In Barclays Wealth Trustees (Jersey) Ltd and another v HMRC  EWCA Civ 1512, the Court of Appeal has confirmed that inheritance tax (IHT) will not apply in circumstances where a transfer between excluded property settlements takes place after a settlor becomes domiciled in the UK.
With certain exceptions, Chapter III of Part III, Inheritance Tax Act 1984 (IHTA), provides that settlements created by UK domiciled persons are 'relevant property' and are subject to a charge at the time the trust is created, at each tenth anniversary, and when the property leaves the settlement, for example, by distribution. If the settlor retains an interest in the settlement, then there will also be a tax charge on the settlor’s death under the 'gifts with reservation of benefit' regime. Certain property is exempt from these IHT charges, such as agricultural or business property.
Section 48(3)(a), IHTA, provides that where settled property is situated outside the UK, the property is 'excluded property' for IHT purposes, unless the settlor was domiciled in the UK at the time the settlement was made. Where a foreign domiciled settlor establishes a settlement, but subsequently becomes UK domiciled (or deemed domiciled) and adds funds to that settlement, the question that then arises is whether those added funds are also excluded property. The date when the settlement was made can be crucial in determining liability to IHT.
Michael Dreelan (the appellant), was domiciled in Ireland and in 2001 he created a trust which was an 'excluded property' settlement (the 2001 settlement). In 2003, he transferred shares in a UK company to the trustees of the 2001 settlement (the UK shares) who in turn held them through a Jersey resident company.
The appellant became deemed domiciled in the UK in 2008. He and his brothers subsequently created a new settlement (the new settlement) in which each brother had a lifetime interest. This settlement was a 'relevant property' settlement.
The trustees of the 2001 settlement transferred the UK shares into the new settlement. The UK shares were deemed to remain in the 2001 settlement for the purpose of section 81, IHTA, however, they could not be considered 'excluded property' because the appellant had become UK domiciled.
The trustees of the new settlement sold the UK shares and retained the proceeds. Thereafter, in 2011, the trustees of the new settlement transferred the appellant's share of the proceeds of sale to a Jersey bank. Accordingly, the proceeds were situated outside the UK.
HMRC issued Notices of Determination which were appealed.
Having been unsuccessful below, the appellant appealed to the Court of Appeal.
Court of Appeal judgment
The appeal was allowed.
In order to determine whether IHT was due in respect of the proceeds of sale held in Jersey, the Court had to determine whether the property held was 'excluded property' and in order to decide that question it was necessary for the Court to consider whether the settlor was UK domiciled at the time the settlement was made (section 48(3)(a), IHTA).
The Court observed that there was no doubt that when the UK shares were originally placed in the 2001 settlement there could be no doubt as to the excluded property status of the shares.
When the UK shares were transferred in 2008 to the new settlement, they remained comprised in the 2001 settlement due to the effect of section 81, IHTA. Accordingly, when the proceeds of the sale of the UK shares were later appointed back to the 2001 settlement, as a consequence of the statutory wording, they remained comprised in that settlement.
When the proceeds of sale comprised part of the new settlement, they were not excluded property because (1) they were not non-UK property and (2) the appellant was UK domiciled. However, once the proceeds were transferred in to a Jersey bank the proceeds became non-UK property. Accordingly, the key question for the Court was whether the property was non-UK property at the time the settlement was made.
HMRC argued that the term must be considered at each point at which a transaction takes place. Accordingly, in its view, a settlement is made and re-made, for the purposes of the legislation, on each occasion a transfer takes place.
The Court disagreed with HMRC and said that 'settlement', for the purposes of IHT, is to be given its normal trust law meaning and accordingly a settlement is a single settlement irrespective of the number of transfers which are made into it. A settlement is created at the point at which the settlor first executes the trust instrument and provides the initial settled property.
As the appellant was not UK domiciled at the time when the 2001 settlement was created, the settlement remained an 'excluded property' settlement for the purposes of IHTA.
The circumstances of this case are relatively unusual, however, the case does provide some clarity on how the issue of trusts law terms are to be interpreted in the context of taxing acts.
The consequence of this decision would appear to be that it is possible, in certain circumstances, to turn relevant property back into excluded property.
HMRC's argument, if correct, would have created considerable complication for those wishing to transfer property between excluded property trusts in that it would have been necessary to consider the status of the settlor on each occasion on which a transfer took place. Given the Court's judgment in this case, it would appear that this is not necessary.
A copy of the judgment can be viewed here.