Before 19 March 1991 it was possible for UK resident domiciliaries to create offshore trusts, retain an interest in that trust, but escape capital gains tax on capital gains that accrued to the trust until such time as the settlor (or another beneficiary) received a capital payment from the trust. Following changes made in the Finance Act 1998, this regime no longer exists for gains made after 5th April 1999 on such trusts unless the settlor is either non-UK resident or non-UK domiciled.
In a recent case before the Special Commissioners the meaning of "capital payment" was examined. The Inland Revenue sought to argue that interest free loans from such an offshore trust to the settlors were in fact capital distributions from the trust rendering them liable to CGT on any accrued gains of the trust that could be attributed to the payment.
The facts of the case were that both taxpayers (Cooper and Fisher) were domiciled and resident in the UK in the relevant tax years. The taxpayer in each appeal settled funds on trustees not resident in the UK before 19 March 1991 on terms that the trust property was held on trust to pay the income to the taxpayer during his lifetime with powers to apply capital for the benefit of the taxpayer.
Each taxpayer was assessed to capital gains tax under on the basis that they had received capital payments within the meaning of s97 of TCGA 1992,.
The taxpayers accepted that the loans were 'capital payments' within s97(1) of TCGA 1992, and (2), but the Revenue's difficulty was in quantifying the amount that was taxable. In this respect s97(4) of TCGA 1992, provided that in order to be taxable the amount of a capital payment is 'equal to the value of the benefit conferred by it'.
The Revenue accepted that the benefit conferred by these loans on each taxpayer was very little or nil because the loans were repayable on demand, but argued that by allowing the taxpayers free use of the money, the trustees also made capital payments on a continuing basis. This meant that while the loans were outstanding, the benefit to the taxpayers corresponded to the interest which would have been payable to a commercial lender.
The special commissioners said that the words of s97 TCGA 1992 contemplated single identifiable payments made on single identifiable occasions, rather than payments made on a continuing basis. Further, it was difficult to see how the taxpayers as beneficiaries of the settlements could benefit from loans from the trustees when they would themselves have been entitled to any interest payable in respect of the loans.
The appeals by the taxpayers were allowed.
This is important decision that may well go further on appeal. For pre 19 March 1991 trusts that have realised capital gains, it has been common practice for trustees to make interest free loans to beneficiaries with a view to minimising CGT liabilities. Many thought that the interest forgone (compared to a commercial rate) would equal the capital benefit to be attributed to previous capital gains. By judicial calculation the benefit gain could be equal to the current CGT annual exemption. Of course sizeable interest free loans will not possible each year because the previous loans and capital benefit thereon would need to be taken into account.
On the basis of this decision interest free loans can be made without concern as to triggering a CGT charge linked to capital gains realised before 17 March 1998. It will need to be seen whether the Inland Revenue let the position rest there.