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EXPLANATORY NOTE CLAUSE 91 AND SCHEDULES 25 AND 26: TRANSFERS OF VALUE BY TRUSTEES LINKED WITH TRUSTEE BORROWING SUMMARY 1. These measures provide for a capital gains tax charge to arise in certain circumstances where trustees make a transfer of value to another person and the transfer is treated as linked with trustee borrowing. Schedule 25 provides for the whole or a proportion of each chargeable asset which remains part of the settled property after the transfer to be disposed of and reacquired by the trustees at market value. Schedule 26 provides for the attribution of gains to beneficiaries where gains accrue to offshore trustees under the rules set out in Schedule 25. Payments or benefits received by beneficiaries of that trust, or any transferee trust, may be taken into account in charging the beneficiaries in respect of gains arising on that transfer of value. These provisions will apply in relation to any transfer of value completed on or after 21st March 2000. _________________________________ DETAILS OF THE CLAUSE 2. Subsections (1) and (2) provide for a new section of, and a new Schedule to, the Taxation of Chargeable Gains Act 1992 (TCGA), to be inserted in that Act and for them to be given effect. The new section, section 76B, and Schedule, Schedule 4B, provide for capital gains to accrue to trustees in certain circumstances where they transfer value out of the settlement and the transfer is linked with trustee borrowing. 3. Subsections (3) and (4) provide for a new section, section 85A, and new Schedule, Schedule 4C, to be inserted into the TCGA and for section 85A and Schedule 4C, and some consequential amendments, to be given effect. Section 85A and Schedule 4C provide for gains arising to non-resident trustees on a transfer of value under the new rules in Schedule 4B to the TCGA to be charged in certain circumstances on UK resident beneficiaries who receive capital payments. 4. Subsection (5) provides for the new rules to have effect for transfers of value which are effectively completed on or after 21st March 2000. ___________________________ DETAILS OF SCHEDULES 25 and 26 5. These are given in paragraphs 19 to 51 below. __________________ BACKGROUND NOTE 6. These provisions are designed to counter an avoidance device which has become commonly known as a "flip flop". This is a device for extracting gains from a trust tax-free, or with a significant tax saving, using borrowed money. 7. The device is used to avoid tax in two situations. The first is where tax is payable by the settlor of a trust (that is the person who creates the trust by putting assets into it). Where a UK resident settlor retains an interest in the capital or income of a trust (irrespective of whether the trust is a resident or non-resident trust) an amount equal to the capital gains of the trustees is chargeable on that person. 8. A device which enables this charge to be avoided works in the following way. The trustees borrow money on the security of assets in the trust and advance the money to another person, usually the trustees of another trust in which the settlor of the first trust has an interest. The settlor then severs his interest in the first trust. In the following tax year the trustees of the first trust sell the assets and use the proceeds to repay the debt. The settlor receives his or her money from the second trust. If the device is successful, the gains cannot be charged on the settlor because in the tax year that they are realised the settlor no longer has an interest in the first trust. In the case of a UK trust, the trustees are charged at the rate applicable to trusts (34%) on the gains instead of the settlor being charged at his or her marginal rate of tax of 40%. 9. The second situation in which the device is used is where UK resident beneficiaries of an offshore trust receive capital payments and are chargeable to tax in respect of gains realised by the trustees. In this situation, the borrowing by the trustees and transfer of funds from the trust enable the beneficiaries to receive capital payments from another trust which has not realised the gains. The purpose of this arrangement is to ensure that the UK beneficiaries pay no tax on the benefits they receive from the realised gains. Schedule 25 10. These provisions counter the "flip flop" by providing for gains on chargeable assets remaining in the trust to be crystallised in the hands of trustees. This will happen if the trustees transfer value out of the trust at a time when they have outstanding debt and the proceeds from that debt have not been wholly