Mark McLaughlin points out a potential capital gains tax pitfall when a trust asset is transferred to beneficiaries.
A principle established in a 1970s tax case can result in a capital gains tax (CGT) trap. This article focuses on the law in England and Wales (the position in Scotland and Northern Ireland can differ).
It's all yours…isn’t it?
When the beneficiary of a trust becomes absolutely entitled to a trust asset, for CGT purposes the trustees are generally treated as having disposed of the asset and reacquired it at market value. The trustees then hold the asset as bare trustees for the beneficiary, until the asset is appointed to that beneficiary.
For inheritance tax (IHT) purposes, most lifetime trusts these days are ‘relevant property’ (e.g., discretionary) trusts. When a beneficiary becomes absolutely entitled to relevant property, there is normally an immediate IHT ‘exit’ charge on the trustees.
To prevent simultaneous CGT and IHT charges on the same event, a CGT holdover relief claim is generally available, subject to certain exceptions and alternative conditions. One such condition is that there is an immediately chargeable lifetime transfer for IHT purposes. For example, the trustees might appoint a buy-to-let property to a discretionary trust beneficiary.
Hold on!
However, what is the CGT position if the trust holds land for (say) several beneficiaries in undivided shares? This issue was considered in Crowe v Appleby Ch D 1975, 51 TC 457.
In that case, a will trust held a freehold property in residue in certain shares for the benefit of the deceased’s five children for life. One child (G) died in August 1952. His 5/30ths share of residue devolved on his son. Another child (C) with a further 5/30ths of residue died in May 1968. Her share devolved on her two children. The deceased’s remaining three children were life tenants of 9/30ths, 6/30ths and 5/30ths of residue respectively. The trustees sold the freehold property in 1969. The Inland Revenue (as was) raised CGT assessments for 1968/69 and 1969/70.
The case proceeded to the High Court (HMRC refers to the leading judgment by Goff J. in its Capital Gains manual), and ultimately the Court of Appeal. It was held not to be possible to segregate a share in the notional proceeds of the sale of unsold land; the relatives of G and C were unable to call for immediate payment of their respective shares or influence the trustees' discretion, so were not absolutely entitled as against the trustees.
CGT trap
The Crowe v Appleby principle gives rise to a potential CGT trap. For example, a will trust holds an industrial unit in London for three children to take in equal shares absolutely at age 25. The property is standing at a gain.
The three beneficiaries reached age 25 in different tax years. However, it is only when the youngest reaches 25 that the beneficiaries can direct the trustees to transfer the property to them, and a CGT charge then arises. Unfortunately, holdover relief can only be claimed on the gain attributable to the younger beneficiary’s interest; the trustees are liable to CGT on the balance. The other two beneficiaries became absolutely entitled for IHT purposes earlier, so there is no simultaneous IHT and CGT charge in respect of them, and holdover relief is not available on their share of the gain.
Practical tip
An individual’s will might leave the trust (say) an undivided share in land (instead of an entire plot of land). According to HMRC’s guidance (at CG37543), the principle from Crowe v Appleby is not considered to apply in those circumstances, because that share is readily divisible.
