Scrip dividends received in trusts
Gilchrist v HMRC  UKUT 169
Trusts within the relevant property regime are subject to Inheritance Tax (IHT) charges on creation, every ten years and when assets leave the trust. This case explores whether in calculating the 10 yearly periodic charges it is necessary to include the proceeds of sale of ordinary shares issued by way of scrip dividend on the assumption that these scrip dividends are capital as a matter of general trust law.
The J P Gilchrist 1993 Settlement was made on 17 May 1993 between Mr Gilchrist and Abacus Trust Company (Isle of Man) Limited. Originally, Mr Gilchrist was entitled to a life interest in the whole of the trust fund but by deed of appointment dated 4 June 1993 the trustees appointed 20% of the trust fund on discretionary trusts for the benefit of other members of his family and he and his wife were permanently removed from benefiting from the appointed fund. Following the appointment, Mr Gilchrist made a further gift of £44,000 to the 1993 trust of which 20% was held upon the trusts of the appointed fund.
The funds in the trust were used to contribute funds to Whitecroft Limited, a Manx incorporated company limited by guarantee, and it in turn subscribed for £44,000 of ordinary 10p shares in Leyland Truck Manufacturing Limited which subsequently became Kepacourt Limited, a holding company for the management buy-out of Leyland Trucks. Whitecroft owned just under 25% of the issued share capital of Kepacourt.
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The trustees of the appointed fund had power to pay or apply the whole or any part of the income of the trust to or for the benefit of one or more of the discretionary beneficiaries and were entitled to retain the income (including the income from the investment of any income) for any length of time during the accumulation period which continued until 2014. During the accumulation period the power of accumulation was to be exercised by resolution of the trustees.
In April 1998, as part of an arrangement to reduce CGT on the sale of issued share capital in Kepacourt, the trustees entered into a scrip dividend scheme. In relation to the scrip dividend shares allocated to the appointed fund the trustees treated their value as income for the purposes of income tax but argued that this deemed income was not subject to the rate applicable to trusts because the scrip dividend shares and their proceeds were trust capital and as deemed income only were not income which is to be accumulated or which is payable at the discretion of the trustees as required by s.686 (2)(a) ICTA 1988.
The trustees therefore thought that the script dividend shares were to be treated as capital for trust law purposes and so the sale proceeds were treated as capital for accounting and trust law purposes. This was the basis on which the IHT account for the 10 yearly charge was then prepared.
Following the decision in Pierce v Wood  EWHC 3225 the trustees changed their mind and determined that the scrip dividend shares and their proceeds should have been regarded as income and not capital of the trust. As a result they made a claim to recover the overpaid IHT.
The Trustee of the J P Gilchrist 1993 Settlement were served with a Notice of Determination by HMRC in respect of the 10 year charge on the settlement under s.64 IHTA 1984 on 17 May 2003. The Notice refused the trust’s claim for a repayment of £177,474.41 of IHT plus interest from November 2004.
If the scrip dividend proceeds were income for trust law purposes at the time of the 10 year anniversary it was agreed that their value should not have been included in calculating the value of the charge since the definition of ‘relevant property’ for the purposes of s.64 IHTA 1984 does not include money or property which is income for trust law purposes, unless such income has been accumulated and added to capital prior to the date of the chargeable event.
The parties agreed that neither the scrip dividend nor their proceeds had been accumulated as at the date of the 10 year anniversary.
If the scrip dividend proceeds were capital at that date in any event for trust law purposes then their value was properly included in the valuation of relevant property and the 10 year charge was correctly calculated so that the appeal fails.
The status of the scrip dividend proceeds depends upon the effect of s.249 Income & Corporation Taxes Act 1988 (ICTA 1988) on the issue of scrip dividend shares. It was agreed that s.249(6) ICTA 1988 applied to the issue of the scrip dividend shares and that for income tax purposes, income equal to the value of the scrip dividend shares was treated as arising to the trustees of the settlement.
The main question in this case was therefore whether s.249(6) ICTA 1988 also had the effect of treating the scrip dividend shares as income for trust law purposes as a matter of general trust law. The parties accepted that if s.249(6) ICTA 1988 did not have this effect then the scrip dividend shares were capital for trust law purposes.
The Trustee of the settlement argued that s.249(6) did have the effect of treating the scrip dividend shares as income on the basis of the cases Howell v Trippier  EWCA Civ 885 and Pierce v Wood  EWHC 3225. HMRC rejected this argument on the basis that they denied that Howell v Trippier decided that the actual scrip dividend shares should be treated as income for trust purposes and also that Pierce v Wood was wrongly decided.
In SP 8/86 HMRC accepts that property which comprises trust income for the purposes of the general law of trusts is outside the scope of ‘relevant property’ unless such income is accumulated or distributed, whether or not there is a qualifying interest in possession held by a beneficiary.