used for normal trust purposes. A "transfer of value" is, broadly, the transfer, or lending, of money or any other asset by the trustees to another person. The gains are crystallised because the trustees are deemed to dispose of the whole or part of each of the chargeable assets remaining in the trust after the transfer and to reacquire them immediately at market value. (A part of an asset is deemed to be disposed of where the amount of value transferred by the trustees is less than the total value of all the chargeable assets remaining in the trust after the transfer which is not attributable to trustee borrowing.) Gifts holdover relief cannot be claimed to relieve the gains arising on the deemed disposal. 11. There will be no deemed disposal and reacquisition if the proceeds of borrowing have been wholly used for normal trust purposes. Trustees apply the proceeds for such purposes if they–
12. For this purpose, "ordinary trust assets" are shares, securities, tangible property (whether movable or immovable), and any property used for the purposes of a trade, profession or vocation carried on by the trustees or any beneficiary with an interest in possession in the settled property. 13. These rules apply to all trusts, except UK trusts in which the settlor does not have an interest. A UK settlor of a trust will be charged in respect of the resulting gains where existing rules provide for it. 14. Paragraphs 20 to 32 below give further details. Schedule 26 15. Special rules are required to charge the gains in the case of a non-resident trust where a UK resident settlor does not have an interest and gains cannot be charged on the settlor. 16. UK resident beneficiaries of offshore trusts who receive certain payments or benefits ("capital payments") from the trustees may be charged to capital gains tax in respect of gains realised by the trustees. The tax due under this charge may be increased by a "supplementary charge" where there is a delay between the gains arising to the trustees and a payment being made to the beneficiary. These rules are contained in sections 87 to 98 TCGA. 17. The new Schedule 4C TCGA replaces those rules in relation to gains arising under the new Schedule 4B TCGA. It provides that those who benefit from the transferor settlement or, where funds are transferred to another trust, the transferee settlement, are charged to tax in respect of the gains realised by the transferor trustees on the transfer of value under Schedule 4B in appropriate circumstances. 18. The detailed circumstances in which beneficiaries who receive capital payments may be charged to tax are set out in Schedule 4C TCGA and described in paragraphs 34 to 51 below, but, broadly, a charge may arise where–
________________________________ /NOTE ON SCHEDULE 25 SCHEDULE 25: TRANSFERS OF VALUE BY TRUSTEES LINKED WITH TRUSTEE BORROWING DETAILS OF SCHEDULE 19. Schedule 25 sets out a new Schedule, Schedule 4B, to the TCGA. _________________________________ DETAILS OF SCHEDULE 4B TO THE TCGA 20. Paragraph 1 is introductory. It provides that Schedule 4B applies where trustees of a settlement make "a transfer of value" (see paragraph 21 below) in a tax year in which the settlement falls within one of the categories described in paragraph 22 below if the transfer is "linked with trustee borrowing" (see paragraph 24 below). It also gives, by way of explanatory guidance, a brief account of the effect that the Schedule has in any case where it applies. 21. Paragraph 2 explains what, for the purposes of Schedule 4B, constitutes the making of "a transfer of value" by trustees. They are treated as making a transfer of value not only where they transfer an asset to anyone at undervalue, but also where they lend an asset or issue a security at undervalue. The amount of value transferred in the case of the loan of an asset is the market value of the asset. Where an asset is transferred, the amount of value transferred is the market value of the asset reduced by any consideration received for it by the trustees except where any part of that value is "attributable to trustee borrowing" (see paragraph 31 below), in which case the whole of the market value is treated as being transferred. If the trustees issue a security the amount of value transferred is the value of the security less any consideration received by the trustees for it. The values used are those immediately before "the material time" except where the asset in question did not exist before that time in which case the value immediately after that time is used. "The material time" is the time at which the loan is made, the transfer is effectively completed, or the security is issued. 