The High Court held that the special commissioners, in considering the tax treatment of trustees’ expenses, had erred in law in resisting the proposition that all costs, charges and expenses incurred for the benefit of the whole estate were inescapably capital in nature 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.

The special commissioners had dismissed the trustees’ appeal, concluding that, 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 is for the benefit of both the income and capital beneficiaries should be charged to capital and should not be attributed to income for purposes of ICTA 1988, s. 686(2AA). Accordingly, the commissioners decided that, whilst investment management fees were capital expenses not chargeable to income, some unspecified proportions of the trustees’ other expenses were properly chargeable to income ((2007) Sp C 595). The Revenue appealed and the trustees cross-appealed.

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

Lindsay J (allowing the appeal in part) said that, subject to particular statutes a trustee had a general discretion to allocate outgoings out of income or capital as he saw fit, but using his powers to effectuate the settlor's purposes and in accordance with his duty to keep a fair balance between the interests of income and capital beneficiaries. In contrast to earlier cases which dealt with matters internal to the particular trust, in the present case the court was concerned in part with trustees’ remuneration, with statutory provision and in a context in a sense external to the trustees as involving a third party, the Revenue. It did not follow, even if fairness still had a role to play where statutory provision was concerned, that what was open to trustees to do as being fair between themselves and their beneficiaries was open to them to do when a third party was involved.

Within the general law of trusts, trustees’ expenditure incurred for the benefit of the whole estate had to be regarded as a capital expense. Whichever pocket the trustees might chose as the pocket from which an expense was paid, the expense had an intrinsic nature under the general law, such that, as between the Revenue and the trustees, if it was incurred for the benefit of the whole estate, it was inescapably assigned to capital. The fact that as between one class of beneficiaries and another or in the ultimate internal accounts of the trustees a given expense could be or was, by reason of some provision other than of the general law, treated or treatable as income would in such a case not overcome its intrinsic nature, as between the trustees and the Revenue, as capital. For immediate purposes, s. 686(2AA) required a look to what the position would be but for any express provisions of the trust: Carver v Duncan (HMIT) [1985] BTC 248 applied.

Since the principle in Carver was binding, it followed that the special commissioners had erred in law; they were wrong to resist that ‘all costs, charges and expenses incurred for the benefit of the whole estate’ were inescapably to be treated as of a capital nature for the purposes of s. 686(2AA). Not only was that expressly stated in Carver but it was the only conclusion consistent with the House of Lords’ treatment of the annual fees of investment advisers in that case.

The next question was whether particular outgoings were or were not incurred for the benefit of the whole estate. There was no dispute between the parties as to accountancy fees and custodian fees; in both of those cases the Revenue had accepted that an apportionment should be made so as fairly to attribute part of the expense to capital and part to income. Part of the bank charges were equally agreed properly to be apportioned.

As for the investment management fees, the trustees accepted that in the main they were properly chargeable to capital but there was an element thereof which was properly chargeable to income. The trustees had resolved to accumulate income but there was not an accumulation, they argued, until the trustees had invested the income and they had before that incurred expense in being advised as to how that income was to be invested. No attention had been drawn to any identifiable or identified element of the overall bill for investment management fees that was attributable to that particular type of advice but, in any event, the advice amounted to advice as to how best to make the income into capital which redounded for the benefit of the estate as a whole. The special commissioners were right in treating the totality of investment management fees as properly chargeable to capital.

No attention had been drawn to particular difficulties as to professional fees and it was to be hoped that an apportionment, if at all appropriate, could be agreed as to them, no doubt on similar lines, whatever they were, to those adopted as to accountancy fees.

As regards trustees’ fees, broadly speaking, that which could be attributable to income under s. 686(2AA) so as to reduce the amount of income chargeable at the higher rate was income applied in defraying the expenses of the trustees which were properly chargeable to income. In approaching the construction of s. 686(2AA), it should be borne in mind that its language was very difficult to construe. In the context of an inept section it would be wrong to treat the expression ‘the expenses of the trustees’ as excluding their remuneration. There was nothing to suggest that but for the express provision of the trusts, the general rule would not have applied, namely that outlay incurred for the benefit of the whole estate was a capital expense.

The test in relation to a trustee's expenses was whether it was incurred for the benefit of the whole estate. The starting point was that trustees’ remuneration should be regarded as incurred for the benefit of the whole estate. Whilst Carver did not expressly deal with trustees’ remuneration, that would be consistent with Carver's treatment of investment management fees. At lowest, there was a heavy evidential burden (not satisfied in this case) upon those who asserted some other conclusion. Finally the special commissioners had concluded that the accruals basis was a proper way of allocating expenses to a particular year of assessment and there was nothing to indicate that the special commissioners had made an error of law in that respect.

Chancery Division.
Judgment delivered 15 November 2007.