HM Revenue & Customs v Trustees of the Peter Clay Discretionary Trust

An additional rate of income tax is payable upon certain income arising to trustees of discretionary trusts but statutory provision is made such that in computing the amount of the income so liable such of the expenses of the trustees as are properly chargeable to income may, in effect, be deducted. It can thus behove trustees to claim that their expenses are regarded as income expenses whilst, conversely, it suits HM Revenue and Customs (“the Revenue”) to see them as outgoings of a capital nature.

On 27^th February 2007 the Special Commissioners had before them (for a decision in principle rather than one leading to a holding in a particular sum) a case between the Trustees of the Peter Clay Discretionary Trust (“the Trustees”) and the Revenue. The Commissioners held that whilst part of the Trustees’ expenses in issue – investment management fees – were capital expenses not chargeable to income, some unspecified proportions of the Trustees’ other expenses in the year ended 5^th April 2001 were properly chargeable to income, hence pro tanto reducing the amount of tax payable by the Trustees. The Special Commissioners adjourned to enable the parties to endeavour to agree the appropriate proportions. However, on 24^th April 2007 the Revenue (appearing both before the Special Commissioners and before me by Mr Baldry) lodged an Appellant’s Notice; in deciding as they had, the Special Commissioners, said the Revenue, had erred in law in two main respects; one, as I shall explain, was said to be an error of principle and one more a question of timing.

The Trustees (appearing both here and below by Mr McCall QC) resist the appeal in both its aspects and raise a cross-appeal. These appeals, under section 56A of the Taxes Management Act 1970, raise questions as to the attribution to capital and to income respectively of trustees’ expenses under the general trust law and questions also as to the interaction between that attribution under the general law and the particular statutory provisions as to income tax which regulate the area. It is to those statutory provisions that I first need to turn.

The Finance Act 1973 section 16 introduced a “charge to additional rate of certain income of discretionary trusts”. By the time of the relevant year of assessment the material provisions had become those of section 686 of the Income and Corporation Taxes Act 1988 which applies to certain income arising to trustees so far as it is “income which is to be accumulated or which is payable at the discretion of the trustees or any other person….” – section 686(2)(a). Such income is chargeable to income tax at the higher Schedule F trust rate (applicable to dividend income) or at the rate applicable to trusts. However, deduction therefrom is possible under section 686(2AA), which is the critical provision in the main part of the Revenue’s appeal. It provides as follows:

“The rate at which income tax is chargeable on so much of any income arising to trustees in any year of assessment as—

(a)

is income to which this section applies, and

(b)

is treated in accordance with section 689B as applied in defraying the expenses of the trustees in that year which are properly chargeable to income (or would be so chargeable but for any express provisions of the trust),

shall be the rate at which it would be chargeable on that income apart from this section, instead of the rate applicable to trusts or the Schedule F trust rate (as the case may be)…."

It is not at this point necessary to set out section 689B.

Apart from the timing issue, which I shall come on to and which is concerned with differences between the point at which an expense is incurred on the one hand or defrayed on the other, the chief question before the Special Commissioners was how far the Trustees’ expenses were “properly chargeable to income” within section 686(2AA) and how far to capital?

The Peter Clay Discretionary Trust was settled by Peter Robert Clay on 5^th December 1995. It is a broad discretionary trust under which almost all of the income is customarily accumulated. There are two “non-executive” Trustees in respect of whom only limited fees are claimed for time spent by them preparing for and attending Trustees’ meetings. There is a family trust company (which does not charge) and an “executive” Trustee, Mr Ralph Stockwell, a former senior partner of Messrs Rawlinson & Hunter, accountants to the Trustees. He is engaged in managing this trust and other Clay family trusts. There are no beneficiaries with any prescribed or present entitlement to income but the Trustees have wide discretionary powers over both capital and income and, in particular, have power to pay or apply current income to a class of “Beneficiaries”, power to accumulate income and power to apply the accumulated income as if it was income arising in a current year.

