Update: tax and trusts

On 1 April 2009 the structure and administration of tribunals which hear appeals on tax decisions by HM Revenue & Customs was reformed. Before that date, there were four different appeal tribunals for tax matters, namely the general commissioners, the special commissioners, the VAT & Duties Tribunal and the s704/706 Tribunal.

The relevant tribunal for a particular hearing depended upon the type of tax and, in some cases, where the taxpayer wanted the appeal to be heard, but the process of appealing was not consistent through all the tribunals. The Tribunals Courts and Enforcement Act 2007 introduced a new framework for tribunals; the new tribunals system does not relate only to tax, but the tribunals will have specific specialist units (known as 'chambers') which include chambers for tax disputes.

From 1 April 2009 there is a unified two-tier tribunal system comprising the First-tier Tribunal and the Upper Tribunal. In the case of direct taxes, the First-tier Tribunal and the Upper Tribunal are not equivalent to the previous general and special commissioners.

The First-tier Tribunal

The First-tier Tribunal replaces the general commissioners, special commissioners, s704/706 Tribunal and the VAT & Duties Tribunal and will hear most appeals at the first instance. The First-tier Tribunal may refer appeals to the Upper Tribunal, but that is subject to the agreement of all parties (and the Upper Tribunal). The Tax Chamber of the First-tier Tribunal deals with both indirect and direct tax appeals, with one set of rules for the procedure and administration of all appeals.

There are time limits for an appeal to the First-tier Tribunal. There is a two-stage process which involves, first, appeal by the taxpayer to HMRC within the time limit relevant to the matter (which is unchanged from the old system). If the matter is not resolved by negotiation between the taxpayer and HMRC, the second stage will operate by the taxpayer notifying the appeal directly to the First-tier Tribunal.

Internal review, time limits and costs

There is now an alternative way of resolving disputes, which gives a taxpayer a statutory right to request that HMRC review a decision made by them. If the review does not produce a satisfactory outcome for the taxpayer, he can still appeal to the tribunal. There are procedures for ensuring that the review is carried out by an independent person.

If an internal review is requested by the taxpayer, there are time limits for notifying the tribunal of the appeal (which is generally 30 days from the date when an internal review is concluded). If the taxpayer does not request an internal review or does not accept an offer of a review by HMRC (or if the dispute is not covered by the internal review procedure), the taxpayer can notify the tribunal at any time after the appeal has been notified to HMRC.

The appeal to HMRC may include an application to postpone all or part of the tax, pending a decision of the appeal, in the same way as operated previously, to avoid interest accruing.

The First-tier Tribunal can award costs in some circumstances (unlike the old general commissioners).

The Upper Tribunal

The Upper Tribunal is also divided into chambers and the Finance & Tax Chamber will hear appeals from the Tax Chamber of the First-tier Tribunal. Such appeals will only be possible on points of law and require permission from the Upper Tribunal. The Upper Tribunal will also hear some first instance appeals, for example complex tax cases.

Under the previous system, the taxpayer had a right to decide whether an appeal should be heard by the general commissioners or the special commissioners in the first instance and also had an automatic right of appeal on points of law from either body to the High Court. Those rights are now gone.

Before an appeal is made to the Upper Tribunal, an application for permission to appeal must be made to the First-tier Tribunal of the Upper Tribunal by either the taxpayer or HMRC within one month of the date of the decision of the First-tier Tribunal. Once permission is granted, an appeal must then be made within one month afterwards.

Inheritance tax liability and trusts

There have been interesting recent cases on trust law, inheritance tax and capital gains tax relief relating to reorganisations.

Bhatt v Others [2009] EWHC 734 (Ch) is a trusts case in which a settlor applied for rescission of a trust deed on the basis that it was entered into in a mistaken belief that it would achieve an inheritance tax benefit. The settlor and her husband bought a property in London in 1992, having previously rented the property from the local council. The property was purchased as joint tenants. The joint tenancy was severed by notice in 2003. The settlor's husband died in December 2003.

The settlor was born in Kenya and spoke little English. She came to the UK in 1978 and was aged 73 when her husband died. Her husband's will, which he made in 2001, left his entire estate to her.

The settlor was advised by a tax adviser that she would have a large inheritance tax liability as a result of her husband's death and the tax adviser and the settlor's solicitor advised her that she should execute a Deed of Variation so that her late husband's half share of the house be held in trust for her children.

The evidence was that the settlor's solicitor gave her very little information or advice in relation to the documents which she signed or their effects and consequences.

