When I reviewed the First-tier Tribunal (FTT) decision of Quentin Skinner 2005 Settlement L & Ors [2019] UKFTT 0516 (TC) concerning entrepreneurs’ relief (ER), I commented that the outcome was in line with what most practitioners expected; for many, the only surprise was why HMRC took the case to the FTT (see TAXline, December 2019). I ended the article by saying we all awaited the outcome of HMRC’s appeal with great interest. I can now comment on the Upper Tribunal’s (UT) findings, but first I begin with a reminder of the case and the FTT’s decision.

Background

The facts of this case were agreed by both sides; immediately prior to the disposal, shares were held in interest in possession settlements, and the life tenant qualified for ER due to a personal holding of shares. The FTT found that an interest in possession is not required for a period of one year prior to trustees disposing of shares that would otherwise meet all ER qualifying conditions. It is worth remembering that since this case, ER has been renamed business asset disposal relief, and the limit is reduced to £1m.

The FTT decision meant that the three Quentin Skinner 2005 Settlements were eligible for ER because, four months before the trustees sold their shares in DPAS Limited, a qualifying beneficiary was granted an interest in possession in the whole of settled property of their respective settlements. For the FTT, the key fact was that each life tenant had personally owned more than 5% of the shares in DPAS Limited with full voting rights for more than one year (now two years) and therefore DPAS Limited was their ‘personal company’.

The legislation

The two sections in the ER legislation at Ch 3, Pt 5, Taxation of Chargeable Gains Act 1992 (TCGA 1992), that specifically refer to settlements are s169J, Disposal of trust business assets, and s169O, Amount of relief: special provisions for certain trust disposals.

Section 169J(3) defines a ‘qualifying beneficiary’ as an individual with an interest in possession over the relevant business assets or, in this case, shares. Section 169J(4) then requires that throughout a period of one year ending not earlier than three years before the date of the disposal:

i) the company is the qualifying beneficiary’s personal company (as defined in s169(3)) and is a trading company; and
ii) the qualifying beneficiary is an officer or employee of the company.

Section 169O includes a reference to ‘material time’ being a period of one year ending not earlier than three years before the date of the disposal.

The FTT decision

The FTT described the required relationship between an individual, their shareholding and the relevant company in order to qualify for ER as the ‘entrepreneurial connection’ and found that the purpose of s169J(4), TCGA 1992, was to extend the entrepreneurial connection to business assets owned by a settlement. The reference to qualifying period was therefore in the context of whether the company was the personal company of the qualifying beneficiary identified in s169J(4). In particular, the FTT dismissed the need to consider the provisions of s169O in determining s169J(4).

This meant that a beneficiary could be granted an interest in possession immediately prior to trustees disposing of shares that would otherwise meet all ER qualifying conditions providing the company was the beneficiary’s personal company.

HMRC appeal to the UT

HMRC appealed the FTT’s decision at the UT – R & C Commrs v Quentin Skinner 2005 Settlement L & Ors [2021] UKUT 0029 (TCC). HMRC has always argued that ER was not due as the life tenants had not held an interest in possession over their respective settlement shares in DPAS Limited for at least one year not ending more than three years prior to the disposal.

Having considered not only the relevant sections of TCGA 1992, but also the provisions of the now abolished retirement relief (as the Explanatory Notes to the Finance Bill 2008 described ER as based on the former retirement relief but that the new rules would be simpler), the judges found in HMRC’s favour.

Part of the rationale for their interpretation of the relevant sections stemmed from the fact that trustees do not have an unqualified right to make a claim for ER; instead, they must make a joint claim with the qualifying beneficiary. The need for a joint claim makes sense given that the trustees use part of the beneficiary’s personal ER limit, but there is no guarantee that the beneficiary will actually benefit from the sale proceeds.

In other words, a life tenant only has a right to any income arising from the settlement, and it is up to the trustees’ discretion as to whether they receive any capital.

The UT therefore felt that the meaning of s169J(4) was clear when understood in the light of s169O. Unlike the FTT, the UT found that it was necessary to consider both s169N and s169O in the case of trustees. They also found that this conclusion was supported by the review of the operation of retirement relief.

Considering the terms of s169J itself, the UT found it significant that s169J(3) and (4) make reference to a ‘qualifying beneficiary’ rather than an ‘individual’ and thought the FTT went too far in its extension of the ‘entrepreneurial connection’ for disposals by trustees.

To quote the UT: “We consider that Parliament intended this ‘transfer’ to be premised on the existence of an enduring link between the qualifying beneficiary’s business and the interest in possession in the trust enjoyed by the qualifying beneficiary. Such a link is provided if there is a requirement in s169J for the beneficiary to be a qualifying beneficiary throughout the one-year period mentioned in subsection (4) of that section.”

It is disappointing that the UT did not address certain related points such as whether the interest in possession must be over all the shares in the company (or other qualifying business assets) for which ER is to be claimed during the entire year prior to sale. Instead, it preferred to leave some points to be determined in a case where this issue is relevant.

Another nail in the trust coffin?

It is understood that the UT’s decision is being appealed. Pending that appeal, the UT’s decision may result in more absolute gifts of shares as part of the pre-sale planning of trading companies. This is because a gift of further qualifying shares to someone who is already eligible for ER will result in the newly gifted shares also being eligible for ER (assuming the current £1m limit is not breached). In contrast, a gift of those shares into a trust where the life tenant has not held their interest in possession for at least a year cannot qualify for ER.

Given the uncertainty of other scenarios (for example a trust that is part discretionary and part interest in possession, with the shares held in the discretionary part for the year prior to sale), then trusts owning shares may be avoided where a claim for ER is to be made. In view of the wide variety of non-tax reasons that settlements are used in estate and succession planning, it is unfortunate that the outcome of this appeal can result in some settlements paying more tax. It will not affect the extent of pre-tax planning that will be recommended prior to sale of a company, but the consequences, whether intended or not, may well be to put more wealth into the hands of individuals and perpetuate some misconceptions about the use of trusts.

About the author

Rachael Dronfield, Private Client Director, Shorts and member of the Capital Taxes & Trusts Working Group of the Tax Faculty’s Private Client Committee