A special commissioner decided that, in accordance with the requirement to achieve a fair balance between income and capital beneficiaries, a proportion of all the expenses incurred in connection with a discretionary trust, with the exception of the investment management fees, was attributable to income and was properly chargeable to trust income for the purposes of ICTA 1988, s. 686(2AA).

Facts

The trustees of a UK resident discretionary trust appealed against a closure notice disallowing certain trustees’ expenses in the computation of the rate applicable to trusts. The case arose out of a dispute between the Revenue and the trustees as to the amount properly deductible for income tax purposes under ICTA 1988, s. 686(2AA) as expenses properly chargeable to the income of the trust. In essence, the dispute raised the question of whether it was proper for trustees as a matter of general law (disregarding any express provision in their trust) to charge part of certain annual expenses to the income of their trust on the footing that that was the proper application of the general rules as to the incidence of trustee expenses.

This case concerned a large trust producing a seven-figure income. It was not in dispute that almost all of the income was customarily accumulated and thus required to be invested for the purpose of that process of accumulation. A specific issue related to the extent, if any, to which it was proper to charge the costs of investment services relating to that process of investment. The trustees said that that was an example of an expense which under the normal rules ought to be charged to the income which it was proposed to accumulate. By contrast, the Revenue argued that investment management fees were by their nature only applicable to capital and so had to be charged to capital.

The trustees had claimed half their expenses by way of trustee fees, investment management fees, bank charges, custodian fees, and professional fees by way of accountancy services. The Revenue had indicated that they would be willing to allow custodian charges and professional fees in so far as they could be shown to relate to income.

Issue

What proportion, if any, of the trustees’ fees, investment managers’ fees, bank charges, custodian fees and accountancy and administration fees charged by the accountants was properly chargeable to income.

Decision

The special commissioners (Adrian Shipwright and Dr John Avery Jones) (dismissing the appeal) said that it was a cardinal principle of trust law that the trustees had to keep the balance between income and capital. The issue in the appeal was whether a single charge could be attributed between the income and capital elements when it covered different work in relation to each element. The attribution was based on the trustee's duty to keep a fair balance between classes of beneficiaries. The underlying general principle was to achieve fairness between beneficiaries entitled to income and capital. As s. 22(4) of the Trustee Act 1925 illustrated, the expenses of an audit could be attributed between income and capital, presumably on the basis that different work was performed on the income and expenditure account than on the balance sheet.

In the light of the general principle of fairness ‘expenses incurred for the benefit of the whole estate’ should not be understood widely as meaning anything that was for the benefit of both the income and capital beneficiaries should be charged to capital and should not be attributed. The preferable approach was that one should attribute unless the expense really was a capital expense where the interest of the income beneficiary was merely the consequential loss of income on the capital that went to pay the expense (Carver v Duncan [1985] BTC 248 and Re Bennett [1896] 1 Ch 778 considered).

It was not the case, on the wording of s. 686(2AA) that, in any event ‘the expenses of the trustees’ could not include payments to the trustees themselves. Those payments were from the trust property to the trustee as an individual in his personal capacity. They were paid to the individual because he was a trustee but he did not receive them as trustee but in his personal capacity as an individual separate from the trustees. One could regard the payments as expenses of the trustees in the sense that they were expenses of the trust property (and therefore of the trustees), and it made no difference that they were paid to one of their number rather than to a third party. There was no real distinction between a payment to a person who was a trustee and a payment to a third party. Accordingly there was no reason in principle why attribution should not apply to trustees’ fees.

Applying those general considerations to this appeal, the accountancy fees related in part to the separate work on checking and recording the income and that part was properly attributed to income. The custodian fees related in large part to the collection of income on foreign investments and an attribution should be made between income and capital. The ‘executive’ trustee's fee based on the time spent could be attributed in part to income in exactly the same way as if a bank trustee had charged separate income and capital fees. However, the fixed fee paid to the non-executive trustees should not be attributed partly to income. The distinction was that the fee of the non-executive trustees did not vary according to the amount of work attributed to income, as did the executive trustee's fee, and it should therefore properly be treated as expenses incurred for the benefit of the whole estate chargeable to capital. The bank charges related in part to the ordinary receipts and payments the majority in number of which were likely to be of an income nature, while another account related to an overdraft on capital account. That part of the charges for the former account should be attributed to income.

The work of the investment managers was predominantly attributable to capital, particularly when, as here, the custodian did the bulk of the work relating to the income. The only part seriously contended for attribution to income was the investment of accumulated income. If the accumulation were for a particular child then it would be proper to attribute the cost of investment of those accumulations to that fund, as opposed to the capital generally. Here since accumulations of income could be paid as income of a future year they were held on different trusts from the original capital and it would be proper to charge the fund with its investment rather than the whole capital. But the real question was whether because this case was dealing with income until the accumulation took place, it was to be attributed to income. Accumulation of income took one beyond the point at which the expenses were ‘properly chargeable to income’. The trustees would have resolved to accumulate the income at which point it became capital and the expenses of investing it were capital. The position might well be different if the trustees were temporarily investing income while deciding whether to accumulate it. On the timing of the deduction, one would expect a correlation between the timing of the income and expenses which was best achieved if the expenses were computed on an accruals basis and set against the income of the year in which the income accrued. If expenses were computed on a cash basis, they would often be set against income of a subsequent year from that in which they were incurred, which lost the correlation and might have the effect of reducing the income of different beneficiaries, or the nature of the trusts might have changed. Section 686(2AA) was not trying to be prescriptive about the timing of the expenditure since the timing of the income against which the expenditure was set depended on the nature of the income. However, while an accruals basis achieved a better result in terms of fairness between income and capital beneficiaries and was more suitable to larger trusts, a cash basis, which might be easier to operate in practice for smaller trusts, was not wrong.

(2007) Sp C 595.
Decision released 27 February 2007.