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The private client briefing for July 2013

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The new restrictions on deductibility of debts in relation to relievable property for IHT purposes will only apply to loans taken out from 6 April 2013. A taxpayer is to appeal against the First-tier Tribunal (FTT) decision in Joost Lobler concerning the chargeable event gains legislation. The rules on time apportioned chargeable event gains are to be amended with effect from 6 April 2013. The list of qualifying investments for stocks and shares ISAs will be expanded to include company shares on SME equity markets from across the European Economic Area. In Clive Bowring, the FTT considered the application of CGT anti-avoidance provisions for offshore trusts.

Grandfathering for IHT debt rules

As reported in our May briefing, a number of uncertainties and concerns arose from the publication of the draft Finance Bill 2013 legislation restricting the deductibility of certain debts for IHT purposes.

One of these concerns was the absence of any grandfathering provisions in respect of existing debts taken out before the new rules were announced, and how this would impact on existing planning arrangements.

A number of MPs expressed views opposing the new rules and their retrospective effect on commercial arrangements which were not carried out to obtain a tax advantage. It was noted that borrowing against existing property is often the main way in which rural estates and landowners can obtain money to invest in their business.

The government has now conceded that existing loans taken out before 6 April 2013 which have been used to acquire relievable property can be ignored. However, this grandfathering provision (FA 2013 Sch 36 para 5(2)) will not apply to loans used to acquire excluded property or where the debt is an ‘artificial’ one and non-deductible on death.

Why it matters: This is welcome news for many business owners with existing loan arrangements.  However, the legislation in its current form will continue to apply to new loans taken out after 6 April 2013, regardless of any commercial motive for doing so. It remains to be seen whether any further clarification will be given in respect of this and other issues which we identified in May.

Taxpayer set to appeal in Joost Lobler

In our March briefing, we reported on the FTT decision in the case of Joost Lobler v HMRC [2013] UKFTT 141 (TC), which highlighted the dangers of making withdrawals from life assurance policies without taking proper advice, and which led the FTT to comment that the strict application of the legislation produced an ‘outrageously unfair result’.

News that the taxpayer is set to appeal the decision is perhaps not surprising, but it will be interesting to see the grounds for appealing, given that the FTT concluded ‘there is nothing we can do about it’.

As we reported in March, the FTT suggested that the taxpayer might wish to ask the High Court to consider whether the effect of the legislation in this case contravenes the Human Rights Act, or to review HMRC’s decision to collect the tax, in view of its power of management of the tax system.

Why it matters: In the current political climate, where targeting tax avoidance is grabbing the headlines, it will be interesting to see whether the Upper Tribunal will agree with the FTT’s comment that ‘it is more repugnant to common fairness to extract tax in Mr Lobler’s circumstances than to permit other taxpayers to avoid tax on undoubted income’.

Rules on time-apportioned chargeable event gains amended

Also on the subject of life assurance policies, FA 2013 Sch 8 contains provisions which align the tax treatment of life policies inside and outside the UK, and ensure the rules on time-apportioned reductions provide more appropriate reductions to chargeable event gains. They take effect from 6 April 2013.

The previous taxing regime provided that a chargeable event gain arising on a life policy issued by a foreign insurer is reduced proportionally if the policyholder has been non-UK resident at any time during the term of the policy. However, these reductions were not available for policies issued by UK insurers even though the policy holder may have had periods of residence outside the UK.

Under the new measures time-apportioned deductions will be available for policies issued by UK assurers. From 6 April 2013, reductions will be calculated by reference to the residence history of the individual liable to income tax on the gains, and residence will be determined in accordance with the new statutory residence test (SRT).

The computation is based on days of non-UK residence rather than years. The gain on which tax is charged will be reduced by an appropriate fraction which is calculated by taxing the number of non UK-residence days during which the taxpayer would be subject to tax on the policy gains, and the number of days in that period.

Policies issued before 6 April 2013 could also be affected by these new rules if the policy is varied, resulting in an increase in benefits, or if there is an assignment of policy rights to an individual, or rights become held as security for a debt of an individual.

In addition, the new SRT rules contain anti-avoidance provisions which tax chargeable event gains that arise during a five-year period of temporary non-residence. If the gain is realised whilst the taxpayer is non-UK resident, the charge to tax is deferred until the year in which the taxpayer resumes UK residence. The gain must have been chargeable if the individual had been UK resident in the year in which the gain arose. Gains arising on death are excluded. The aim is to prevent avoidance strategies whereby individuals become non-resident, realise gains and then resume UK residence.

