Kleinwort Benson for purchase of gilts by the Family Settlement. This was under a borrowing facility for £2.2 million entered into on 9 January 2002. On 19 February Mr Herman sent a fax to Orbis stating that UK trust bank accounts have been set up. He gave the details of the bank accounts for the Personal Settlement and the fax ends with the words - "Over to you".

On 20 February 2002 Orbis, as trustee of the Family Settlement, asked Kleinwort Benson for a cheque for £3,500 payable to the Personal Settlement. There was a Trustee's meeting for the Family Settlement on 20 February 2002. This approved the appointments. The persons present at the meeting were senior managers of Orbis Taxation Services.

On 20 February 2002 Orbis transferred £1.57 million of Treasury stock plus "an interest free loan due by Mr Herman of £375,999" plus cash of £3,500. This was approved by deed on 22 February. A further deed of the same date transferred a further £700 of Treasury stock.

On 25 February 2002 Orbis wrote to Kleinwort Benson stating that the borrowing facility was to be repaid. The borrowing from Kleinwort Benson had lasted for ten days. Mr Herman confirmed in evidence that throughout that period the Family Settlement had had sufficient liquid funds to make the appointments to the Personal Settlement (and to a further settlement known as the Children's Settlement) without the need for borrowing; he accepted also that the Trustees had had the funds in hand to repay the borrowing at any time. Mr Herman also accepted that the borrowing had only been necessary for the purposes of the scheme, i.e. to "switch off" section 90. It is a realistic inference that the borrowing must have been inserted in the scheme so that it could be said that the transfers between the Family Settlement and the Personal Settlement were treated as "linked with trustee borrowing".

Accompanying the deeds of transfer was a letter of 25 February 2002 from Orbis explaining that the Personal Settlement trustees could keep or sell the Treasury Stock. Mr and Mrs Herman replied on 28 February stating – "it is the Trustee's wish that the Treasury Stock be sold and the proceeds paid into the settlement's bank account". On 4 March 2002 Orbis wrote to Kleinwort Benson authorising the sale of the gilts and directed that funds be transferred to the Personal Settlement bank account.

The next event was the despatch of a draft deed of termination of the Personal Settlement from Orbis to Ms Hawdon on 12 March 2002. A letter from Orbis to Mr Herman and Mrs Herman of 18 March 2002 explained the tax position, with particular relevance to the Personal Settlement. Mr Herman had been told this was coming when Orbis Taxation Services wrote to him on 14 December 2001. The letter explained that the accrued gain remained in the Family Settlement and that the Personal Settlement had no accrued gain "so it should be possible to distribute capital from that settlement without liability to UK tax". (Mr Herman confirmed in oral evidence that that was not new to him.) The letter went on to say :

"You will probably realise that such an unusual and potentially advantageous situation has arisen because of a flaw in the UK legislation (in fact as a result of legislation in the Finance Act 2000) and it may not be too long before the "flaw" is corrected. … During the course of our consultations with tax counsel, counsel expressed the opinion that because there has been a clear error in drafting the law, legislation intended to correct it could well be retrospective at least so far as any assets still held in trust at the time of the correction are concerned; he felt it unlikely however that any change could affect a situation where assets are no longer held in trust. … It is entirely up to the trustees of the Personal Settlement to decide if or when to distribute capital but it does appear to be a "window of opportunity" during which the trustees should be able to confer significant benefits on one or more of the beneficiaries – it is not known for how long the window may remain open of course."

On 22 March 2002 Ms Hawdon received a telephone call from Mr Herman in which he said he needed to go through the draft Deed of Appointment terminating the settlement (sent to him on 12 March 2002). Ms Hawdon stated that the position of Rogers & Norton (who provided the professional trustee) was one of willingness to comply with the wishes of the Hermans. On 28 March 2002 Orbis e-mailed a corrected Deed of Appointment for the Personal Settlement to Ms Hawdon. The Deed was signed and dated 28 March 2002.

Conclusions

I am satisfied from the evidence that, from Orbis's point of view, the plan comprehensibly involved the entire contents of the Family Settlement as it stood on 20 February 2002 (less expenses and less the amounts appointed to the Children's Settlement) being transferred to the Trustees of the Personal Settlement and then on to Mr and Mrs Herman free of all charges to capital gains tax. In particular the plan was designed to leave the trust gains of the Family Settlement stranded off-shore; and to avoid the impact of any corrective legislation the scheme had to be completed before 2002 Budget. Orbis's tax team devised and master-minded the scheme. Their implementation went beyond looking after the interest of the Family Settlement. Orbis produced the drafts of the Deed of Appointment to terminate the Personal Settlement. Orbis advised as to the UK tax position of the Personal Settlement. Orbis advise in connection with indemnification of Rogers & Norton. Orbis advised on the opening of bank accounts. Orbis can be seen to have planned and implemented the arrangements leading to the receipt by Mr and Mrs Herman of the funds originating from the Family Settlement.

