Pearson and Ors v Inland Revenue Commissioners
[1981] A.C. 753(Judgment by: Lord Keith of Kinkel)
Between: Pearson and Ors - Respondents
And: Inland Revenue Commissioners - Appellants
Judges:
Viscount Dilhorne
Lord Salmon
Lord Russell of Killowen
Lord Keith of KinkelLord Lane
Subject References:
REVENUE
CAPITAL TRANSFER TAX
SETTLEMENT
Trust for settlor's children subject to overriding power of appointment
Trustees' power to accumulate and apply income for duties, taxes, outgoings
Appointment of cash to beneficiary
Whether beneficiary's interest 'interest in possession' before appointment
Whether chargeable to capital transfer tax
Legislative References:
Finance Act 1975 (c. 7) - s. 21, Sch. 5, para. 6 (2)
Case References:
Allen-Meyrick's Will Trusts, In re - [1966] 1 W.L.R. 499; [1966] 1 All E.R. 740
Alston-Roberts-West's Settled Estates, In re - [1928] W.N. 41
Attorney-General v. Farrell - [1931] 1 K.B. 81, C.A.
Attorney-General v. Heywood - (1887) 19 Q.B.D. 326, D.C.
Attorney-General v. Power - [1906] 2 I.R. 272
Aylwin's Trusts, in re - (1873) L.R. 16 Eq. 585
Baden's Deed Trusts, In re - [1971] A.C. 424; [1970] 2 W.L.R. 1110; [1970] 2 All E.R. 228, H.L.(E.)
Baird v. Lord Advocate - [1979] A.C. 666; [1979] 2 W.L.R. 369; [1979] 2 All E.R. 28, H.L.(Sc.)
Berkeley, decd., In re - [1968] Ch. 744; [1968] 3 W.L.R. 253; [1968] 3 All E.R. 364, C.A.
Burrell and Kinnaird v. Attorney-General - [1937] A.C. 286; [1936] 3 All E.R. 758, H.L.(E.)
Buttle's Will Trusts, In re - [1977] 1 W.L.R. 1200; [1976] 3 All E.R. 289; [1977] 3 All E.R. 1039, Templeman J. and C.A.
Clitheroe Estate, In re - (1885) 31 Ch.D. 135, C.A.
Commissioner of Stamp Duties (Queensland) v. Livingston - [1965] A.C. 694; [1964] 3 W.L.R. 963; [1964] 3 All E.R. 692, P.C.
Corbett v. Inland Revenue Commissioners - [1938] 1 K.B. 567
Fleming v. London Produce Co. Ltd - [1968] 1 W.L.R. 1013; [1968] 2 All E.R. 975
Gartside v. Inland Revenue Commissioners - [1968] A.C. 553; [1968] 2 W.L.R. 277; [1968] 1 All E.R. 121, H.L.(E.)
Gestetner Settlement, In re - [1953] Ch. 672; [1953] 2 W.L.R. 1033; [1953] 1 All E.R. 1150
Gourju's Will Trusts, In re - [1943] Ch. 24; [1942] 2 All E.R. 605
Gulbenkian's Settlements, In re (No. 2) - [1970] Ch. 408; [1969] 3 W.L.R. 450; [1969] 2 All E.R. 1173
Joel's Will Trusts, In re - [1967] Ch. 14; [1966] 3 W.L.R. 209; [1966] 2 All E.R. 482
Jones, In re - (1884) 26 Ch.D. 736, C.A.
Kirkness v. John Hudson & Co. Ltd - [1955] A.C. 696; [1955] 2 W.L.R. 1135; [1955] 2 All E.R. 345, H.L.(E.)
Locker's Settlement, In re - [1977] 1 W.L.R. 1323; [1978] 1 All E.R. 216
Londonderry's Settlement, In re - [1965] Ch. 918; [1965] 2 W.L.R. 229; [1964] 3 All E.R. 855, C.A.
Lord Advocate v. Fothringham - [1924] S.C. 52
Ormond Investment Co. Ltd. v. Betts - [1928] A.C. 143, H.L.(E.)
