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Cite as: [2007] UKSPC SPC00616, [2007] UKSPC SPC616

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Lyon (Alloro Trust) v Revenue & Customs [2007] UKSPC SPC00616 (26 June 2007)

Spc00616

INHERITANCE TAX – GIFT WITH RESERVATION – Discretionary Trust – Settlor beneficiary under the trust – Settlor powers of revocation and investment strategy in the trust deed – Settlor the only beneficiary to benefit from the trust during his lifetime – gift with reservation – yes – Appeal dismissed – section 102 (1)(a) & (b) Finance Act 1986

THE SPECIAL COMMISSIONERS

THE PERSONAL REPRESENTATIVES OF Appellants

HARRY DEXTOR LYON DECEASED

AND

THE TRUSTEES OF THE ALLORO TRUST

-and-

HER MAJESTY'S REVENUE and CUSTOMS Respondents

Special Commissioner: MICHAEL TILDESLEY OBE

Sitting in public in London on 21 May 2007

Jane Thomson & Jodee Webb of Price Waterhouse Cooper LLP for the Appellants

Colin Ryder, Assistant Director of HM Revenue & Customs, for the Respondents

© CROWN COPYRIGHT 2007

DECISION

The Appeal

The Appellants were appealing against the Respondents' Notice of Determination dated 6 July 2006 that the property held at 5 August 2004 by the trustees of the Alloro Trust falls to be treated as property to which Harry Dexter Lyon (the deceased) was beneficially entitled immediately before his death.

The Issue in Dispute

On 22 November 1999 Mr Lyon gifted £2.7 million to the trustees of the Alloro Trust. Under the trust deed Mr Lyon was a beneficiary. He remained one of the potential beneficiaries of the trust throughout the period from his gift until his death.

The Respondents contended that Mr Lyon's gift of £2.7 million was a gift with reservation of benefit in that he was beneficially entitled to the income and capital of the trust fund under the terms of the trust deed. Thus the gift did not comply with the requirements of section 102(1)(b) Finance Act 1986 because the property gifted was not enjoyed to the entire exclusion, or virtually to the entire exclusion of Mr Lyon. The Respondents also submitted that the possession and enjoyment of the gifted property was not bona fide assumed by the trustee during the lifetime of Mr Lyon section (102(1)(a) Finance Act 1986). In those circumstances the trust property formed part of Mr Lyon's estate immediately before his death on 5 August 2004.

The Appellants submitted that the benefit received by Mr Lyon from the trust was insignificant. In the Appellant's view the Respondents were applying a too rigid interpretation of the legislation which meant that a settlor's beneficial interest under a discretionary trust always constituted a reservation of benefit. The Appellants contended that whether a beneficial interest of a settlor amounted to a reservation depended upon the facts of the individual case. The Appellants considered the disputed question from the perspective of the benefit that Mr Lyon actually derived from the trust not the potential benefit that he might enjoy. In those circumstances Mr Lyon received only £15,965 out of total trust property of £2.7 million which was insignificant and took the arrangements outside the gifts with reservation regime.

The issue for determination was whether the gift of property made by Mr Lyon to the Alloro Trust was a gift with reservation within the meaning of section 102 of the Finance Act 1986.

I was not required to determine the amount of tax arising from the outcome of the Appeal. The amount of tax in dispute was in the region of £200,000. The monetary amounts cited in the decision are approximate and expressed in pounds sterling.

The Legislation

The applicable parts of the Inheritance Tax Act 1984 and the Finance Act 1986 to this Appeal are as follows:

Section 4 Transfers on Death (IHTA 1984)

(1): On the death of any person tax shall be charged as if, immediately before his death, he had made a transfer of value and the value transferred by it had been equal to the value of his estate immediately before his death.

Section 5 Meaning of Estate (IHTA 1984)

(1): For the purposes of this Act a person's estate is the aggregate of all the property to which he is beneficially entitled except that the estate of a person immediately before his death does not include excluded property.

Section 102 Gifts with Reservation (FA 1986)

(1) Subject to subsections (5) and (6) below, the section applies where, on or after 18 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 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.