The settlor claimed that she would never have signed the Deed of Variation and other documents had she known that she was making a number of mistakes in doing so. The first mistake was the belief that she needed to take action to reduce inheritance tax on her late husband's death, but there was no inheritance tax liability because of the surviving spouse exemption. The second mistake was the belief that inheritance tax would be reduced on her death by entering into the documents. The third mistake was that she believed that she would have an undisturbed right to occupy and have control over the property during her lifetime and sell it whenever she thought fit without anyone's consent.

It was clear that, had the settlor understood the nature and effect of the transaction that she was entering into, she would not have entered into it and the court therefore found that the transaction as a whole should be set aside. However, the court said that HMRC have a legitimate interest in the outcome of the claim and should therefore be given immediate notice of the decision of the court and given 28 days in which to contest the decision.

In Howell, Robinson and Thompson (as trustees of the Joyce 1948 and 1968 Settlements) [2009] EWHC1754 (Ch), the trustees held a trust fund upon trust for such one or more of a discretionary class of beneficiaries as they should appoint during the trust period. In default of any such appointment, the trust fund was held upon trust for a child, subject to him reaching the age of 25 'absolutely'. The trustees argued that if they did not exercise their overriding power of appointment before the child reached age 25, the child would become entitled to the trust fund at that time, because of the inclusion of the word 'absolutely'.

The court held that the gift to the child was in default of the appointment made by the trustees. The use of the word 'absolutely' in relation to the default gift did not mean that the power of appointment was always subject to the default gift and therefore the full provision did not create an indefeasible gift to the child on reaching the age of 25. Therefore, the trustees' power to appoint remained exercisable through the whole of the trust period.

Company reorganisations

The case Coll v Revenue & Customs Commissioners (TC00028) [2009] concerned a husband and wife who had sold all of their shares in their company to another company in consideration for loan notes. They had previously applied for clearance under section 138 of the Taxation of Chargeable Gains Act 1992 that the no gain/no loss capital gains tax treatment would apply to the exchange of shares for loan notes. In that clearance application they mentioned that they planned to become non-UK resident.

The application for clearance was refused. The taxpayers became resident in Belgium and redeemed their loan notes. In the tax return which they submitted in relation to the disposal, which was completed by their tax adviser, the taxpayers incorrectly specified that the disposal had received clearance.

HMRC assessed the disposal of shares as a chargeable disposal. They also issued penalties equal to 85 per cent of the capital gains tax. The court considered whether the taxpayers had acted fraudulently, given the incorrect statements in the tax returns.

The burden of proving that the HMRC assessment was wrong rested on the taxpayers. On the other hand, HMRC had the burden of showing that the taxpayers had acted fraudulently or negligently in making an incorrect tax return.

The court decided that there had been a scheme or arrangement with the main purpose of avoiding capital gains tax (so the assessment stood), but that the taxpayers had not fraudulently made incorrect returns and were instead negligent in not checking them before signing them. The penalty was reduced to 30 per cent of the CGT due.

In Adams v Revenue & Customs Commissioners (TC00048) [2009], the taxpayer applied for clearance under section 138 TCGA 1992 in respect of a sale of shares in consideration for cash, shares in the purchaser and an 'earn out' right to receive further shares in the purchaser.

An exchange of shares for an earn out right is not strictly covered by a clearance application under section 138 because it does not involve an exchange of shares for shares, but an exchange of shares for a right to acquire shares. HMRC therefore gave clearance on the specific point of whether they believed that the transaction was a bona fide transaction in relation to a share-for-share exchange.

After the disposal was made by the taxpayer, HMRC assessed a liability to capital gains tax on the exchange of shares for the earn out right.

The commissioners in the First-tier Tribunal (Tax Chamber) decided that the application for clearance under section 138 also constituted a valid election under section 138A (which efficiently allows the treatment for share-for-share exchanges to extend to an exchange of sharesfor earn out rights). The application for clearance did refer to section 138A TCGA 1992, even though it was not expressed to be an election as such. The application for clearance met all the conditions of a section 138A election.

Offshore accounts

On 30 July, HMRC published details of their previously proposed arrangements under which taxpayers can voluntarily disclose unpaid taxes linked to offshore accounts or assets and settle their tax liabilities at a favourable penalty rate. This arrangement is known as the New Disclosure Opportunity (NDO).

The NDO will run from 1 September 2009 until 12 March 2010 and there are a number of stages within that time frame. Only taxpayers who have notified a liability by 31 October 2009 will be able to make a disclosure using the NDO.

The favourable penalty can range from zero per cent (where the tax due is less than £1,000) to 20 per cent (for those who failed to use the previous disclosure facility in 2007). A taxpayer who does not use this new facility will potentially be subject to a penalty of between 30 and 100 per cent, plus an increased risk of prosecution.