Did you know that the tax & trust treatment of royalties are not the same? Mary Poppins explains….

 In Tax, Trusts

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Tax and trust treatment of royaltiesTrustees of The Mrs PL Travers Will Trust v HMRC [2013] UKFTT 436 (TC)

The literary estate of the late author PL Travers, famous for the Mary Poppins books, was the subject of a recent decision at First Tier Tax Tribunal   This is an interesting case that primarily deals with the royalties from the stage musical Mary Poppins received by The Mrs PL Travers Will Trust and highlights the differences between the tax and trust treatment of royalties.

The Facts

Between 1934 and 1982 PL Travers (‘PLT’) published six children’s books about Mary Poppins.  In 1960 PLT and a family company signed an agreement with Walt Disney Productions (‘Disney’) to grant Disney the sole and exclusive motion picture rights in adaptions of any of the Mary Poppins books (subject to conditions as to approval of their content) and together with ‘merchandising’. The rights assigned did not include dramatic, radio or TV rights but PLT gave an undertaking to Disney not to exploit these particular rights except through an arrangement with Disney with mutually agreeable terms and conditions. In 1962 the assignment was made and in 1966 PL Travers set up the Cherry Tree Foundation charitable trust and transferred to the Trustees the right to receive 9% of the receipts under the Disney Agreement. PL T received a lump sum from Disney rather than receipts.

In 1994 PLT made an agreement which related to a stage musical about Mary Poppins (‘The 1994 Agreement’) with David Pugh Ltd and CML. This agreement was the subject to the consent of Disney due to PLT’s 1960 Agreement with Disney. CML and Disney could not reach agreement and the stage musical was not produced until 2004 after the Trustees of the PLT Will Trust intervened to break the deadlock. Under the 1994 agreement licences only were granted in respect of a musical production. In 2004 this agreement was amended and Trustees assigned the right to stage the musical in return for royalties

In 1996 PLT died.  Under the terms of her Will she bequeathed her literary estate to a Settlement. The Beneficiaries of the Settlement were PL Travers descendants and the Cherry Tree Foundation. The terms of the Settlement specified that the Trustees were to pay the income of the Settlement to the Beneficiaries for 80 years and then after this period the Trustees were to distribute the capital between certain descendants of PLT who were living at this point.

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In 2004 the stage musical Mary Poppins opened in London’s West End. The Trustees treated the royalties from the musical production (‘CML royalties’) as capital and not income of the Trust and accordingly did not distribute them but ‘preserved’ them for 80 years, complying with the terms of PLT’s Will.  The Trustees also took the view that the CML royalties were liable to income tax at the basic rate on the basis that they did not fall within the provisions of section 686 of the Income Tax and Corporation Taxes Act 1988 (‘ICTA 1988’). The Trustees prepared the Trust’s annual tax returns and included a note on the return indicating what had been done. From 2007 onwards HMRC made enquiries in relation to the tax returns and confirmed that the receipts were in fact subject to tax at the higher rate applicable to trusts due to being caught by section 686 of ICTA 1988 (replaced by s479 Income Tax Act 2007).

The Law

Section 686 of ICTA 1988 governed the first four years of the tax assessment in relation to the Appeal. It provides:-

(1)     So far as income arising to the trustees of a settlement is income to which this section applies it shall…… be chargeable to income tax at the rate applicable in accordance with subsection (1AA) below, instead of at the basic rate…

(1AA)    The rate applicable in accordance with this subsection is-

(b) in the case of any other income to which this section applies, the rate applicable to trusts

(2)          This section applies to income arising to the trustees of a settlement in any year of assessment so far as it-

(a) is income which is to be accumulated or which is payable at the discretion of the trustees or any other person (whether or not the trustees have power to accumulate it)…

Sections 479 and 480 of the 2007 Act applied in the final year under appeal. They provide:-

(1)    This section applies if-

(a)    Accumulated or discretionary income arises to the trustees of a settlement…

(2)    Income tax is charged on the income at the rates referred to in this section instead of the rates which would otherwise apply……….

(3)    Income tax is charged on the income at the dividend trust rate so far as income is dividend income

(4)    Otherwise, income tax is charged on the income at the trust rate…….

480 Meaning of “accumulated or discretionary income”

(1)    Income is accumulated or discretionary income so far as-

(a)    It must be accumulated, or

(b)   It is payable at the discretion of the trustees or any other person, and it is not excluded by subsection (3)

The issues in the case

The above provisions catch income in two categories:  where it is to be accumulated and where it is payable at the Trustees’ discretion.

The focal issue is whether the CML royalties are actually receipts which the law of trusts regards as income and if they are income how they should be taxed.

The parties disagreed as to whether the royalties are receipts which the law of trusts regards as income. They also disagreed as to whether, if they are income, the manner in which the Trustees are directed to deal with them in the circumstances to effecting an accumulation of income.

The Trustees maintained that the royalties were not income in trust law terms because; (1) such receipts were held to be capital receipts for trust law purposes or, (2) because PLT’s Will directed the Trustees to treat them as capital, something which case-law indicates that a Settlor is empowered to do. Alternatively, even if the receipts were income the manner in which the Trustees were required to deal with them could not amount to accumulating because copyright has a limited life and the building up of a fund to replace such a wasting asset does not amount to an accumulation.

HMRC maintained that the CML royalties came from the 1994 agreement, made by PLT in her lifetime, giving them the character of income according to case law. Further they derive from copyright in the Mary Poppins books and as she received publication royalties from the outset this supported the conclusion that the royalties were income.  The structure of PLT’s Will did not prevent the receipts being classified as an accumulation.

The Judgement

Judge Nicholas Paines and Judge Jill Gort allowed the Trustees appeal in part.

The Tribunal analysed the terms of PLT’s Will and found that under its terms there was a discretion to treat royalties as income. Having established that, the Tribunal had to consider whether the CML royalties were income for the purposes of the law of trusts.

The Tribunal held that in executing the agreement in 2004 this brought about an assignment to CML of the right to perform or licence others to perform further acts restricted by PLT’s copyright.  As such the Trustees had, pursuant to their duty to maximise the value of Trust Property in a manner consistent with PLT’s wishes, disposed of portions of her copyright that had come to the Trustees after her death. As such they had replaced the relevant portions of copyright with a stream of receipts which the Tribunal held were the proceeds of the disposal of property by the Trustees retaining as a result their capital nature under the law of Trusts. The Tribunal therefore held that the replacement of Trust Property by cash was not an accumulation of income.

This conclusion only covered receipts following the 2004 agreement. Receipts prior to the 2004 agreement fell under the terms of the original 1994 agreement and were considered as income by the Tribunal. This is because the Tribunal found that such receipts were a stream of payments generated by Property (the relevant portions of copyright) that remained with the Trustees and as such had the characteristic of income.

Consequently receipts received prior to the 2004 variation of the 1994 agreement were taxable at a rate applicable to trusts by virtue of section 686 ICTA 1988 whereas payments received in the period following 2004 were not so taxable.

Practice Points

  1. The judgment is useful for Practitioners as it highlights the difference between the tax treatment and trust law treatment of royalties.
  2. It should be noted that from 6 April 2013 for tax purposes, capital treatment has been removed and the receipts are all taxed at income
  3. Accordingly, the knock on effect of this is that where beneficiaries are subject to higher rate income tax this will mean  an increase in tax from 28% to 40% or 45% in relation to discretionary trusts and life interest trusts.

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