The Facts

The Appellants produced an agreed bundle of documents which included a draft statement of agreed facts. No witnesses were called.

Mr Lyon was domiciled in England throughout his life.

On 28 September 1999, a discretionary trust known as "The Alloro Trust" was established with Mr Lyon as the settlor, and UBS Trustees (Bahamas) Limited as the original trustee.

Under the trust deed the trustee held the fund to pay apply or appoint whole or any part of the capital and income to or for the benefit of all or one of the beneficiaries as the trustee shall in its discretion think fit and any income not so applied shall be accumulated.

Clause 2 of the trust deed defined the potential beneficiaries of the Alloro Trust as:

(1) The settlor

(2) The settlor's spouse

(3) The settlor's issue

(4) The settlor's parents

(5) Other issue of the settlor's parents

(6) Any person or classes of persons nominated by the trustee.

Clause 13 of the deed enabled Mr Lyon in his capacity as settlor to revoke the trust in his lifetime by delivering a signed written instrument to the trustee. Upon revocation the assets of the trust would be returned to the ownership of the Mr Lyon.

Under the first schedule of the deed the settlor was given specific powers in respect of the investment management of the trust fund held in a special company, defined as a company in which the trust had a controlling interest.

Mr Lyon set out his wishes to the trustee in a letter dated 13 September 1999 requesting the trustee to exercise its discretion in the following manner:

(1) That the trustee considers any requests made by Mr Lyon during his lifetime on any matter concerning the trust.

(2) That the trustee considers any requests made by Mr Lyon's children and son-in-law in respect of distributions from the trust for his living and medical expenses in the event of mental or physical incapacity.

(3) That in the event of Mr Lyon's death the trust fund to be distributed immediately in equal shares to Mr Lyon's son and daughter.

(4) The contents of the letter were to be kept confidential save where the trustee considered disclosure necessary for the proper administration of the trust.

On 22 November 1999 Mr Lyon settled £2.7 million into the Alloro Trust which was invested immediately by the trustee in the share capital of a new Bahamian company, called Aurora Trading.

Over the period from its incorporation until its winding up at April 2005, Aurora Trading Inc made distributable profits of around £300,000.

Mr Lyon died on 5 August 2004.

The trustee made distributions totalling £25,965 from the trust during the lifetime of Mr Lyon. A Mrs Ward received £10,000 whilst £15,965 was paid to Mr Lyon.

It was until several months after Mr Lyon's death that his family discovered the existence of the Alloro Trust.

At April 2005 the whole of the funds within the Alloro trust were distributed to Mr Lyon's two children in accordance with the terms of the letter of wishes dated 13 September 1999.

The Reasons for the Decision

The principal issue in dispute was whether the fact that Mr Lyon as one of the class of discretionary beneficiaries under the terms of the Alloro trust meant that there was a reservation of benefit within the meaning of section 102(1)(b) Finance Act 1986. This particular issue was considered by the High Court in Inland Revenue Commissioners v Eversden [2002] STC 1109, Lightman J stated at paragraphs 15 -17, 19:

"There is no direct authority on the question raised whether the right of the settlor as a member of a class of discretionary benefits 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.

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.

I entirely agree. The insertion of the provision enabling benefits to be conferred on the settlor creates the potential for the conferment of substantial benefit on the settlor and the consequent diversion of benefit from others. The provision in the settlor's favour is not consistent with the settlor's entire exclusion or the settlor's 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 the settlor".

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".

The Court of Appeal considered an appeal against the decision of the High Court in Eversden. However, the issue under Appeal concerned the provisions of section 102(5) and whether the disposal was an exempt transfer which displaced the reservation of benefit restrictions. The ruling of Lightman J regarding the legal effect of a beneficiary settlor upon the operation of section 102 was accepted by both parties as acknowledged by Lord Justice Carnwath in IRC v Eversden [2003] STC 822 at paragraph 13:

"Turning to the reservation of benefit provisions it is now common ground that, as decided by Lightman J, the reservation of benefit provisions apply in principle for two separate reasons: (i) in relation to the Meadows alone, because the settlor enjoyed a benefit by virtue of her rent-free sole occupation; and (ii) in relation to both Meadows and the bond, because the settlor was a discretionary object in relation to the entire trust fund".