The trust has an income of the order of seven figures but it was agreed below and remains the case that the precise amount of the income and of the capital of the trust fund is irrelevant. Mr Stockwell in the year in question was remunerated for his service to the trust as a partner in Rawlinson & Hunter; he divides up the cost of his time as between the various Clay trusts in respect of which he acts according to his best estimate of the amounts of time spent in dealing with each. Mr Stockwell’s rôle was held by the Special Commissioners to be very active. As for investment management, written agreements with investment managers were produced to the Special Commissioners and the remuneration of each was based on a fee calculated by reference to capital value. The Special Commissioners, Mr Adrian Shipwright and Dr John F. Avery Jones CBE, received evidence from Mr Stockwell and from Mr Kevin Custis, a director of Rathbone Trust Company Limited, an expert on the practice of trustees generally in relation to the attribution of expenses between capital and income and on practices in relation to very large and actively managed trusts.

In the year ended 5^th April 2001 the Trustees incurred the following relevant expenses or outlays :

Leaving aside bare trusts, trusts usually, perhaps invariably, create successive interests so that there is inevitably, says Mr McCall QC, on behalf of the Trustees, a possible conflict in all trusts between the interests of those who are in possession and those who are for the time being in remainder. Thus at a simple level a question might arise whether work to be done to settled landed property is a repair such that its cost should be paid out of income and thus at the expense of the life tenant or is, instead, an improvement which might benefit the estate as a whole and hence in fairness ought to be paid, at least in part, out of capital. In a more complicated case, if an estate includes an income-yielding wasting asset, one not specifically devised, would it not be unfair to keep it, thus benefiting only those interested in income, but be better to sell the same before it wasted further so that those interested in remainder might also derive benefit from it? In such a case, under the Court’s long-established practice, a sale would be likely to be directed “to give everyone an equal chance” – Howe v Lord Dartmouth (1802) 7 Ves Jun 137 at 148-149. One might take as another example of the need for balance between conflicting interests a trust where its property included a valuable reversion which the trustees could have sold but which, instead, they had retained for some 19 years during which the life tenant derived nothing from its value. When it eventually fell into possession as a capital sum, ought not some compensation thereout to be payable to the tenant for life to reflect the years during which he had derived nothing from it? The task, said Sir John Romilly MR, was to devise a “fair mode of dealing with the case” as between tenant for life and remainderman – Wilkinson v Duncan (1857) 23 Beav 469 at 472; 53 ER 184 at 185-6. A complicated apportionment ensued - see also in Re Earl of Chesterfield’s Trusts (1883) 24 Ch Div 643 where it had been urged in the successful argument that the power to postpone conversion was a power not to be exercised for the benefit of the tenants for life as against the remaindermen, or for the benefit of the remaindermen as against the tenants for life, but for the benefit of the estate “without disarranging the equities between the successive takers”. Again, a complicated division was required between the interests of capital and income. As yet another example, where a trust consisted of an aggregate made up of one solvent landed estate and another which was subject to mortgages created by its prior owner and was out of repair, the Court decided it would sanction repairs only in such a way as did not throw the burden entirely upon either the tenant for life or the remainderman. The division between those interested in income and those interested in capital was to be “done in a mode which is equitable as between the tenant for life and the remainderman, and not so as to throw the whole burden upon either” – per Lindley LJ in Re Hotchkys, Freke v Calmady (1886) 32 Ch Div 408 at 420 and Cotton LJ at page 418.

A study of cases of such a kind, said Mr McCall, showed that, in allocating as between capital and income and in the absence of some specific provision to the contrary, trustees were under the general law always and unsurprisingly to be guided by what was, in all the circumstances, fair. He drew attention to Underhill & Hayton, Law Relating to Trusts and Trustees 17^th edition at paragraph 51.1 where the authors, in the beginning of a passage, said:

"Subject to particular statutes a trustee has a general discretion to allocate outgoings out of income or capital as he sees 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 beneficiaries and capital beneficiaries…”