Macfarlang v. Inland Revenue Commissioners - 1929 S.C. 453
Master's Settlement, In re - [1911] 1 Ch. 321
Morgan, In re - (1883) 24 Ch.D. 114
Murray v. Inland Revenue Commissioners - [1926] 11 T.C. 133
Phipps (P.) & Co. Ltd. v. Rogers - [1915] 1 K.B. 14
Rank Xerox Ltd. v. Lane - [1981] A.C. 629; [1979] 3 W.L.R. 594; [1979] 3 All E.R. 657, H.L.(E.)
Rochford's Settlement Trusts, In re - [1965] Ch. 111; [1964] 2 W.L.R. 1339; [1964] 2 All E.R. 177
Sargaison v. Roberts - [1969] 1 W.L.R. 951; [1969] 3 All E.R. 1072
Spens v. Inland Revenue Commissioners - [1970] 1 W.L.R. 1173; [1970] 3 All E.R. 245
Vestey v. Inland Revenue Commissioners - [1980] A.C. 1148; [1979] 3 W.L.R. 915; [1979] 3 All E.R. 976, H.L.(E.)
Vine v. Raleigh - [1891] 2 Ch. 13, C.A.
Westminster Bank Ltd. v. Inland Revenue Commissioners - [1958] A.C. 210; [1957] 3 W.L.R. 427; [1957] 2 All E.R. 745, H.L.(E.)
Judgment date: 1 May 1980
Judgment by:
Lord Keith of Kinkel
My Lords, this appeal is concerned with the incidence of capital transfer tax on settled property under section 21 of and Schedule 5 to the Finance Act 1975. The particular problem which has to be determined arises in connection with paragraph 3 (1) of that Schedule, which provides:
"A person beneficially entitled to an interest in possession in settled property shall be treated as beneficially entitled to the property in which the interest subsists."
The coming to an end of such an interest in possession results, under other provisions of the Schedule and subject to certain exemptions which need not be considered in detail, in a charge to tax on the basis that the person in right of the interest has made a transfer of value equal to the value of the property in which the interest subsisted. The general incidence of the tax is affected very materially by the total amount of all relevant transfers of value made by an individual during his lifetime and such as he is deemed to have made on his death.
A different regime prevails as regards the incidence of tax on settled property in which no interest in possession for the time being subsists. Broadly speaking, a charge to tax arises when a capital distribution is made out of such property or (under paragraph 6 (2) of the Schedule) when a person becomes entitled to an interest in possession in the whole or any part of the property. It is under paragraph of (2) that the Crown has sought to raise the charge to taxation in the present case. There are further provisions which impose a periodic charge to tax upon settled property for the time being not subject to any interest in possession. It is to be observed that under this alternative regime no transfer of value made or deemed to be made by any individual is relevant to the amount of tax chargeable. So the distinction between the two different systems of taxation is of extreme importance, and for the purpose of determining which of them is to apply it is vital to ascertain whether or not "an interest in possession" subsists in the property at the material time. That is the nature of the issue in the present appeal.
The facts and circumstances giving rise to the issue cannot be better summarised than was done by Fox J. in his judgment at first instance [1980] Ch. 1, 4-5. [His Lordship cited the facts there set out and continued:] It remains to be added only that the trustees have throughout exercised their power of accumulation in respect of the whole income of the settled property so far as unaffected by any of the appointments described.
In that state of affairs, the Crown raised a charge to capital transfer tax in respect of the appointment on March 20, 1976, of the sum of £16,000 to Fiona. They founded as justification for the charge upon paragraph 6 (2) of Schedule 5 to the Act of 1975, to which I have already referred.
The actual charge to tax on capital distributions is imposed by paragraph 6 (4), and other provisions deal with the rate of tax applicable. The amount of tax charged in respect of the alleged capital distribution was £444.73, and this sum was claimed by a determination of the Inland Revenue Commissioners dated May 23, 1977. The respondents, who are the trustees acting under the settlement, appealed against this determination on the ground that at the time of the appointment to Fiona each of the three daughters of the settlor was beneficially entitled to an interest in possession in one third of the settled property, so that paragraph 6 (2) did not apply. The appeal was allowed by Fox J. on July 31, 1978, and on June 11, 1979, his decision was affirmed by the Court of Appeal (Buckley, Bridge and Templeman L.JJ.). The commissioners now appeal to this House.