22. Paragraph 3 gives the categories of trusts which fall within the scope of Schedule 4B. Broadly, they consist in trusts which can fall within the scope of section 77, 86 or 87 TCGA. These are, in effect, trusts in which a UK settlor has an interest and offshore trusts which have one or more UK beneficiaries. 23. Paragraph 4 sets out the circumstances in which, for the purposes of Schedule 4B, the trustees of a settlement are treated as borrowing. These are not restricted to cases where the trustees are lent money or other assets, but also include cases where an asset is transferred to the trustees and they assume a contractual, as distinct from a fiduciary, obligation to restore or transfer it (or any other asset) to any person. (References in Schedule 4B to a "loan obligation" include such obligations.) The amount borrowed (the "proceeds" of the borrowing) in any case of this latter sort is the market value of the asset concerned reduced by any consideration received for it. 24. Paragraph 5 provides that a transfer of value is "linked with trustee borrowing" if there is any outstanding borrowing at the material time. The amount of outstanding borrowing at any time is the total amount borrowed in respect of the trustees’ outstanding loan obligations which has not, at that time, been applied for "normal trust purposes" (see paragraph 25 below) or been taken into account in relation to an earlier transfer of value. The amount taken into account in this way is determined by sub-paragraph (3). 25. Paragraph 6 provides that borrowing proceeds are used for "normal trust purposes" if the trustees apply them in¾
26. Paragraph 7 defines "ordinary trust assets". These include shares and securities, tangible property, and property used for the purposes of a trade, profession or vocation carried on by the trustees or a beneficiary who has an interest in possession in the settled property. 27. Paragraph 8 sets out the "alternative condition" referred to in the first bullet in paragraph 25 above. In essence, this condition is that either the asset has been destroyed (or has otherwise ceased to exist) before the material time, or that it is represented by one or more assets taken together, each of which forms part of the settled property immediately after the material time or has itself been destroyed (or has otherwise ceased to exist) before then. 28. Paragraph 9 is a regulation-making power which provides for the Treasury to modify the rules which determine whether, for the purposes of Schedule 4B, the proceeds of trustee borrowing are treated as applied for normal trust purposes. 29. Paragraph 10 provides for the whole, or a proportion, of each of the chargeable assets remaining in the trust immediately after the material time ("the remaining chargeable assets") to be treated as disposed of by the trustees at the material time under a bargain at arm’s length, and immediately reacquired by them at market value. Gifts holdover relief under section 165 or 260 TCGA cannot be claimed in respect of such a disposal because its availability is restricted to non-arm’s length disposals. Where a proportion of an asset is deemed to be disposed of, it is deemed to be reacquired for an amount equal to the same proportion of the market value of the asset. 30. Paragraph 11 contains the rules which determine whether a proportion, rather than the whole, of each of the remaining chargeable assets is deemed to be disposed of. The principle is that the amount of value transferred is compared with¾
A proportion of each asset is deemed to be disposed of in any case where the amount of value transferred is less than the effective value of the remaining chargeable assets. This proportion is the proportion of the effective value of the remaining chargeable assets which is represented by the amount of value transferred or, if less, by the amount of outstanding trustee borrowing. In any other case, the whole of each asset is deemed to be disposed of. 31. Paragraph 12 provides the rules which determine the extent to which the value of an asset is "attributable to trustee borrowing". Where the asset has not been borrowed (within the meaning of the Schedule) by the trustees, its value is attributable to trustee borrowing to the extent that¾