Applying the ruling of Lightman J to the facts of this Appeal it would appear that the Appellants have no argument that the gift of Mr Lyon to the Alloro Trust was a gift with reservation because Mr Lyon was one of the beneficiaries for the entire trust fund. The Appellants, however, considered that they had a case which was based on a series of propositions dependent upon:

(1) A wider interpretation of the ruling of Lightman J.

(2) The facts of this Appeal were distinguishable from those of Eversden.

(3) The Respondents' interpretation of the gift with reservation provisions in Tax Bulletin 9 (November 1993) and Inheritance Tax Manual at paragraph 143333.

The Appellants considered that the Respondents placed a restrictive interpretation of Lightman J ruling that a gift to a discretionary settlement where the settlor has not been excluded as a potential beneficiary would always fall within the gifts with reservation regime. The Appellants contended that an alternative interpretation was sustainable, namely, that a gift to a discretionary settlement where the settlor has not been excluded as a potential beneficiary may well fall within the gifts with reservation scheme but equally it might not. The Appellants justified their alternative interpretation on the premise that it could not have been the intention of Lightman J to impose arbitrarily a punitive treatment on a particular class of taxpayers. I find there is no support in the judgement of Lightman J for the alternative interpretation propounded by the Appellants. His ruling is unambiguous and to the point. The whole purpose of the gifts with reservation scheme would be defeated if section 102 was so construed that the interest of any settlor under a discretionary trust created by the settlor did not constitute a reservation of benefit. On the facts of this Appeal Mr Lyon created a trust where the trustee had the power to confer a substantial benefit upon him as he was a potential beneficiary under the trust. Mr Lyon was in exactly the same position as any other beneficiary of the trust, namely, to receive income or capital from the trust fund at the discretion of the trustees. When he set up the trust Mr Lyon did not exclude himself from obtaining a substantial benefit from it.

The Appellants stated that Eversden was decided principally on the fact that the settlor in that case enjoyed a substantial benefit from the trust fund in her lifetime by living rent free in the trust property. Thus the facts of the Eversden case were distinguishable from this Appeal because Mr Lyon only received £15,965 out of total trust property of £2.7 million which was less than one per cent of the value of the trust fund. The Appellants overlooked the extent of the ruling in Eversden. As the Court of Appeal pointed out, the Eversden settlement was in principle a gift with reservation on two distinct grounds. The first was that the settlor received a substantial benefit from the trust by virtue of her rent free occupation of the property. The second was that the settlor was a beneficiary of the trust. The second ground was not dependent upon whether the settlor actually received a substantial benefit from the trust during her lifetime, it stood on its own as a reason for finding that the gift of the settlor in Eversden was one with reservation of benefit. The fact that the Eversden settlor received a substantial benefit in her lifetime was not relevant to the second ground which undermined the Appellants' reliance upon the differences in Eversden. The reality was that this Appeal shared the identical factual basis with Eversden in respect of the second ground, namely, both settlers were potential beneficiaries under the trusts created by them.

The Appellants drew on the Respondents' interpretation of the gifts with reservation scheme in Tax Bulletin 9 issued November 1993 to argue that the benefit received by Mr Lyon during his lifetime from the trust was minimal, and, therefore, his gift to the trust was not a gift with reservation. Leaving aside the issue that Tax Bulletin 9 has no force in law, the Appellants have misinterpreted the scope of the Bulletin which was about the donor's access to the property given away. Tax Bulletin 9 considered a range of situations where the subsequent actions of the donor might compromise the nature of the gift. Tax Bulletin 9 presupposed that a gift without reservation has been made. The dispute in this Appeal was not primarily about the actions taken by Mr Lyon subsequent to the creation of the trust but about whether a gift without reservation was made in the first place.

