Is a scrip dividend income or capital for RPT tax purposes?

 In Tax, Trusts

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Case Summary from LawSkills | Private Client specialist trainersScrip dividends & RPT tax – Seddon v HMRC [2015] UKFTT 140

The Trustees of a discretionary trust argued that a scrip dividend received by them over nine years before they made a distribution out of the trust, was to be treated by them as income. It had not been accumulated by the time of the distribution so should not be taken into account when calculating the exit charge. In contrast, HMRC treated the scrip dividend as capital, resulting in an exit charge of £54,640.43. The First Tier Tax Tribunal (FTT) agreed with HMRC.

The facts

On 5 March 1999 Mrs M Seddon created a trust known as the ‘Mrs M Seddon Second Discretionary Settlement’ (‘the Trust’) and transferred five £1 ordinary shares in Seddon Seedfeeds Ltd to it. These shares were valued at the time of transfer at £200,000. The trustees appointed were Meena Seddon, Wayne Seddon and Debra Seddon (‘the Trustees’).

On 30 January 2000 the Trustees received a scrip dividend of 187,500 1p preference shares in Seddon Seedfeeds Ltd which they sold on 1 February 2000. The Trustees were paid cash of £768,194 and loan notes of £614,556, making the total value of the scrip dividend £1,382,750.

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A few days before the first ten year anniversary of the Trust, on 1 March 2009, the Trustees distributed £1,260,361 to certain beneficiaries. The Trustees took the view that the scrip dividend was income in the hands of the Trustees and had not been accumulated as capital as at 1 March 2009. It did not therefore need to be taken into account in calculating the exit charge. It followed that the rate of tax for the exit charge was 0%, resulting in no IHT being payable on the 1 March 2009 distribution.

HMRC did not share this view and treated the scrip dividend as capital in the Trustees’ hands, meaning it would be taken into account when calculating the exit charge. The tax rate was therefore 4.817%, resulting in IHT of £54,640.43 being due. HMRC sent Notices of Determination to this effect to the Trustees on 19 November 2012. The Trustees appealed these notices.

There were three issues to be decided at the FTT:

  1. As a matter of principle, is the scrip dividend income or capital in the hands of the Trustees?
  1. If the scrip dividend is capital, does it fall to be taken into account in s.68(5)(c) Inheritance Tax Act 1984 (IHTA 84) when calculating the exit charge?
  1. If the scrip dividend is income, had the Trustees accumulated it as capital by the time of the distribution on 1 March 2009?

The law

There are conflicting decisions by the High Court and Upper Tribunal on the question of the correct treatment of the scrip dividends. In Pierce v Wood [2009] EWHC 3225 the High Court held that scrip dividend shares are income for trust law purposes. The Trustees relied on this decision.

Contrasting with this, in Gilchrist v HMRC [2014] UKUT 169 the Upper Tribunal held that scrip dividend shares are capital and HMRC relied on this decision.

S65 IHTA 84 provides that a charge will arise where property ceases to be relevant property (i.e. on an exit from a relevant property trust):

  • There shall be a charge to tax under this section —
  • where the property comprised in a settlement or any part of that property ceases to be relevant property (whether because it ceases to be comprised in the settlement or otherwise); and
  • in a case in which paragraph (a) above does not apply, where the trustees of the settlement make a disposition as a result of which the value of relevant property comprised in the settlement is less than it would be but for the disposition.

  …(3) The rate at which tax is charged under this section shall be the rate applicable under section 68 or 69 below.

S.68 IHTA 84 applies where there is an exit before the first ten year anniversary:

(1) The rate at which tax is charged under section 65 above on an occasion preceding the first ten-year anniversary after the settlement’s commencement shall be the appropriate fraction of the effective rate at which tax would be charged on the value transferred by a chargeable transfer of the description specified in subsection (4) below (but subject to subsection (6) below).

  ….(4) The chargeable transfer postulated in subsection (1) above is one—

 (a) the value transferred by which is equal to an amount determined in accordance with subsection (5) below;

(b) which is made at the time of the charge to tax under section 65 by a transferor who has in the period of seven years ending with the day of the occasion of the charge made chargeable transfers having an aggregate value equal to that of any chargeable transfers made by the settlor in the period of seven years ending with the day 5 on which the settlement commenced, disregarding transfers made on that day or before 27th March 1974; and

  •  on which tax is charged in accordance with section 7(2) of this Act.

