HM Revenue & Customs v Peter Clay Discretionary Trust

Trustees’ expenses may be charged to income only where they are incurred exclusively for the benefit of income beneficiaries. Expenses incurred for the benefit of both income and capital beneficiaries are expenses for the benefit of the whole estate and must be charged to capital. A single expense may be apportioned where an identifiable part relates exclusively to income, including a fixed fee; the fact that the fee is fixed does not itself prevent apportionment. Investment advice obtained after a decision to accumulate income is a capital expense. Advice obtained while deciding whether to distribute or accumulate may be an income expense to the extent the income is ultimately distributed.

The trustees appealed from the order of Mr Justice Lindsay on an appeal and cross-appeal under section 56A of the Taxes Management Act 1970. The dispute concerned whether expenses of a United Kingdom resident discretionary trust could be attributed partly to income for the year 2000–01, reducing the income taxed at the trust rate under section 686(2AA) of the Income and Corporation Taxes Act 1988.

The Special Commissioners allowed attribution for most categories of expense, but excluded investment management fees and the fixed fees of the non-executive trustees. The High Court allowed HMRC’s appeal on the general approach and dismissed the trustees’ cross-appeal. The central issues in the Court of Appeal were whether the non-executive trustees’ fixed fees could be apportioned and whether investment management expenses connected with accumulated income were chargeable to income.

1. Appeal allowed in part. The order of 15 November 2007 was set aside and replaced. HMRC’s appeal was dismissed. The trustees’ cross-appeal was allowed in relation to the fixed fees paid to the non-executive trustees and otherwise dismissed.
2. Under the general law, an expense is incurred for the benefit of the whole estate when its purpose is to benefit both income beneficiaries and those entitled to capital when the income interests determine. Such an expense must be charged to capital. Only an expense incurred exclusively for the benefit of income beneficiaries may be charged to income. This was the effect of In re Bennett, Jones v Bennett [1896] 1 Ch 778 and Carver v Duncan [1985] 1 AC 1082, and the Special Commissioners erred by treating fairness as permitting a different approach.
3. Apportionment is permissible where an identifiable part of a single expense relates exclusively to income. Apportionment is not precluded because the fee is fixed. The executive trustee’s time-based fee could therefore be apportioned, and the fixed non-executive trustees’ fees could also be apportioned in principle.
4. Investment management expenses incurred after the trustees decided to accumulate income were not incurred exclusively for income beneficiaries. They had to be charged against the capital of the accumulated funds. Expenses incurred before that decision for temporary investment while deciding whether to distribute or accumulate could be charged to income to the extent that the income was ultimately distributed.
5. The trustees bore the evidential burden of showing what work was exclusively for the benefit of income beneficiaries and the relevant proportion. A realistic estimate could be made despite the absence of time records.

• Court of Appeal (Civil Division): [2008] EWCA Civ 1441 allowed the trustees’ appeal in part, dismissed HMRC’s appeal, and allowed the trustees’ cross-appeal concerning the fixed fees of the non-executive trustees.
• High Court, Chancery Division: [2007] EWHC 2661 (Ch) allowed HMRC’s appeal on the attribution of expenses, dismissed its appeal on accruals allocation, and dismissed the trustees’ cross-appeal.
• Special Commissioners of Income Tax: [2007] UKSPC SPC00595 held that proportions of most expenses, excluding investment management fees and the fixed non-executive trustees’ fees, could be attributed to income.