The decision of Mann J. in Barclays Wealth Trustees (Jersey) Ltd and Michael Dreelan v HMRC [2015]EWHC2878 (Ch) answers an important question regarding what is excluded property for purposes of the Inheritance Tax Act 1984 s.48(3). This provides that foreign situs property which is settled property is excluded property for IHT purposes unless the settlor was domiciled in the U.K. at the time the settlement was made. Suppose a settlement was made when the settlor was domiciled outside the U.K, he subsequently becomes domiciled in the U.K and then adds foreign property to the settlement. Is the added property excluded property? HMRC have always contended that it is not. It has been argued in leading textbooks that it is. Mann J. has decided that HMRC are right.
The Facts
The taxpayer had settled funds on a trust in Jersey (S1) at a time when he was not domiciled in the U.K. The trust property, which was foreign property, was consequently excluded property. After the taxpayer had become domiciled in the U.K some of the trust property was transferred to another trust settled by the taxpayer (S2). The effect of IHTA s.82 was that this property ceased to be excluded property since it was now comprised in a settlement made a settlor domiciled in the U.K. The property was subsequently transferred back to S1 in which it was comprised when the ten yearly charge to IHT arose in respect of S1.
The Issue
The taxpayer contended that, since the property was comprised in a settlement made when he was not domiciled in the U.K, it was excluded property because the words “at the time the settlement was made” in s.48(3) should be taken to refer to the time when S1 was originally made rather than the time when the property was transferred back to S1. HMRC contended that in relation to the property the settlement should be treated as made on the occasion when the property became held on the trusts of S1 following the transfer back from S2.
The Decision
The judge held that the contention of HMRC should be upheld. If the taxpayer’s contention were correct, this would mean that, once a non-domiciled taxpayer had created a settlement containing excluded property, he would able, after having become domiciled in the U.K, to add foreign property to the settlement which would be excluded property. This would be a strange result since, if such a taxpayer were instead to create a new settlement of foreign property, such property would not be excluded property. There was no logic in permitting a domiciled settlor to add property to an existing settlement which would have the status of excluded property simply because he had not been so domiciled when he originally made the settlement. It was most unlikely that Parliament intended to permit that. It was not a distortion of language to construe the words “at the time the settlement was made” in s.48(3) as referring to the time when the disposition was made whereby the property became held on the trusts of S1. The word “made” itself focussed on the act of disposition rather than just the end result. Moreover, result contended for by the taxpayer would be anomalous having regard to s.44(2) which provides that, where there is more than one settlor, the Act has effect as if there separate settlements made by each of them. Accordingly, if the taxpayer were correct, property added by him to an existing settlement when he was domiciled in the U.K could be excluded property while property added by a domiciled third party could not.
The judge rejected a contention of the taxpayer that the effect of s.81, which provides that for the purposes of Chapter III of Part III of the Act property which moves from one settlement to another should be treated as remaining comprised in the first settlement, was that the property should be regarded as having been comprised in S1, and consequently excluded property, throughout. He pointed out that the definition of excluded property in s.48(3) was not in Chapter III so that the deeming provision in s.81 did not apply to it.
The Implications
Assuming that the decision is not subject to a successful appeal, the view of HMRC that a U.K domiciled settlor cannot add foreign property with the status of excluded property to a settlement made by him when he was not U.K domiciled has been confirmed. This is no longer a safe option if it ever was. What about the converse case of the U.K domiciled settlor who makes a settlement and, after subsequently acquiring a foreign domicile, adds foreign property to it? Following the logic of this decision, the added property should be excluded property. However, logic should give way to prudence and the settlor should play safe by making a new settlement of the foreign property rather than adding it to an existing one.