In my opinion it is not open to doubt that each of the settlor's daughters was beneficially entitled to an interest of some kind in one third of the settled property. Each of them having attained 21 years of age had a vested interest in the fee of one third subject to the possibility of divestiture through the exercise of the trustees' overriding power of appointment and also, during the lifetime of the settlor, to the possibility of defeasance pro tanto through the birth to him of any further child who attained the age of 21. The latter possibility was terminated by the settlor's death on December 9, 1976. Each daughter's vested interest carried the right, unless and until removed by exercise of the overriding power, to receive one third of any income which the trustees did not decide to accumulate under the power in that behalf conferred upon them by clause 3 (a) of the settlement.
Upon the question whether each daughter's interest was an interest in possession in the relevant sense, it was common ground that the mere existence of the overriding power had no relevance. But the appellants contend that the mere existence of the trustees' power of accumulation did have the effect of preventing any daughter's interest being an interest in possession, and that irrespective of whether or not the power was exercised to any extent. Their contention, as succinctly stated in their printed case, is that a beneficiary only has an interest in possession if his interest enables him to claim the whole or an ascertainable part of the net income, if any, of the property at the moment at which it is in the hands of the trustees; he does not have an interest in possession if the trustees have any discretion to withhold current income from him by, for example, accumulating it or diverting it to another beneficiary or class of beneficiaries. The argument distinguishes such a discretion from an overriding power of appointment on the basis that the latter is exercisable only over future income.
The primary contention for the respondents, which was accepted both by Fox J. and by the Court of Appeal, was that each daughter's interest was an interest in possession because it carried the present right to present enjoyment of one third of whatever part of the income of the settled property the trustees decided not to accumulate. The power of accumulation, like the overriding power of appointment, was properly to be regarded as one which might lead to defeasance of the vested right to income but which did not, by its mere existence, deprive the interest of the character of being in possession. Buckley L.J. [1980] Ch. 1, in the course of his judgment in the Court of Appeal, said, at p. 23:
"In my judgment the expression 'interest in possession' has a clear, recognised and well-established meaning in our law, indicating an interest which confers a right to present enjoyment of the subject matter. If one were to ask what interest one of the settlor's daughters had under the settlement as at the first day of a trust year of account next before March 20, 1976, in the unappointed part of the trust fund and its income during the ensuing year, the answer could, in my opinion, only be that she was then entitled to one third of that income. True, one would have to go on to say that that interest was in certain respects defeasible, but it was a vested interest carrying the right to the enjoyment of the whole one third of the income unless and until it was defeated, either by an appointment or by an exercise of one or more of the discretionary powers vested in the trustees. The description 'interest in possession' would, in my opinion, fit it perfectly. The fact that the immediate enjoyment Of the income might be postponed for a reasonable period to permit the trustees to consider whether to exercise any discretionary power vested in them in defeasance of the lady's vested right to the income is not, in my opinion, sufficient to deprive her interest of the character of an interest in possession. During that period she would be the person entitled to the income, although in the event her right to it might be partially or wholly defeated."
This passage appears to place upon the same footing the defeasance of the interest through an exercise of the overriding power of appointment and its defeasance through an exercise of the power of accumulation. If that be correct, it is difficult to see why the consequences of the exercise of the one power should be any different from the consequences of the exercise of the other. One would therefore logically expect the point of view expressed in the passage to lead to the conclusion that the interest goes in and out of possession according as the trustees refrain from accumulating or decide to do so, and to the further conclusion in the present case that, as the trustees did actually accumulate all the income up to the date of the relevant appointment, the interest was never in possession. This was not, however, a position taken up by either of the parties to the appeal. It seems to me that the trustees' contention necessarily involves that the subject matter of the present right to present enjoyment which they claim to exist is not the actual current fruits of the settled property or of any ascertained part of it. The right is said to extend to whatever income the trustees do not take away through the exercise of the power of accumulation. It is clear enough that when the fruit falls from the tree the beneficiary cannot then claim it as of right. The trustees may within a reasonable time divert it to the accumulation fund, so that in the event it accrues for the benefit of others, and it is only if they fail to do so that the beneficiary can come to enjoy it. I find difficulty in accepting that an interest of this character is an interest in possession.