Mr McCall also referred me to Lloyds Bank plc v Duker & Others [1987] 1 WLR 1324 per Mr John Mowbray QC sitting as a Deputy High Court Judge in which, at page 1330, the learned Deputy Judge, also distinguished as an editor of Lewin on Trusts, said that he could get some assistance from “the principle that trustees are bound to hold an even hand amongst their beneficiaries and not favour one against the other, stated for instance in Snell’s Principles of Equity 28^th edition page 225” – see also para 27-08 in the current 31^st edition of Snell. Of course, accepted Mr McCall, there would be instances where the “even hand” had led to a particular outgoing being treated properly as wholly out of income or wholly out of capital. In Re Bennett [1896] 1 Ch 778, which I shall need to deal with in more detail, was, he said, an example of a case where, on the facts, it was not inappropriate and was fair that the whole cost – there of an audit of the business a loan to which was the trust’s main asset - should be paid for out of capital. But, said Mr McCall, there was nothing in Bennett to suggest that the case laid down a general rule or that earlier cases as to equity and fairness were to be overborne, nor was Hotchkys supra cited to the Court of Appeal in Bennett.

In Bennett the trustee held as a chief remaining asset of an estate an unsecured loan to a firm of wine merchants. The loan was repayable by capital instalments over some 10 years with interest payable on the reducing balance in the meantime. Amongst a number of other conditions applicable to the loan were conditions intended to ensure that the trustee could investigate into and establish the borrowers’ financial soundness (or otherwise) and their continuing ability to repay, inter alia, the loan. If the business was conducted at a loss or the interest was in arrear then the trustee would be entitled immediately to demand and recover the whole of the remaining capital of the loan. In order to ascertain, inter alia, whether the principal monies remaining owing had become immediately payable, the trustee considered it necessary that an independent audit of the books and stocktaking of the wine merchants’ business should be periodically made. One such audit, the first, had taken place at the expense of £213. But the trustee was in doubt as to how that expense should be borne and sought directions from the Court.

At first instance, the Vice Chancellor of the Duchy of Lancaster held that the first audit, the only one by then undertaken, should be paid out of capital but that the expense of future audits should be paid out of income. There was no appeal against the decision that the first audit should be paid for out of capital; so far as concerned the expenses of audits it was thus only future audits that were in issue. The trustee, it seems, made no proposal for how the cost of future audits should be borne, leaving the argument wholly to a contest between the tenant for life and the reversioners. Down to the date of the appeal the wine merchants had duly paid off some capital and all current interest. At page 783 the report includes Mr Cozens-Hardy QC’s argument for the tenant for life in reply as follows:

“These expenses really come under the head of costs, charges and expenses properly incurred by the trustees for the benefit of the estate, and, therefore, like all other costs, charges and expenses of trustees, are payable out of capital. The opposite view would be very hard on the tenant for life, for the interest she receives will diminish as the debt is paid off, while the costs of the audits and stock-takings will not.”

It is hard to see why the interest which the tenant for life would receive would diminish as the debt was paid off unless, which does not appear, the capital that was repaid, instalment by instalment, was re-invested at less than the 5% per annum which was payable on the wine merchants’ debt. It was, however, Mr Cozens-Hardy’s argument which succeeded; at page 784 Lindley LJ says:

“I think the suggestion made by Mr. Cozens-Hardy was the true one - namely, that an expense of this kind is part of the costs, charges and expenses properly incurred by the executor and trustee in the performance of his duty. Why is this expense to be thrown upon the tenant for life? For whose benefit is it incurred? It is really for the benefit of the whole estate, though the practical effect of throwing it upon the whole estate will be that the tenant for life will lose the income of the sums expended.”

Lindley LJ (in a passage to which I shall later refer) continued:

“It has been suggested that such expenses are like annual outgoings. I do not think they are. By an "outgoing" is generally meant some payment which must be made in order to secure the income of the property.”

Lindley LJ held that there should be no distinction drawn between the expenses of the first stocktaking and the future stocktakings, thereby, as it seems to me, negating a distinction which Mr McCall wished to draw between a case in which only future outlay was in issue and a case which concerned both present and future. Kay LJ held it to be “a fair way of dealing with the case” that the expense should be paid wholly out of capital. A.L. Smith LJ held that, as the expense was incurred “for the benefit of the whole estate”, it “therefore ought to come out of the capital and not out of income”. By his use of the word “therefore” he emphasised more than had Lindley or Kay LJJ, the causal connection whereby an expense being incurred for the benefit of the whole estate led to that expense being taken to be a capital one. The payment, he held, was one which was for the benefit of the tenant for life as well as of the remainderman.