Where the asset is a borrowed asset its value is additionally attributable to trustee borrowing to the extent that the proceeds of the borrowing in question have not been applied for normal trust purposes. 32. Paragraph 13 provides that, for the purposes of Schedule 4B, the normal meaning of "asset" in section 21 TCGA is extended to include money expressed in sterling, and that references in the Schedule to the value or market value of such an asset are to its amount. It also provides for references in Schedule 4B to the "transfer of an asset" to have a very wide meaning. Such references include anything which is, or is treated as, the "disposal" of an asset for TCGA purposes. In particular, this means that a part disposal of an asset is treated as a transfer of the asset. Where an asset is created by the part disposal of another asset, however, the created asset is not treated as transferred for Schedule 4B purposes. This means, for example, that if the trustees of a settlement own a freehold interest in land and grant a leasehold interest in the land to another person, the asset they are treated as transferring to that person for Schedule 4B purposes is the freehold interest rather than the leasehold interest. ________________________________ /NOTE ON SCHEDULE 26 SCHEDULE 26: TRANSFERS OF VALUE: ATTRIBUTION OF GAINS TO BENEFICIARIES DETAILS OF SCHEDULE 33. Part I of Schedule 26 sets out a new Schedule, Schedule 4C, to the TCGA. Part II provides for a number of consequential amendments to be made to the TCGA and the Income and Corporation Taxes Act 1988. _________________________________ DETAILS OF SCHEDULE 4C TO THE TCGA 34. Paragraph 1(1) provides that Schedule 4C applies where a chargeable gain or allowable loss has accrued to offshore trustees by virtue of a transfer of value made by them which falls within the new Schedule 4B TCGA. For this purpose, an offshore trust is one where the trustees are either not resident in the UK or, if they are resident, are treated for the purposes of a Double Taxation Agreement as resident in a territory outside the UK ("treaty non-resident"). 35. Paragraph 1(2) applies Schedule 4C to charging beneficiaries in respect of certain gains accruing to offshore trustees by virtue of a transfer of value made by them which falls within Schedule 4B ("Schedule 4B trust gains"), in place of the general rules for charging beneficiaries in respect of gains realised by offshore trustees, contained in sections 86A to 95 TCGA. 36. Paragraph 1(3) ring-fences Schedule 4B trust gains from the general charge on beneficiaries in respect of gains realised by offshore trustees and, further, ring-fences other gains realised by the trustees from the charge, under Schedule 4C, on beneficiaries in respect of Schedule 4B trust gains. 37. Paragraph 2 sets out the general scheme of Schedule 4C, which is that Schedule 4B trust gains can be attributed to beneficiaries of the transferor or a transferee settlement who receive capital payments and that any allowable loss arising under Schedule 4B can only be set against a gain arising under that Schedule. 38. Paragraph 3(1) introduces the term "Schedule 4B trust gains", which are to be computed separately for each transfer of value falling within Schedule 4B (paragraph 3(2)). 39. Paragraph 3(3) provides rules for computing the amount of Schedule 4B trust gains. Briefly, any sums attributed to a settlor (paragraph 6 gives more detail) and any allowable losses (paragraph 7 gives further detail) are deducted from the "chargeable amount" to arrive at the Schedule 4B trust gains. 40. Paragraphs 4 and 5 define a "chargeable amount" as the amount on which, had they been resident in the UK both under domestic law and under the provisions of a Double Taxation Agreement, offshore trustees would have been chargeable in respect of gains arising under Schedule 4B TCGA. 41. Paragraph 6 provides for any gains arising under Schedule 4B, in respect of which there is a charge on the settlor of the transferor settlement, to be deducted in arriving at the Schedule 4B trust gains, and sets out some rules for computing the amount to be deducted (sub-paragraph (1), with further details in paragraph 12). If the amount of gains arising under Schedule 4B on which the settlor is charged has been reduced by non-Schedule 4B losses, these losses are disregarded in working out how much to take off in arriving at Schedule 4B trust gains (sub-paragraph (2)). Sub-paragraph (3) provides that the "chargeable amount" is computed without regard to the possibility that, had the trustees been resident, the settlor rather than the trustees may have been chargeable in respect of gains arising under Schedule 4B. 42. Paragraph 7 deals with losses that arise under Schedule 4B on a transfer of value by trustees. For the purposes of attributing gains to beneficiaries under this Schedule, such losses can be deducted from chargeable amounts arising in respect of other transfers of value by the