Chris Thorpe looks at the ‘settlements’ anti-avoidance legislation.
In December 1805, William Wordsworth wrote to his lawyer brother Richard:
“……about the income tax, wishing to know what way ours could be given in to be the least burdensome. Persons under sixty pounds a year, I understand, pay nothing, could we not take advantage of this in some way?”
What he was asking was presumably fairly common thinking at the time – is there a way we can artificially lower our assessable income so it falls below the £60 ‘personal allowance’ (as it was in 1805, circa £3,700 in today’s money)? The onset of the ‘super-tax’ in 1909 only encouraged further the practice of paying family members in their business (usually farming in those days) to lower their own taxable income.
A Royal Commission in 1920 highlighted this practice and Finance Act 1922 contained the embryonic settlements legislation. The 1936 Act included revocable interests in favour of minor children and is the forerunner to the modern law.
What is it?
The modern legislation is contained within ITTOIA 2005, Ch 5 (ss 619-648) and concerns the transfer of income to someone closely related to the original owner of that income, resulting in a lower income tax charge – just as it did a hundred years ago.
The legislation takes effect when a ‘settlement’ has been established to transfer the income and effectively applies to a ‘settlor-interested’ trust to ensure the tax burden stays with the income’s creator (the ‘settlor’). A key criterion, however, is that this transfer must include an element of ‘bounty’, i.e., it must be something uncommercial and with benevolent intent. The relevant legislation (ITTOIA 2005, s 620(1)) now defines a settlement as “any disposition, trust, covenant, agreement, arrangement or transfer of assets”.
So, it is very wide in application! That definition can include a series of events and decisions, including the formation of companies, taking low salaries to artificially inflate distributable reserves subsequently paid out to spouses or minor children, and excess dividends beyond capital entitlement etc. Transfers can be made to a spouse if they include the capital asset which underlies that income.
The legislation’s ‘victims’
There have been instances throughout the last century of well-known people being caught by this legislation. The actor Jack Hawkins was held by the Court of Appeal in 1967 (Crossland v Hawkins, CA 1961, 39 TC 493) to have created a settlement by being director of a limited company to receive his professional earnings, 98% of whose shares were held in trust to benefit his children. By taking a tiny salary, that company’s profits, which found their way to the children, were unduly inflated. Ultimately, his earnings found their way to his children; Jack knew about it and so a settlement had been created.
The child-actress Hayley Mills, likewise, also fell foul of the legislation when her father (Sir John) set up a production company to receive her fees and transferred the shares into a trust for Hayley’s benefit once she was 25. Even though Sir John was the actual settlor of the trust, the fruits of Hayley’s labours ended up going to Hayley, despite the income being accumulated within a separate entity set up by someone else. The House of Lords held in 1974 (Mills v CIR, HL 1974, 49 TC 367) that Hayley was, therefore, the effective settlor of her own trust and thus remained assessable on the income (despite there being some discussion in the Court of Appeal about her capacity and knowledge of the settlement due to her being only 14 years old at the time).
Practical tip
The legislation has a very wide reach and will deem as settlor anyone who tries to pass income to a spouse or minor children, or themselves indirectly. Therefore, any transaction which would not be commercially undertaken and which benefits close family members should be carefully examined to make sure a ‘settlement’ (and ‘settlor-interested trust’) is not being unwittingly created.
If you are interested in learning more about the settlements legislation and implied trusts from a tax angle, Chris’s book ‘Implied Trusts and Beneficial Ownership in Modern UK Tax Law’ is now available in hardcopy and pdf from Spiramus Press:
https://spiramus.com/implied-trusts-and-beneficial-ownership-in-modern-uk-tax-law and also at Amazon, Waterstones, Blackwells and other major book retailers.