Two at least of the Lord Justices had applied a form of “cui bono” test; where the answer was that the expense was incurred for the benefit of the whole estate then it was right that the whole estate – the capital – should bear the burden. As I have mentioned, Mr McCall argues that, despite all the width of its language, Bennett laid down no inescapable rule that where a trustee’s expense was incurred for the benefit of the whole estate then its expense was to be borne by capital. Mr McCall is entitled to point out that not only was no relevant authority cited in Bennett but that no authority at all was cited in it, let alone authority that was said to be overruled. Hotchkys supra was unmentioned. The argument had proceeded on the basis of a questionable hardship upon the tenant for life and the case was, it seems, argued on an all or nothing basis, the trustee having made no suggestion of an apportionment such as would pass part of the expense to income, part to capital. It is tempting to wonder how adamant the Court would have been had, for example, £50 been suggested by the trustees as to be taken from income with the rest out of capital.

Putting Bennett aside, practice in Chancery, said Mr McCall, was not to adopt, with respect to trustees’ remuneration, the all or nothing approach of Bennett but rather, as could be seen in Re Duke of Norfolk’s Settlement Trusts [1979] 1 Ch 37 at 62, to see that particular kind of outlay as chargeable at least in part to income in appropriate circumstances. In that case Walton J. at page 62, speaking of trustees’ remuneration, said, à propos the Court’s inherent jurisdiction to award trustees’ remuneration where otherwise none was authorised, that:

“…it appears to me that any remuneration allowed ought to come out of income, if it be remuneration for running the affairs of the trust pure and simple - general remuneration. This, I have been informed by Chief Master Ball, was the invariable practice in those cases decided by the former Chancery judges whom he has served, and it accords with my own impressions. This would seem only logical. But in those cases such as the present where the special services rendered by the trustees have been, in substance, the development of the capital assets of their trust, it would be appropriate that any special remuneration should be paid out of capital.”

Mr McCall, when appearing for the Trustees before the Special Commissioners, pointed also to the provisions of section 22(4) of the Trustee Act 1925 as an illustration that even if a trustee’s expense could fairly be said to be for the benefit of the whole estate it did not follow from that that it was in its totality to be borne by income. Section 22(4) provides:

“Trustees may, in their absolute discretion, from time to time, but not more than once in every three years unless the nature of the trust or any special dealings with the trust property make a more frequent exercise of the right reasonable, cause the accounts of the trust property to be examined or audited by an independent accountant, and shall, for that purpose, produce such vouchers and give such information to him as he may require; and the costs of such examination or audit, including the fee of the auditor, shall be paid out of the capital or income of the trust property, or partly in one way and partly in the other as the trustees, in their absolute discretion, think fit, but, in default of any direction by the trustees to the contrary in any special case, costs attributable to capital shall be borne by capital and those attributable to income by income.”

Mr McCall had argued before the Special Commissioners that section 22(4), coupled with the authorities as to fairness and apportionment as between capital and income, illustrated that, within the general law, there is no invariable rule, merely because a trustee’s outgoing has the character that it tends to the benefit of the whole estate, that, without more, the whole of its cost is to be borne by capital and without the trustees having any ability to apportion and then to attribute part to capital and part to income. Given that a tenant for life of a Settled Land Act settlement is trustee both of the relevant settled land and of his powers, attention could be drawn, as an example of a trustee’s outlay for the benefit of the whole estate being chargeable to income, to section 88 of the Settled Land Act 1925 whereunder the tenant for life is bound to insure against fire at his own expense even though the proceeds of the policy would be capital money – see also Trustee Act 1925 section 20, to which I shall later refer.

The Trustees’ argument proved attractive to the Special Commissioners who, in their paragraph 17, said

“We consider 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. We therefore prefer the approach that one should attribute unless the expense really is a capital expense where the interest of the income beneficiary is merely the consequential loss of income on the capital that goes to pay the expense.”