Reference was made to the interpretation of s.249(6) ICTA 1988 in Howell v Trippier:
“….s.249(6)(a) requires one to ‘ascertain’ the amount of income which, had the bonus shares been issued to an individual, that individual would have been deemed to have received pursuant to s.249(4) and s.251. That sum would, in the present case, be the value of the bonus shares as at their date of issue, grossed up by reference to the Schedule F ordinary rate. By virtue of s.249(6)(b), that grossed-up amount is ‘treated as having arisen to the trustees’ on the date of the issue of the bonus shares.”
s.251(2) ICTA 1988 determines that if the amount of the cash dividend and the market value of the scrip alternative are not substantially different then the trustees are treated as receiving an amount equal to the cash dividend, even if the trustees elect for the scrip alternative. If, however, there is a substantial difference between the two values then the trustees are treated as receiving an amount equal to the market value of the scrip alternative.
So the Tribunal had to decide whether the deeming provisions of s.249(6) ICTA 1988, which treat scrip dividend shares as income for income tax purposes, could also have the effect of treating them as income for the purposes of general trust law. Counsel for the trustee argued this was the effect which meant that the scrip dividend proceeds were income for the purposes of trust law as well as tax law. Counsel for HMRC asserted the opposite and said the provisions in s.249(6) were restricted to ICTA 1988 purposes and did not apply for the purposes of general trust law.
The Tribunal considered the proper approach to deeming provisions – which is to give them their ordinary and natural meaning consistent so far as possible with the policy of the Act and purposes of the provisions so far as such policy and purposes can be ascertained unless this approach leads to absurdity or injustice.
The Tribunal concluded that the deeming provisions in s.249(6) ICTA 1988 did not extend to general trust law or to other tax statutes. They argued that if the provisions did have the ability to override all settlement deeds and affected other statutes it would have needed to be explicit. Usually, if the intention in an Act is to extend its impact to other statutes then this is usually achieved by reference to ‘the Taxes Acts’ or something similar. Without such words the Tribunal felt that the deeming provisions would be confined to the Act in which they were placed.
The Tribunal also felt that if the deeming provisions extended to the general trust law it would give rise to practical problems given the need to determine for income tax purposes the appropriate value in cash terms of the scrip dividend. If that value is less than the trustees actually receive the excess over its deemed value for income tax purposes must surely be capital. This would produce an odd result in that the majority of the dividend would be deemed to be income and the balance would be capital. Equally, if the determination was the other way around and the trustees actually received less value than the deemed amount of income, how would they account for a difference which they had never received?
The Tribunal emphasised that Lord Neuberger in Howell v Trippier was considering the deeming provisions for the purposes of whether the value was subject to the rate applicable to trusts and not for any other purpose, such as IHT charges. However, the High Court in Pierce v Wood expressly held that:
“… the effect of the Court of Appeal’s decision in Howell v Trippier is that s.249(6) ICTA 1988 is to be construed as treating a scrip dividend received by trustees as income in their hands for the purposes of trust law as well as for income tax purposes.”
The Pierce case was identical to the present case – the settlors were shareholders in Leyland Trucks and they settled some of their shares on trust. The same counsel acted and advised in the same way as this case. HMRC were invited to be joined in proceedings but they declined giving only written submissions to the court. The letter expressed the view that the court’s ruling would not set a binding precedent and reserved their rights in any future case.
The Tribunal concluded the decision of the Judge in Pierce, without the benefit of full argument on both sides, was wrong. The decision in Pierce would have to be followed though if it bound the Tribunal. Counsel for the trustee argued that the High Court was a supervisory jurisdiction and decisions of the High Court judicially reviewing the Upper Tribunal bind the Upper Tribunal so when making substantive decisions the Upper Tribunal was bound by substantive decisions of the High Court.
HMRC disagreed and said there was a distinction between judicial review decisions and substantive decisions and it was only judicial review decisions in the High Court which bound the Upper Tribunal – Tribunal Courts & Enforcement Act 2007.
The Tribunal determined that the Upper Tribunal is not bound by previous decisions of the High Court and that it would therefore not follow Pierce v Wood as that decision was wrong. It was satisfied that the Court of Appeal decision in Howell v Trippier did not hold that the deeming effect of s.249(6) ICTA 1988 applied for the purposes of trust law in general or indeed for any purpose outside ICTA.
Therefore, in dismissing the trustee’s appeal, the Tribunal held that the scrip dividend shares and their proceeds of sale were, both for general trust purposes and for the purposes of IHT, capital of the settlement.
This is a useful case in that it examines how deeming provisions work and their limitations. It also reveals the effect of the differences between tax law and trust law which could mean that the same monetary value is taxed twice – here the scrip dividend proceeds were deemed to be income and therefore subject to income tax at the higher rate at the time of receipt and also subsequently they were liable to IHT at the time of the relevant property regime 10 yearly charge being actually capital of the fund.
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