ANNEX 1:: MINOR CHANGES IN THE LAW MADE BY THE BILL This change has no implications for the amount of tax due, who pays it or when. It affects (in principle and in practice) only administrative matters. Change 91: Settlements: trustees’ expenses reducing beneficiary’s income: sections 500, 503 and Schedule 1 (section 646A of ITTOIA)
This change makes explicit some of the rules about the way expenses incurred by trustees in connection with income to which a beneficiary is entitled reduce the amount of the beneficiary’s income for tax purposes.
There are only two provisions in ICTA that concern the tax treatment of expenses in relation to income to which a beneficiary is entitled before it is distributed (where the beneficiary is regarded as having an interest in possession). These are:
	section 689A, which deals with the disregard of some expenses in the case of a non-resident beneficiary; and
	section 689B, which concerns the order in which expenses reduce the beneficiary’s income.
While there are additional provisions in section 686(2AA) of ICTA that give some rules on the treatment of trustees’ expenses in relation to accumulation or discretionary income, there is no corresponding provision for interest in possession trusts. The practices that have become established and which are reflected in these sections are based on the principle that the income of a beneficiary is the income arising to the trustees so far as the beneficiary is entitled to it.
There are two ways in which this principle operates.
First, if the trustees’ expenses are chargeable to income under a provision of the settlement, then irrespective of whether they would be so chargeable in the absence of that provision, the expenses are to be taken into account. This is subject to the existence of any law that in a particular case (for example by way of a court order) overrides the provision in the trust deed.
This is different from the rule that operates in relation to accumulated or discretionary income where the terms of the settlement are to be ignored, and from what it appears that section 689A of ICTA provides for in this context.
If the deed is silent on whether a particular expense is chargeable to income then the expense is taken into account if it would be chargeable to income under general trust law.
These rules are reflected in section 500. They mean that an expense is allowable if it is chargeable to income under the trust deed, even if it would be chargeable to capital under general trust law. Conversely, in cases where general trust law would require an expense to be charged to income, but the trust deed charges it to capital, then the change means that the expense is not allowable.
The second area concerns how trustees’ expenses are taken into account in such cases.
The expenses do not affect the amount of income on which the trustees are chargeable to tax, but operate to reduce the amount of the beneficiary’s income. It is not that the beneficiary gets relief for the expenses as such; it is simply that the beneficiary is not entitled to the income used to pay the expenses. So, the beneficiary’s income (as reduced by allowable expenses) is grossed up at the normal rate appropriate to that income to arrive at the gross amount which is to be treated as part of the beneficiary’s total income.
This is not set out in the source legislation but, based on the decision in CIR v Lord Hamilton of Dalzell (1926), 10 TC 406 CS, it is the accepted way that expenses are taken into account. Section 503 reflects this.
This change also provides rules about cases where the trustees’ expenses exceed a beneficiary’s income. Section 500(1) applies in relation to the tax year in which the beneficiary’s entitlement to income is reduced, whether the expense was incurred in that tax year or an earlier tax year. The reference to an earlier tax year means that the section covers cases where the trustees’ expenses in an earlier tax year exceed the income in that earlier year and so the trustees are carrying forward the excess.