Do you want to access the full text of articles?

Please see our digital edition archive for the full text of articles.

Alternatively:

If you are a Chartered Accountants Ireland member, please visit the RIS service where Accountancy Ireland is available free of charge via the EBSCO databases.

If you are an Accountancy Ireland subscriber (i.e. you pay each year to receive your copy of Accountancy Ireland) please contact our Subscriptions Department quoting your subscription number and include details of the article you want.

All other users should enquire from their local public or college library about accessing full text Accountancy Ireland articles.

Home / 2007 / June 2007 / Capital Gains Tax and Trusts

When dealing with trusts it is important to be aware of when a charge to capital gains tax arises. Trustees have a charge to capital gains tax when they make a disposal during the course of the administration of a trust or when there is an appointment from a trust to a beneficiary. This might seem obvious but what about the case where assets are held in trust for a minor until they reach a certain age or the termination of a limited interest?

The capital gains tax provisions deal with two types of trust: -Bare trusts; and -Settlements.

In the case of both bare trusts and settlements, there is no charge to capital gains tax when there is a change in trustees. The trustees are deemed to be a continuing body of persons.

Bare Trusts

Bare trusts or simple trusts are dealt with in S 567 TCA 1997. A bare trust arises where property is held merely as nominee for another person: essentially that other person owns the asset and will be taxed as such (except in certain circumstances involving minors).

Example 1: John buys a property as nominee for Mary. John is the nominee or trustee and Mary is the beneficiary. A reason for such a structure might be that Mary does not want her name appearing on the title but she is essentially the purchaser and owner of the property. For tax purposes, the trust is looked through and on the disposal of the property by John as nominee for Mary, it is Mary that is liable for the capital gains tax. Her annual exemption and any losses available to her can be used.

Settlements

Assets that are put into settlements are known as “settled property”. Essentially, settlements for capital gains tax purposes are trusts that are not bare trusts. The charge to capital gains tax in respect of settlements is set out in Ss 574 to 578 TCA 1997.

Reliefs that are available to individuals, such as the annual exemption, cannot, in general, be claimed by the trustees of settlements. However, it is possible for trustees to claim retirement relief (Ss 598 and 599 TCA 1997) and principal private residence relief (S 604 TCA 1997) if the conditions set out in the relevant sections of the legislation are satisfied.

Transfer of Assets into Settlement There is no charge to capital gains tax on death where a settlement is created by will. However, if a settlement is created during a settlor’s lifetime, a charge to capital gains tax will arise.

S 575 states that a transfer of assets into a trust, during a settlor’s lifetime is a disposal for capital gains tax purposes. As the settlor and the trustees are connected persons for capital gains tax purposes, market value is imposed. It is that market value that will be the base cost for future disposals.

On a transfer of an asset into settlement, a charge to capital gains tax arises even though:

-the transfer is revocable; and/or -the donor retains an interest in the settlement for himself; and/or -the donor is a trustee.

Example 2: John transfers a property to himself for life and thereafter to his wife, Mary. This is a disposal into settlement and the property will be subject to capital gains tax on the disposal. This is the case even though John is both the settlor and the life tenant.

Similarly, there would also be a charge to capital gains tax if John transferred a property to his wife Mary for her life and thereafter to their daughter Joanne. The spousal exemption would not apply because it is a disposal to a settlement and not to a spouse.

Due to the connected parties rule, if a loss is suffered on the transfer of assets into settlement, the loss will be restricted: the settlor can only set it against future gains arising from dealings with the trustees of the settlement.

Of course there is no capital gains tax (or stamp duty) on the transfer of cash. Therefore, cash can be transferred into a settlement, without triggering a capital gains tax charge, and used to invest in assets for the beneficiaries.

Where a Beneficiary becomes Absolutely Entitled as against the Trustees S 576 provides that when a person becomes absolutely entitled to settled property as against the trustee, the assets to which that person becomes entitled shall be deemed to have been disposed of by the trustee and immediately reacquired by the trustee in his capacity as a bare trustee for market value.

‘Absolutely entitled as against the trustee’ essentially means that the beneficiary is now entitled to the enjoyment of that asset. It is not necessary that the trustee has actually transferred it into the beneficiary’s name.

Example 3: John in his will left some land to be held on trust for his daughter Joanne until her 24th birthday.

On Joanne’s 24th birthday, she will be absolutely entitled to the settled property as against the trustees. This is a deemed disposal by the trustees and an occasion for a charge to capital gains tax. On this date, the property ceases to be settled property and the trustees can either pass the land to the beneficiary or retain it as bare trustees.

Capital gains tax is payable by the trustees on the increase in value of the land from the date it was acquired by the trustees to the date the beneficiary became absolutely entitled to it, i.e. the difference between the market values at the date of death and the date of Joanne’s 24th birthday.

The charge to capital gains tax on the trustees set out in S 576 also appears to apply in the case of a disposal of a limited interest in certain circumstances: where a life tenant makes a gift of his life interest to a remainder person or a remainder person makes a gift of his remainder interest to a life tenant.

In both situations, the interests merge and the beneficiary, on a strict reading of the legislation, is absolutely entitled as against the trustees to settled property. There is, therefore, a deemed disposal andreacquisition of the entire trust property by the trustees.

In my view, this treatment is unfair given that all that was disposed of was a limited interest. There is also an issue with the fact that in some settlements (Settled Land Act settlements), the “trustees” to not hold the legal interest in the settled property.

Example 4: John died and left some land to be held on trust for his wife Mary for her life and thereafter to their daughter Joanne.

