The Gazette 1985

SEPTEMBER 1985

GAZETTE

Capital Taxation on Settled Property following the Finance Act 1985

by David Kennedy, Barrister-at-Law

Introduction S ECTIONS 23 to 26 of the Capital Acquisitions Tax Act 1976 ensure that the potential charge to inheritance tax on the vesting in possession of a future interest in settled property is preserved, despite dealings with the trust property prior or subsequent to the vesting in possession of the expectant interest. Section 15 Capital Gains Tax Act 1975 may also impose a charge to Capital Gains Tax on settled property in these circumstances. Sections 61 to 63 Finance Act 1985 have introduced significant changes in the operation of these provisions. In its simplest form, the type of fixed trust envisaged by these provisions is a settlement "To LT for life, with remainder to R absolutely". More complex settlements of this kind may include a succession of life or remainder interests and may impose conditions and provide for contingencies, such as the marriage or death before a certain age of the beneficiaries. Such settlements were commonly used to ensure that property, particularly real property, remained in the ownership of the settler's family from generation to generation. This was done by granting only a life interest to the person in possession, which gave him restricted powers to deal with the land. Marriage settlements often took this form, to protect the parties to the marriage and their descendants from a wayward or spendthrift spouse. 1 Nowadays, settlements of this kind are commonly used as a means of reducing or eliminating the liability of the beneficiaries of an estate to inheritance tax. In the straightforward case of a settlement "To LTfor life with remainder to R absolutely", a charge to inheritance tax will arise on the death of LT on the full value of the trust assets. 2 The function of Sections 23 to 26, CATA 1976, is to preserve this charge to tax despite:— (a) the alienation of his future interest by R (Section 23). (b) the advance termination of LT's limited interest and the breaking of the settlement by R alienating his future interest to LT or vice versa, or by the agreed partition of the trust assets (Section 24); (c) the resettlement of his future interest by R (Section 25). Section 26 sets out the method of computing tax where R transfers his remainder interest to LT. Similarly, Section 15, CGTA 1975, imposes a charge to Capital Gains Tax in circumstances which may include dealings with trust property covered by Sections 23 to 26, CATA 1976. A double charge both to Capital Acquisitions Tax and Capital Gains Tax may therefore arise in certain circumstances.

Prior to the passing of the Finance Act 1985, the application of Sections 23 to 26, CATA 1976, could result in an excessively severe charge to inheritance Tax on an estate due to the levying of tax on a series of successions by different beneficiaries on the same event. However, Sections 61 to 63, FA 1985, have been introduced with retrospective effect to mitigate the hardship that could arise under the old legislation. These new provisions have resulted in a significant alteration in the basis of capital taxation of settled property. If the life tenant of a settlement dies and the trust property passes absolutely to the remainderman, a charge to inheritance tax will arise. Section 23, CATA 1976, preserves this charge where the remainderman's future interest passes to a third party, whether for full considera- tion or otherwise, before the interest vests in possession. Example 1 R is the remainderman of a settlement in which LT has a life interest. R gifts his interest to a third party, T. T takes absolutely on LT's death. Section 23 provides that a charge to tax arises in these circumstances as if R had himself inherited the property. The charge to inheritance tax and the relevant exemption are calculated on the basis of the relationship between the settlor (the disponer) and the original remainderman. However, the transferee T is accountable for any tax arising on the death of the life tenant, 3 but only to the extent of the interest in the trust property actually taken by him. 4 As regards entitlement to agricultural relief, the transferee T and not the remainder- man must fulfil the necessary conditions to qualify. 5 Section 23 (1), CATA 1976, governs both the disposal and the devolution of the remainder interest. Thus, if in the above example R had died before inheriting and had left his expectant interest to T who took on the death of LT, the charge to inheritance tax 6 on the death of LT would again be preserved. Section 23 (2), CATA 1976, preserves the second charge to gift or inheritance tax which may arise on the gift or inheritance of the remainderman's future interest. In Example 1 above, T would be potentially liable under Section 23( 1) to inheritance tax on the death of LT, and to gift or inheritance tax on the value of the benefit taken from R under Section 23(2). Both charges will arise on the same property on the event of the death of the life tenant. If T died before he inherited from LT, and his estate 243 Disposal or Devolution of Remainder Interest 1. Capital Acquisitions Tax A. Section 23 CATA 1976