It was such a view that led the Special Commissioners to their conclusion that there was a requirement to achieve a fair balance between income and capital beneficiaries and that, in accordance with that, a proportion of all the expenses in issue, with the exception of the investment management fees, should be attributable to income and hence should be properly chargeable to income for the purposes of section 686(2AA), thereby pro tanto reducing the amount susceptible to the higher rate of tax. All the investment management fees, they held, were chargeable to capital.

It is worth noting that, leaving aside in Re Duke of Norfolk’s Settlement Trusts, none of the cases I have cited deals with the proper treatment of trustees’ remuneration, none deals with statutory provision, and all, including the Norfolk case, dealt with matters that were internal to the trust concerned, concerning no others than the relevant trustees and their beneficiaries. By contrast, I am 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 does not follow, even if fairness still has a role to play where statutory provision is concerned, that what is open to trustees to do as being fair between themselves and their beneficiaries is open to them to do when a third party is involved.

Furthermore, I have so far left out of account the most authoritative case in the area. In Carver (more fullyBosanquet v Allen (Inspector of Taxes) and Carver v Duncan (Inspector of Taxes) [1985] 1 AC 1082) the Commissioners and Courts involvedconsidered the chargeability for the purposes of section 16(2) of the Finance Act 1973 of various classes of trustees’ expenditure. It is accepted before me, as to section 16(2)(d) of the 1973 Act, that it can be taken for all present purposes to be an indistinguishable forebear of the section 686(2AA)(b) which I am considering. The reports in Carver cover two trusts and the trust expenses involved varied from one trust to another but included assurance policies (of an investment character, having no surrender value and payable on the death of the settlor) which had been kept up out of and charged to income in the trustees’ accounts, other endowment life policies kept up out of income and, as is the more relevant to this decision, investment management fees.

Vinelott J at first instance had held that the outgoings were properly to be apportioned between that part chargeable to capital and that to income and remitted the matter to the Special Commissioners to make appropriate assessments. On the appeal the judgment of Oliver LJ in the Court of Appeal illustrates the immense difficulties of construction which the legislation gave rise to; there were difficulties – see page 1092 – with either the trustees’ or the Revenue’s competing constructions. He spoke of the legislature having evolved a delphic pronouncement – page 1094 – and of the section being very ineptly drawn – page 1097. But he held that for the purposes of the legislation the Court was obliged to look beyond whether an outgoing was in fact paid or initially paid out of income or out of capital – page 1097f – and beyond also (where the trustees had a discretion to apportion) looking at whether the trustees had treated the outgoing in their books as out of income or out of capital (as that – page 1095d – would lead to different tax consequences in otherwise identical discretionary trusts). Instead the Court had to fix the character of each outgoing by reference to the general law of trusts – page 1097, disregarding express provisions of the trust instruments concerned.

When he turned to the character, under the general law, of one of the various outgoings in issue– page 1098g – it appeared to Oliver LJ, with my emphasis:-

“, and indeed Mr. Walker [Mr Robert Walker QC, as he then was, Leading Counsel for the trustees in the second of the two cases] did not really argue to the contrary, that the payment of the fees of the investment advisers, which were incurred for the benefit of the fund as a whole, would be properly chargeable to capital and would not … be deductible: see In re Bennett [1896] 1 Ch 778.”

That passage does not in terms lay down that it was because the fees of the investment advisers were incurred for the benefit of the fund as a whole that they were chargeable to capital but it is, at the very lowest, consistent with that being so and with Bennett being regarded as authority for such a view. Stott v Milne (1884) 25 Ch Div 710 could also be regarded as authority at least consistent with a view that where trustees’ expenses are incurred for the benefit of the estate as a whole they should be chargeable to capital. In that case the trustees’ expenses incurred by them in bringing in two actions were in issue. The Earl of Selborne LC at page 714 said:

“The actions were compromised before trial. That the result of the first action was beneficial to the estate is clear. Whether the estate was benefited by the second action is disputed, but I am disposed to think that it was. Looking at the whole circumstances, at the manifest bona fides of the trustees, and at the opinion of the Vice-Chancellor that the costs ought to be allowed, I am of opinion that the direction for payment of them out of the corpus must be sustained.”

Cotton and Lindley LJJ agreed.