A considerable part of the argument revolved round the traditional distinction between interests in possession and interests in expectancy. Some reference was made to the position under the Settled Land Acts, particularly section 20 of the Act of 1925, which by subsection (1) provides:
"Each of the following persons being of full age shall, when his estate or interest is in possession, have the powers of a tenant for life under this Act, (namely): - ... (viii) A person entitled to the income of land under a trust or direction for payment thereof to him during his own or any other life, whether or not subject to expenses of management or to a trust for accumulation of income for any purpose ..."
This provision was founded upon for the respondents as an illustration of the recognition by the legislature that the right to income of land under a settlement may be an interest in possession notwithstanding that the right is subject to a trust for accumulation. In my opinion the provision does not favour the respondents' case. In the first place it appears in the context of a classification of persons who are to have the powers of a tenant for life as conferred by the Act, a special purpose not apt to found any general inference about the meaning of "interest in possession." In the second place the phrase is necessary to exclude persons whose interests, whatever they are, are merely in expectancy. In the third place, paragraph (viii) is apt to and does cover persons whose interests are subject to, not merely a power, but a trust to accumulate, these being interests which would clearly and admittedly not fall to be treated as being in possession for present purposes. I do not consider reference to the Settled Land Acts to be of any assistance for these purposes.
It is well established that the traditional dichotomy of interests in possession and in expectancy does not cover the whole field of such interests as may exist in settled property. In the estate duty case of Gartside v. Inland Revenue Commissioners [1968] A.C. 553 this House, while accepting that a beneficiary under a discretionary trust had an interest of some kind in the settled property, held that he did not have an "interest" therein within the meaning of the original section 2 (1) (b) of the Finance Act 1894 or a fortiori "an interest in possession" within the meaning of section 43 of the Finance Act 1940. Lord Reid said, at p. 607:
"It does not seem to me to be a reasonable method of construction to say first that you must disregard technicalities when considering what 'interest' means and then, with regard to the rest of the phrase 'in possession,' introduce the technicality that any interest which is not 'in expectancy' must be an interest 'in possession.'"
As noted by Lord Reid at p. 612, the decision in Gartside's case had the effect that a different meaning fell to be attributed to the word "interest" in section 2 (1) (b) of the Act of 1894 from that which it bore for the purposes of section 2 (1) (c), incorporating section 38 of the Customs and Inland Revenue Act 1881. The reference in section 38 (2) (c) to reservation to the settlor of an "interest" had been construed in Attorney-General v. Heywood (1887) 19 Q.B.D. 326 as covering the situation where trustees had a discretion to apply income for the benefit of a class of persons which included the settlor.
Your Lordships heard a considerable amount of argument directed to the question whether, for purposes of estate duty, there would have been a deemed passing of settled property under section 2 (1) (b) of the Finance Act 1894 upon the death of a person entitled to the income of the property for life subject to a power of accumulation exercisable by the trustees. This aspect featured largely in the judgment of Fox J., who, with the agreement of Templeman L.J. in the Court of Appeal, took the view that there would have been a passing in such circumstances, on the basis that the expression "interest in possession" in section 5 (3) of the Act of 1894 was used in the traditional sense of contrast with an interest in expectancy. There is no reported decision on the point, and the matter is academic in the light of the radical alterations in the applicable law brought about by the Finance Act 1969 and the abolition of estate duty effected by the Finance Act 1975. But under section 2 (1) (b) property was deemed to pass only to the extent to which a benefit accrued or arose by the cesser of the interest, and provision was made by section 7 (7) for valuation of the benefit by reference to whether the interest extended to the whole income or to less than the whole income of the property. There are difficulties in the way of applying those provisions where the income of the property both before and after the death is subject to a power of accumulation for the benefit of a class of beneficiaries other than the deceased. The impossibility of applying those provisions in the case of discretionary beneficiaries formed an important part of the ratio decidendi in Gartside v. Inland Revenue Commissioners [1968] A.C. 553: see per Lord Reid at p. 604. Lord Wilberforce said, at p. 622:
"... for the purposes of estate duty, cases may exist where, at the relevant time, no 'interest in possession' can be found: one such is where the whole income is being validly accumulated for the benefit of persons with contingent interests."