The Appellants' approach to Tax Bulletin 9 demonstrated the flaw in their reasoning. The Appellants worked backwards from the final distribution of the trust funds following the death of Mr Lyon to justify their position. The Appellants should have started with the gift itself to the Alloro Trust and asked themselves the question whether the gift was a true gift or a pretend gift. A proper analysis of the trust deed would have revealed that not only did Mr Lyon stood to benefit from the whole trust fund as a potential beneficiary but also Mr Lyon retained significant control of the trust by giving himself the powers to revoke the trust at any time, and to regulate the investment management of trust funds held by a special company.

Mr Lyon's letter of wishes dated 13 September 1999 signalled his intention to derive benefits from the trust during his lifetime, and to exercise control over the trust. He expressed the wish that the trustee considers his requests during his lifetime on any matter concerning the trust. The trustee was to consider requests made by his children for living and medical expenses of Mr Lyon if he fell ill. The contents of his letter of wishes were to be kept confidential from the other beneficiaries, save where the trustee considered that disclosure would be of benefit to the administration of the trust. In fact Mr Lyon's children did not know of the trust's existence until after his death. The letter of wishes was silent about potential distributions of funds to other beneficiaries during Mr Lyon's lifetime. The sole reference to other beneficiaries in the letter related to the distribution of trust funds following Mr Lyon's death.

The actual operation of the trust during the lifetime of Mr Lyon demonstrated that he benefited from the trust funds. Mr Lyon was the only beneficiary to receive distributions from the trust during his lifetime. A sum of £10,000 in total was also made to a Mrs Ward, who was not a beneficiary. The Appellants have been unable to identify or locate Mrs Ward. In those circumstances it is reasonable to assume that the payments to Mrs Ward were made at the instigation of Mr Lyon. Thus Mr Lyon's total benefit from the trust during his lifetime amounted to £25,965 including Mrs Ward's £10,000. The Appellants expressed the view that the sum paid to Mr Lyon was insignificant in the context of the overall value of the trust fund. However, the fact remains that the sum of £25,965 in absolute terms and in the context of Mr Lyon being the only beneficiary to benefit from the trust during his lifetime was not a minimal amount.

I make the following findings of fact:

(1) Mr Lyon was one of the beneficiaries under the discretionary trust, the Alloro Trust, set up by him in September 1999, which created the potential for the conferment of substantial benefit on him and the consequent diversion of benefit from others.

(2) Under the terms of the trust deed dated 28 September 1999, Mr Lyon not only stood to benefit from the trust but also retained significant control of the trust.

(3) Mr Lyon's letter of wishes dated 13 September 1999, and the actual operation of the trust during Mr Lyon's lifetime demonstrated that Mr Lyon exercised control of the Alloro trust and received benefits from it during his lifetime.

I conclude from the above analysis and findings of fact that the Mr Lyon's gift to Alloro Trust in September 1999 was a pretend gift, a gift with reservation. The fact that Mr Lyon was one of the beneficiaries under the discretionary trust with the potential for the conferment of substantial benefit upon him was on its own sufficient to find that the property gifted to the trust was not enjoyed to the entire exclusion or virtually to the entire exclusion of Mr Lyon.

At the hearing the Respondents submitted that Mr Lyon's gift was also a gift with reservation under the terms of section 102 (1)(a) of the 1986 Act. The Respondents relied on the terms of the trust deed and the actual operation of the trust during his lifetime. In view of the above analysis and findings of fact I am satisfied that the possession and enjoyment of the property gifted by Mr Lyon was not bona fide assumed by the trustee of the Alloro Trust during the lifetime of Mr Lyon.

I, therefore, find that Mr Lyon's gift of property to the Alloro Trust was a gift with reservation within the meaning of section 102(1) (a) and 102(1)(b).

Decision

For the reasons set out above I confirm the Notice of Determination dated 6 July 2006 that the property held at 5 August 2004 by the trustees of the Alloro Trust falls to be treated as property to which Harry Dexter Lyon (the deceased) was beneficially entitled immediately before his death. I, therefore, dismiss the Appeal.

MICHAEL TILDESLEY OBE

SPECIAL COMMISSIONER

RELEASE DATE: 26 June 2007

SC 3159/2006