The Upper Tribunal has considered the meaning of the word “settlement” in the context of section 624 of the Income Tax (Trading and Other Income) Act 2005 (“ITTOIA“).
The Upper Tribunal has provided an extended meaning of the word “settlement” which may affect all sorts of planning. It can specifically cause a problem for one of the most common examples of planning: the situation where you have an offshore trust (set up by a non-UK domiciled individual) that owns an offshore company which in turn may own an income-producing asset (for example, shares in a UK based company that may provide dividends).
It had generally been accepted that the part of the structure in these circumstances which constituted the “settlement” was the trust alone. When I say generally I mean that even HMRC accepted that this was the case (see the non-doms consultation response at paragraph 2.3.3 https://assets.publishing.service.gov.uk/government/uploads/system/uploads/attachment_data/file/574450/non_doms_consultation_response_final.pdf):
“The settlor charges under the settlements legislation will not need to be dis-applied to foreign income of any corporate structure underlying the settlement, because the settlements legislation only applies to income arising to a settlement.”
Unfortunately, two new cases cast some doubt on this position.
The first of these decisions was HMRC v Mattu  UKUT 0245. This was an application by HMRC for the imposition of a tax-related penalty. The Upper Tribunal had to consider whether the conditions for HMRC to impose the specific penalty had been met. To determine this, the Tribunal had to establish whether or not HMRC had reason to believe there was an underpayment of tax. It was in this context that the Tribunal provided some guidance on the meaning of the word “settlement”.
The Tribunal found that here the “settlement” included both the trust and the underlying companies. As such, when income arose to the underlying companies, the settlor could be taxed. This is in contrast to the expected position where the income needs to arise to the trust itself.
Whilst this is a decision of the Upper Tribunal, it is thought that its precedent value is somewhat limited for two reasons:
- The Tribunal does not appear to have had the benefit of full argument on the point. They failed to consider both Crossland v Hawkins and Vestey v IRC in their Decision.
- The Upper Tribunal ultimately had to consider whether to impose a penalty, not the actual substantive question on whether the tax was in fact due.
Bearing this in mind, this decision is less concerning than initially thought. That being said, it is a decision of the Upper Tribunal and so it will be of persuasive value.
Dunsby v HMRC  UKUT 0289 (TCC) involved a tax avoidance scheme. Many people who have looked at this case have noted that it is very artificial and was unlikely to ever succeed.
The goal of the scheme was to filter the income from dividends to the taxpayer’s non-resident wife through the use of a trust scheme. Had the scheme worked, the trust income would have been attributed to the non-resident under section 624 ITTOIA. It would then have not been taxed in the UK.
Unlike in Mattu, the Upper Tribunal here did consider the relevant case law in establishing that the “settlement” comprised more than the trust.
More specifically, at paragraph 96, the Tribunal stated:
“Nevertheless, and without aspiring to set out any exhaustive test, it seems to us that at least for present purposes a relevant question to ask is whether the act of settlement, narrowly defined, has an economic logic that is freestanding and severable from the preparatory steps leading to that settlement. If it does, then (absent unusual circumstances) that is a strong indication that the preparatory steps are not to be regarded as integral to that settlement.”
It is worth bearing in mind that the scheme, in this case, was particularly artificial and egregious. It will therefore be easy for advisors to distinguish their clients’ circumstances from it.
In addition, the test arguably is not drawn specifically from the authorities in the area.
I hope that this decision gets overturned on appeal. If it does not, it has potentially far-reaching consequences for many individuals.
What to remember?
If you have clients with these sorts of structures, you may want to review them in light of these two decisions. It may not be necessary to take immediate action, especially if Dunsby is appealed. Further, it may be possible to distinguish your clients specific circumstances.
Please contact me if you have any further questions regarding these cases or if you require advice.