Following the decision in Gartside's case the Finance Act 1969, by sections 36 and 37, radically recast section 2 (1) (b) and associated enactments with the principal object of levying a charge to estate duty in respect of the death of a discretionary beneficiary who had actually received payments of income at any time during the period of seven years prior to his death, the charge being calculated by reference to the proportion borne by such payments to the whole income of the property during the relevant period.
Section 36 introduced a "substituted section 2 (1) (b)" containing three paragraphs (i), (ii) and (iii). Paragraph (i), which referred specifically to "an interest in possession," corresponded roughly to the original section 2 (1) (b) and paragraph (ii) to section 43 of the Finance Act 1940. Paragraph (iii) contained the enactment designed to catch the interests of discretionary beneficiaries.
Section 37 dealt with the extent to which property was to be deemed to pass in various circumstances related to the nature and scope of the relevant interest. It was argued for the appellants that the cesser on death of a life interest subject to a power of accumulation would be caught by paragraph (iii), and by the respondents that it would fall under paragraph (i). Fox J. expressed the opinion that such a case would fall under paragraph (i), because he did not think the deceased could be regarded as a person "eligible to benefit as a result of the discretion" within the meaning of those words which appear in paragraph (iii) (aa), and because it seemed to him that section 37 (1) (a) dealing with the extent of the charge under paragraphs (i) and (ii), and specifically referring to the situation where the deceased's interest "conferred a right to receive a part of that income which varied in accordance with ... the exercise of any power" contemplated the application of paragraph (i) to the interest of a life tenant subject to a power of accumulation.
However, sufficient content for the words quoted may be found in the case of an annuity variable at the discretion of the trustees - a case which is specifically excluded from the application of paragraph (iii) and which was traditionally regarded as falling within the original section 2 (1) (b). As regards the application of paragraph (iii), section 31 (1) (a) of the Finance Act 1970 provided:
"the deceased shall be treated as having benefited as a result of the discretion therein referred to if any of the income with respect to which that discretion was exercisable was paid to him or applied for his benefit."
The purpose of this provision may have been to clear up any doubt whether paragraph (iii) applied to a person entitled for life to any income failing the exercise by trustees of a discretionary power either to distribute among a particular class of beneficiaries or to accumulate. It seems clear enough that for this purpose no distinction is properly to be drawn between a discretionary power of distribution with or without power of accumulation, and a bare power of accumulation. So in the result I am of opinion that it cannot be said with any certainty that an interest such as is the subject of consideration in the present case would have been regarded as an interest in possession for estate duty purposes, and that no helpful guidance can be obtained from the now repealed legislation on that topic.
It is necessary to note a further argument for the respondents that Fiona's interest, subject as it was to the trustees' power of accumulation, did not differ on that account from the interest of an ordinary tenant for life, because that power was similar in principle to the ordinary administrative powers of trustees. Such powers might be exercised so as to absorb all the income received by the trustees in, for example, repairs and maintenance of the settled property, so that there was nothing left for the life tenant to enjoy. I am unable to accept this argument.
I consider that a distinction is properly to be drawn between powers directed to the preservation of the trust estate for the benefit of life tenant and remainderman alike, and discretionary powers the exercise of which is intended to have an effect upon the actual benefits which the beneficiaries as such became entitled, by virtue of their several interests, to receive. It is not at all appropriate, in my view, to equiparate a power to execute repairs with a power to distribute income at discretion among a class of beneficiaries, from the point of view of a person who is entitled to receive any income not dealt with under the power. And the considerations applicable in the case of a discretionary power to distribute income apply equally to a discretionary power of accumulation, the exercise of which in effect rolls up income for the benefit of a class of beneficiaries or objects contingently entitled.
So in the end it comes down to a question of ascertaining the meaning intended by the legislature to be attached to the expression "interest in possession" in the particular context of the Finance Act 1975. There is no general definition of the expression to supply an answer to the question. Paragraph 11 (10) of Schedule 5 which by virtue of paragraph 11 (1) applies for the interpretation only of paragraphs 6 to 10 is not of assistance, doing no more than to indicate that under certain conditions a company, not only an individual, may be beneficially entitled to an interest in possession. Paragraph 1 (9) of the Schedule, dealing with its application to Scotland, provides that
"any reference to an interest in possession in settled property is a reference to an interest of any kind under a settlement actually being enjoyed by the person in right of that interest ..."