(5) The amount referred to in subsection (4)(a) above is equal to the aggregate

of—

  • the value, immediately after the settlement commenced, of the property then comprised in it;
  • the value, immediately after a related settlement commenced, of the property then comprised in it; and

(c) the value, immediately after it became comprised in the settlement, of any property which became so comprised after the settlement commenced and before the occasion of the charge under section 65 (whether or not it has remained so comprised).

In Statement of Practice SP 8/86 HMRC state:

This statement sets out the Board’s practice concerning the IHT/CTT treatment of income of discretionary trusts.

 The Board takes the view that –

– undistributed and unaccumulated income should not be treated as a taxable trust asset; and

 – for the purpose of determining the rate of charge on accumulated income, the income should be treated as becoming a taxable asset of the trust on the date when the accumulation is made.

 This practice applies from 10 November 1986 to all new cases and to existing cases where the tax liability has not been settled.

The decision

Cannan J and Mr Wilson considered the three issues in turn:

  • As a matter of principle is a scrip dividend income or capital in the hands of trustees?

They found that in looking at the conflicting Pierce and Gilchrist cases, they should not scrutinise either case, but should follow the later of two first instance authorities where the later authority had fully considered earlier authorities. In Gilchrist the Upper Tribunal had considered earlier cases, as well as Pierce on the question of whether the scrip dividend was income or capital. It had also carried out a detailed review of the law on whether the High Court binds the Upper Tribunal and found that it did not.

Cannan J and Mr Wilson held that they were bound by the Upper Tribunal decision and the scrip dividend and its proceeds were therefore capital in the hands of the Trustees.

  • If the scrip dividend is capital, does it fall to be taken into account in s.68(5)(c) IHTA 84 when calculating the exit charge?

Here the question was whether the scrip dividend is property which became comprised in the settlement after its commencement for the purposes of s.68(5)(c). The FTT accepted that the scrip dividend shares came to be held by the Trustees without a chargeable transfer being made. No one had made a disposition and reduced the value of their estate. However, s.68(5)(c) should not be limited to property becoming comprised in a settlement by way of a chargeable transfer. Property could be added by way of an exempt transfer, such as within the settlor’s annual exemption, and this property should be included within s.68(5)(c).

Section 68(5) focuses on the property comprised in the settlement at the time the settlement commenced, and any property which subsequently becomes comprised in the settlement prior to the distribution.

We find that the value of the scrip dividend when it was received by the Trustees is property comprised in the settlement for the purposes of section 68(5)(c).”

  • If the scrip dividend is income, had the Trustees accumulated it as capital by the time of the distribution on 1 March 2009?

In light of their decision regarding the first and second questions, it was not necessary for the FTT to consider this question. They did however, go on to comment that there was no evidence before the FTT from the Trustees on whether the dividend had been accumulated. In the absence of such evidence the FTT could not be satisfied that the scrip dividend remained part of the income of the settlement at the date of the distribution.

For all the above reasons the FTT therefore confirmed HMRC’s Determination Notice and dismissed the Trustees’ appeal.

Practice points

  • If in doubt about conflicting authorities from different courts or tribunals, it is clear that a High Court decision will not bind the Upper Tribunal. Remember too that the FTT will be bound by the Upper Tribunal.
  • Where there are two first instance authorities in conflict, it is the later first instance decision which considers earlier authorities which will be followed.
  • Remember that a dividend received by a discretionary trust in the form of a scrip issue will not be treated as income by HMRC, but will be treated as capital, despite the High Court having the opposite view. It must therefore be taken into account when calculating any exit or anniversary charge.
  • Trustees should remember that following s.110 & Sch 21 of the Finance Act 2014, for IHT purposes, income that is not otherwise distributed will be deemed to have been accumulated automatically with capital for the purposes of the relevant property calculations after five years. This does at least provide some certainty now in this area.
  • If Trustees want to argue that any trust income (but not scrip dividends which will be treated by HMRC as capital) has not been accumulated prior to the five year accumulation deeming provision, they will need to produce evidence of this. Advise Trustees to consider the accumulation question at their annual meetings and minute their decision not to accumulate income as well as their decision to accumulate it.

 

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