Mary did not need the land and wanted to transfer her life interest to Joanne. Joanne on receipt of the life interest is now absolutely entitled to settled property as against the trustees. This would appear to be treated as a deemed disposal of the land by the trustees and an occasion for a charge to capital gains tax.

On the Death of a Life Tenant S 577 gives an exemption from capital gains tax where a beneficiary becomes absolutely entitled to settled property as against the trustees. This exemption applies where the beneficiary becomes absolutely entitled on the death of a life tenant. The exemption provides that the trustees have no charge to capital gains tax on such an event. In addition, the base cost for a future disposal of that asset by the beneficiary will be the market value at the date the beneficiary became absolutely entitled to it.

Example 5: John settled shares on his wife, Mary, for her life with remainder to their daughter Joanne.

On Mary’s death, Joanne becomes absolutely entitled to the shares as against the trustees and the sharescease to be settled property. There is no charge to capital gains tax as it is on the death of the life tenant. If Joanne sells those shares at a future date, the base cost will be the market value on the date she acquired them i.e. the date of Mary’s death.There may be some scope for planning using this provision in the case of discretionary settlements.

There is some case law on the subject in the UK but the issue has not been decided in Ireland. The appointment of settled property to a person for life with remainder to another, on the death of the life tenant, should enable the trust assets to come out of the trust without giving rise to a liability to capital gains tax. It is arguable that the life interest is not a disposal because the life tenant did not become absolutely entitled to the settled property and on the life tenant’s death, no capital gains tax should arise. If planning such an appointment, it is important to seek legal advice to ensure that the appointment is properly drafted.

Contrary to the above relief, on the death of a life interest where the property continues to be settled property there is a charge to capital gains tax. This is the case even though no person is absolutely entitled as against the trustees. The trustees are deemed to make a disposal and immediately re-acquire the property for market value (S 577 TCA 1997).

Example 6: John settled shares on his wife Mary for her life, then for his daughter Joanne for her life, remainder to his granddaughter Sarah. When Mary dies, the shares remain settled property as Joanne takes a further life interest. The trustees will be deemed to make a disposal of the shares at their full market value on Mary’s death.

CAT/CGT Set Off

You will find that in certain settlements there are no named trustees. In addition, where you have a minor child who is a beneficiary, often the trust will have been dealt with in a very informal manner. The trustees may not realise that there is some tax planning that can be put in place. When a transaction eventually happens, it can come as a surprise that there is a charge to capital gains tax in addition to other tax charges.

If the trustees of a settlement do have a capital gains tax liability, the beneficiary may be held accountable if it is not paid by the trustees within six months. The Revenue Commissioners can seek payment from the beneficiary within two years.

In many situations, there is only one asset in the trust and, on a beneficiary becoming absolutely entitled as against the trustees to that asset, the trustees will not have any funds to pay the capital gains tax.

This can cause a serious problem for the beneficiary in trying to fund the payment of the tax. In addition to the capital gains tax liability, there will probably also be a charge to capital acquisitions tax and ossibly even discretionary trust tax charges.

There is a relief in S 104 CATCA 2003 which allows a credit for capital gains tax against capital acquisitions tax where they occur on the same event. This relief was restricted in the 2006 Finance Act: the relief is clawed back if the beneficiary disposes of the asset within two years of acquiring it.

So, if the beneficiary sells the land to pay the tax, he will have a double charge to tax that would not have arisen had he not sold it. This is a situation that was certainly not intended in the 2006 amendments. (Depending on the circumstances, there may be means available of deferring the disposal date and part funding the capital ains tax.)

Example 7: If we look again at Example 3 above: land is held on trust for Joanne ntil her 24th birthday. On that date, Joanne will be beneficially entitled to the land as against the trustees and a charge to capital gains tax arises.

On the same date, Joanne will have a charge to capital acquisitions tax as she will be beneficially entitled to the land. Due to the relief in S 104 CATCA 2003, the capital gains tax is payable first in priority. The capital acquisitions tax is only payable to the extent that it exceeds the capital gains tax.

Joanne does not have any cash to pay the capital gains tax so she has to sell some of the land. She will not get the relief in S 104 on the portion she sells and will have a double charge to tax: capital gains tax and capital acquisitions tax.

On a strict reading of S 576 TCA 1997, the capital gains tax should at least be allowable as a deduction in computing the capital acquisitions tax, as there is a deemed disposal and reacquisition by the trustees. However, the wording in S 104 CATCA 2003 would appear to deny it: S 104 states that the “capital gains tax, if any, chargeable on the disposal is not deducted in ascertaining the taxable value”.

Conclusion

As can be seen from the above, there are many occasions in dealing with trust property where a charge to capital gains tax arises. A harge to capital gains tax can make an unavoidable appointment of assets from a trust very expensive. This is particularly true today with the recent spiralling of the price of property.

As such, it is increasingly important to be aware of any planning opportunities that can be employed to reduce the exposure to capital gains tax. The availability of reliefs such as retirement relief, principal private residence relief and the CAT/CGT set-off should also be examined in detail. The use of reliefs and properly timed planning are essential as they can ensure that the benefit of the trust is not lost by reason of a capital gains tax liability.

A loss can only be set off against other chargeable gains. However, there is a restriction in the case of development land. Losses can be carried forward to future years of assessment. They cannot be set off against previous gains unless they occur in the year of death.

If a plot of land is sold at a capital loss , can this capital loss be offset against any other tax liabilities in the Republic of Ireland taking into account that there will be no present or future capital gains arising in the business