As far as the trusts were concerned, every step in the implementation of the plan was related. The transfer from the trustees of the Family Settlement to the Personal Settlement was in process of a properly exercised power for the benefit of the two beneficiaries, Mr Herman and Mrs Herman as the intended recipients of the amounts transferred.

Mr Herman was, I am satisfied, aware of the plan. He was consulted at every point. He was consulted as to the purpose of the plan and he was consulted as to its means of implementation. I accept that he kept his options open as to whether and when the Personal Settlement should be closed. The same goes for Mrs Herman. Nevertheless he agreed to the adoption and implementation of the plan at every stage. The outcome was intended, though not necessarily preordained. That outcome was the release of the funds originating from the Family Settlement to Mr Herman and Mrs Herman absolutely. To conclude otherwise would, I think, be shutting one's eyes to the obvious.

For all those reasons I have concluded that the amounts transferred to them from the Personal Settlement on 28 March 2002 were received by Mr and Mrs Herman indirectly from the trustees of the Family Settlement for the purposes of section 97(5)(a).

I dismiss the appeal in principle. I understand that the amounts can be agreed. If anything further is required, the matter should be referred back to me.

SIR STEPHEN OLIVER QC

SPECIAL COMMISSIONER

RELEASED: 26 March 2007

SC 3161/2006

SC 3162/2006

APPENDIX

Double Counting

It was argued for Mr and Mrs Herman that the implications of the Revenue's argument that Mr and Mrs Herman each received capital payments indirectly from the Trustees of the Family Settlement, by virtue of section 97(5(a), was that the same payment could be treated as made by the trustees of two settlements. (This consequence did not actually follow in the circumstances of the present case.)

The example given assumed two non-resident settlements ("A" and "B") with a common beneficiary ("X"). Settlement A has trust property of 100 and stockpiled gains of 80. Property of 50 is appointed to Settlement B and the Trustees of that Settlement appoint the property to X.

The analysis of that example is that under section 87(4) and (5) as applied to Settlement A, on the Revenue's analysis, gains of 50 are imputed to X. Under section 90(2) the outstanding trust gains for the purposes of section 90(1) are 80 minus 50 leaving 30. Accordingly gains of 50% of 30, i.e. 15, are carried to Settlement B under section 90(1). Under section 87(4) and (5) as applied to Settlement B, gains of a further 15 are then imputed to X as a result of the "direct" capital payment from that Settlement. The result is that though X has received 50 in total, chargeable gains of 65 (50 plus 15) are attributed to him. Moreover, if in the above example Settlement B had stockpiled gains of its own, the capital payment by X to Settlement B would have resulted also in some or all of those gains being imputed to X.

The second example assumes that Settlement A had trust property of 100 and stockpiled gains of 80. Property of 50 is appointed to Settlement B and in a later year the trustees of that settlement appoint the property to X.

The analysis of the second example is that under section 90(2) the "outstanding trust gains" of Settlement A for the year of transfer are 80 (no capital payment having yet been made to a beneficiary). Section 90(1) then requires gains of 40 (i.e. 50% of the outstanding trust gains) to be carried across to Settlement B since one half of the fund has been transferred.

When X receives 50 in a subsequent year this will be (a) an indirect payment, on the Revenue analysis, to him from Settlement A triggering its 40 of the remaining gains (by reason of section 87(4) and (5) and (b) a direct payment to him from Settlement B, triggering its 40 of gains (again by virtue of section 87(4) and (5)). The overall result is that 80 of gains are attributed to a beneficiary receiving 50.

Matching and the surcharge : an example

A further example illustrating the consequences of the Revenue's contention as to the application of section 97(5)(a) concerns surcharge where property is transferred between settlements and distributed from the transferee settlement in a later year of assessment.

The facts of the example assume two non-resident settlements (A) and (B) with a common beneficiary (X). Settlement A has trust property of 100 and stockpiled gains of 80 arising from a disposal several years ago. Property of 100 is appointed to Settlement B and in a later year the trustees of that settlement appoint the property to X.

The analysis advanced for Mr and Mrs Herman is as follows. It is first pointed out that Settlement A has an unmatched "qualifying amount" of 80 at the end of the year of assessment in which the transfer is made by reason of section 94(1)(b). That unmatched "qualifying amount" passes across to Settlement B and is eliminated from Settlement A by reason of section 94(2). The overall consequence is that the receipt of 100 by X will be (a) a capital payment received indirectly from Settlement A but not carrying a surcharge because there is no unmatched "qualifying amount" remaining in Settlement A (see section 91(1)) and (b) a capital payment received directly from Settlement A giving rise to a surcharge in that the "qualifying amount" of 80 in Settlement B can be matched against 80 of the payment (by reason of section 91(1) and 93(2)).