Why it matters: The changes to time-apportioned reductions will apply to any new life assurance policy made on or after 6 April 2013. They will also affect policies taken out before 6 April 2013 if, after 6 April, the policy is either varied to increase the benefits secured, there is an assignment of the rights or some of the rights on the policy to the individual or the deceased, or some or all of the rights become held as security for a debt of an individual.

ISA qualifying investments extended to AIM-listed shares

The government has announced that it is to expand the list of qualifying investments for stocks and shares ISAs to include company shares on SME equity markets from across the European Economic Area, which will include shares listed on the alternative investment market (AIM).

The government launched a consultation in March this year on the proposed approach to implementing this policy. In response to this consultation, the government intends to put legislation before parliament this month to extend the range of qualifying ISA investments, and it is expected that this will take effect in the autumn.

Why it matters: Investors will be able to hold a wider range of shares in a way that is free from income tax and CGT, which will no doubt be attractive to some investors. However, the perceived tax advantages of such an investment do not obviate the need to obtain independent financial advice in the first instance.

Application of CGT anti-avoidance provisions for offshore trusts

In the case of Clive Bowring v HMRC [2013] UKFTT 366 (TC), the FTT considered whether distributions to beneficiaries from a new UK resident trust should be matched to gains in the original offshore trust by virtue of the provisions contained in TCGA 1992 s 97(5). The case was heard in the context of planning which involved a ‘flip flop mark II’ arrangement. Such arrangements were being used at the time to exploit an apparent wrinkle in anti-avoidance provisions contained in TCGA 1992 s 90 which effectively turned off the operation of this provision when a transfer from an old settlement into a new one is linked with trustee borrowing by virtue of TCGA 1992 Sch 4B. This wrinkle was effectively ironed out in 2003 by an amendment to the anti-avoidance legislation which provided that the resulting Sch 4C pool is a floating pool which applies to distributions from either the original trust which gave rise to the Sch 4B charge or the new one.

Clive Bowring and his sister were principal beneficiaries under a discretionary trust set up by their father in 1969. The trustees of the 1969 settlement sold the trust assets and used the cash proceeds to purchase £4m of gilts. They then borrowed £3.8m from the bank against the value of the gilts and transferred the cash to a new trust which they had set up in 2002 in similar terms to the 1969 trust, with similar beneficiaries and a similar perpetuity period. The trustees of the 2002 settlement then made distributions totalling £2.4m out of the moneys to the Bowrings.

HMRC accepted that the flip flop mark II scheme was effective to prevent gains arising in the new trust, given that the planning took place in 2002 before the amendments to Sch 4C took effect. However, HMRC contended that, by virtue of TCGA 1992 s 97(5), the Bowrings should have been treated as receiving their distributions from the 1969 settlement, and not the 2002 one.

Section 97(5) applies where the beneficiary receives a capital payment ‘directly or indirectly’ and is intended to catch the many ways in which a person can benefit other than by a simple transfer of money from offshore trustees. The FTT noted that the section did not expressly contemplate the situation in the present case where money held by one trust was passed to another, but noted that the provision was intended to be interpreted widely as a broad anti- avoidance measure.

The FTT relied on the three ‘sign posts’, as identified in the case of Herman [2007] UKSPC 609, to determine whether s 97(5) applied in this case. These included: (1) whether a plan existed to make distributions free of tax; (2) whether the new trust served as a vehicle to receive and continue the act of bounty effected by the original settlement; and (3) whether the means by which the scheme was implemented established a sufficient linkage between the two.

The FTT in reliance on the second ‘signpost’ considered that the act of bounty was the act of bounty of the settlor of the 1969 settlement, and that the distributions from the 2002 trust could not and would not have taken place except for the transfer of funds from the 1969 trust. On that basis, the FTT concluded that the arrangement was within the scope of s 97(5) and disallowed the appeal.

Why it matters: The FTT agreed that a wide interpretation of s 97(5) could give rise to a double tax charge on UK resident beneficiaries of offshore trusts under s 90 and also under s 97(5). However, it is considered that a double tax charge should not arise on the basis that s 87(5) should be read purposively, so that gains attributed to a beneficiary under s 87(4) should not exceed the amount of the capital payments received. It remains to be seen whether the taxpayers will appeal the decision.