It is hard to see what this definition seeks to achieve. While property may be actually enjoyed by virtue of an interest, it is difficult to visualise the actual enjoyment of an interest. No useful inference can in any event be drawn regarding the meaning of the expression in the application of the Schedule to England. The obscurity of the definition is no doubt the reason for its having been amended by the Finance Act 1976, Schedule 16, paragraph 10, but that amendment cannot properly be taken into account for purposes of the present appeal, since it came after the relevant appointment to Fiona.
I regard it as a significant aspect of the context that the criterion of the existence or otherwise of an interest in possession forms the sole basis for determining which of the two alternative regimes of capital transfer tax is to apply to particular settled property. The Act of 1975 makes no attempt to deal with the interests of discretionary beneficiaries as being in themselves the subject of taxation. The sophisticated type of provisions which appeared in sections 36 and 37 of the Finance Act 1969 have been completely departed from, and there is no mention by name of discretionary or of accumulation trusts. Interests in possession are set on the one side, and all other kinds of interest on the other. This seems to me to require that the concept of interest in possession should in this context be a clear and definite one. Such an approach is, in my view, favoured by the terms of sub-paragraphs (2) and (3) of paragraph 3, Schedule 5 to the Act of 1975, which provide:
- "(2)
- Where the person entitled to the interest is entitled to part only of the income (if any) of the property, the interest shall be taken to subsist in such part only of the property as bears to the whole thereof the same proportion as the part of the income to which he is entitled bears to the whole of the income.
- (3)
- Where the part of the income of any property to which a person is entitled is a specified amount (or the whole less a specified amount) in any period, his interest in the property shall be taken ... to subsist in such part (or in the whole less such part) of the property as produces that amount in that period."
These provisions appear to me to contemplate that the entitlement to income which is spoken of is an entitlement which, for the time being at least, is absolute. If that is true of the part, it must also be true of an interest which extends to the whole of the income of the property.
In the present case Fiona certainly did not have an absolute right to any income of the property as it accrued. At that moment her entitlement was qualified by the existence of the trustees' power of accumulation, to the effect that she had no immediate right to anything, but only a right to later payment of such income as the trustees, either by deliberate decision or by inaction for more than a reasonable time, did not cause to be subjected to accumulation. In my opinion a right of that nature is not a present right of present enjoyment.
Further, I do not consider it to be a satisfactory state of affairs that the question whether a person has an interest in possession should turn on the distinction between the position where his interest derives from his being the object of a discretionary power and that where his interest results in a benefit only failing the exercise of such a power. The practical results as regards the person having the interest are unlikely to be materially different in either case, and I can see no good reason why the distinction should lead to a difference of treatment for purposes of capital transfer tax. The distinction between a trust and a power may be of importance for certain other purposes (see for example In re Baden's Deed Trusts [1971] A.C. 424), but none of the considerations leading to that result appear to me to be applicable here.
In the course of the argument much was sought to be made, on either side of the Bar, of anomalies which it was said would arise should the opposing contention prevail. It is sufficient to say that the decision of this appeal cannot turn upon a balance of such anomalies. This is not the type of case where a particular conclusion either way would lead to such bizarre results that it cannot be taken to have been intended by the legislature. The Act under consideration introduced an entirely novel system of capital taxation and it would not be surprising if certain of its provisions gave rise to anomalies which had not been foreseen, and which might in due course have to be rectified by amending legislation.
My Lords, for the foregoing reasons I have reached the conclusion that prior to the relevant appointment in favour of Fiona, neither she nor her sisters were beneficially entitled to an interest in possession in the settled property within the meaning of paragraph 3 (1) of Schedule 5 to the Act of 1975, and that accordingly the appointment had the effect of bringing paragraph 6 (2) into operation. I would accordingly allow the appeal to the effect of restoring the determination of the commissioners.
The appellants were granted leave to appeal to this House upon the condition that in the event of the appeal succeeding they would not seek to disturb the orders as to costs in the courts below nor ask for costs against the respondents here. There should therefore be no order as to costs here or below.