same transferor trustees (sub-paragraph (1)), but must be set first against such chargeable amounts arising in the same year, if necessary on a proportionate basis (sub-paragraph (2)). Where such losses exceed other such chargeable amounts of the transferor settlement in the year, any excess can be carried forward and set against such chargeable amounts of the transferor settlement of later years (sub-paragraph (3)). Sub-paragraph (4) provides an ordering rule. 43. Paragraph 8 provides that Schedule 4B trust gains can be treated as chargeable gains accruing to beneficiaries of either a transferor or transferee settlement (sub-paragraph (1)), who receive capital payments from the transferor or transferee settlement (sub-paragraph (2)). Capital payments are taken into account for this purpose where they exceed the trust’s other gains which can be attributed to beneficiaries under section 87 or 89(2) TCGA (sub-paragraph (2)). Any excess Schedule 4B trust gains over capital payments made can be carried forward to later years (sub-paragraph (3)). Where necessary, gains are to be attributed on a proportionate basis (sub-paragraph (4)). 44. Paragraph 9 provides some supplementary rules on attributing gains to beneficiaries. Any part of a capital payment which has been taken into account in attributing Schedule 4B trust gains to beneficiaries is subsequently ignored for the purposes of further attributions of gains, whether under Schedule 4C, or the general rules for attributing gains to beneficiaries in sections 87 and 89 TCGA (sub-paragraph (1)). Sub-paragraph (2) provides that a beneficiary is not charged to capital gains tax on the attributed gains unless he or she is domiciled in the United Kingdom at some time in the year. Sub-paragraph (3) provides that any capital payment made before 21st March 2000, or before the year of assessment preceding that in which the transfer of value was made is disregarded for the purposes of paragraph 8. 45. Paragraph 10 provides rules which apply where the transferor or transferee settlement migrates, or the transferee settlement has always been resident. In effect, gains can be attributed to beneficiaries under the rules in paragraph 8 regardless of whether the trustees of the transferor or transferee settlements are or have been resident, non-resident, or treaty non-resident (sub-paragraph (1)). Sub-paragraph (2) provides for any capital payment to be ignored for the purposes of paragraph 8 where it was received by a beneficiary in a year in which the trustees are resident or ordinarily resident in the UK if it was made before a transfer of value giving rise to Schedule 4B trust gains but was not made in anticipation of such a transfer or such gains. Sub-paragraph (3) provides that treaty non-resident trustees are not treated as resident trustees for the purposes of sub-paragraph (2). 46. Paragraph 11 provides that taper relief is not available in respect of gains that are attributed to beneficiaries under Schedule 4C. 47. Paragraph 12 provides detailed rules for cases where Schedule 4B trust gains arise when the settlor of the transferor settlement is temporarily non-resident in respect of which beneficiaries have not been wholly charged under Schedule 4C when the settlor resumes his or her UK residence. It applies where such gains would, under section 10A TCGA, be treated as accruing to the settlor on his or her return (sub-paragraph (1)). 48. Paragraph 12(2) provides that only the amount of gains arising under Schedule 4B during the settlor’s period of temporary non-residence that have not already been charged on beneficiaries under Schedule 4C are to be charged on the settlor on his or her return. 49. Paragraph 12(3) defines the amount of gains charged on beneficiaries, and paragraph 12(4) deals with the case where there is more than one settlor of the transferor settlement. Paragraph 12(5) defines expressions used in paragraph 12. 50. Paragraph 13 provides for an increase in any tax due where an attribution has been made to a beneficiary under Schedule 4C (sub-paragraphs (1) and (2)). The increase is at a specified rate (sub-paragraph (3) refers) over a chargeable period which (as provided for by sub-paragraphs (4) and (5)) runs–
51. Paragraph 14 defines various terms for the purposes of Schedule 4C, for example, "transfer of value" and "transferor/transferee settlement" (sub-paragraphs (1) and (2)). Sub-paragraph (3) ensures that, for the purposes of th Schedule, persons will continue to be treated as beneficiaries of a settlement after a capital payment was made to them, even if–
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