When, in Carver, Oliver LJ came to look at the chargeability of various insurance or assurance premiums he again used, as had been the case in Bennett, a test of a cui bono kind. At page 1099 he said:

“Accepting, however, that it may not be possible to derive an entirely clear picture of universal treatment of premiums from reported decisions, there does not appear to me to be any real difficulty in principle. Obviously individual trusts will vary, but the universal answer is, I should have thought, that one has to look in each case at the person or group of persons for whose benefit the policy is in fact being maintained under the relevant trust. If on such an investigation it is perfectly plain that the policy is being maintained as an investment of capital and for the benefit of capital, then I should have thought that it must inevitably follow that the premiums paid by the trustees, in the absence of express direction in the trust, would be chargeable to capital and not to income.”

Purchas LJ, in agreeing with Oliver LJ, himself referred to the legislation as being somewhat obscure – page 1102c – but he, too, recognised that it was the general law governing the administration of trusts by which the allocation to capital or income was to be adjudged. Waller LJ agreed with Oliver LJ. The determination by the Special Commissioners that, inter alia, the investment management fees were not allowable deductions but were chargeable to capital was thus restored.

The trustees in both cases appealed, arguing, inter alia, that annual investment advisers’ fees were in any case expenses properly chargeable to income under the general law – page 1107h. Counsel for the Crown, though, argued – page 1112 - that the payment of fees to investment advisers, whilst properly to be described as expenses:

“are chargeable to capital under the general law; see in Re Bennett [1896] 1 Ch 778 which states a general principle and has stood unchallenged since the last century”.

In his reply Mr Robert Walker QC for the trustees specifically argued that Bennett supra had stated too wide a principle, drawing attention to many expenses, for instance, repairs, insurance and trustees’ ordinary remuneration, which were incurred for the benefit of the trust property as a whole but which were nonetheless, he said, chargeable to income – page 1113a-b.

The reasoning of the majority of the House of Lords in Carver, Lord Diplock having dissented on the construction of the material legislation, is wholly to be found in the speech of Lord Templeman, with whom Lord Fraser, Lord Roskill and Lord Brandon agreed. The decision of the Court of Appeal was affirmed. At page 1120 Lord Templeman says:

“Trustees are entitled to be indemnified out of the capital and income of their trust fund against all obligations incurred by the trustees in the due performance of their duties and the due exercise of their powers.”

So far the citation excites no controversy; indemnification of the Trustees is not in issue before me although, in relation to trustees’ remuneration (with which Carver was not directly concerned), the word “obligation” might be thought unfitting. The citation continues:

“The trustees must then debit each item of expenditure either against income or against capital. The general rule is that income must bear all ordinary outgoings of a recurrent nature, such as rates and taxes, and interest on charges and incumbrances. Capital must bear all costs, charges and expenses incurred for the benefit of the whole estate.”

It is not difficult to find instances where that “general rule” in the second sentence would be unclear in its applicability; “Rates, taxes, interest on charges and incumbrances” may have in common that they are all inescapable incidents of enjoyment of the trust property concerned and by referring to outgoings “such as” those it is unclear whether Lord Templeman was requiring that some such inescapable character was required of an outgoing if it was to be attributed to income. He may have been adopting a meaning of “outgoing” such as that referred to by Lindley LJ in Bennett in the passage which is cited in para 15. above but Lord Templeman does not say he was doing so and at that point in his speech he had not mentioned Bennett. The practical consequences of an application of Lindley LJ’s meaning are, I respectfully suggest, some way short of clear in the context of a modern trust fund of actively managed investments including, for example, works of art, commodity futures, hedge fund participation and advices taken with respect thereto. I am far from sure that Lindley LJ’s meaning could nowadays be taken to be a common one and it would be reasonable to expect Lord Templeman expressly to have said so if he was meaning to adopt something such as Lindley LJ’s description. He does not say so.

If, conversely, some such meaning was not intended, then it would not be difficult to find examples of outgoings of a recurrent nature which are incurred for the benefit of the whole estate, thereby in some circumstances putting the second sentence of the citation in conflict with the third. In his argument in reply in Carver, Mr Robert Walker QC, as I have mentioned, had pointed out that many expenses (he included trustees’ remuneration) are incurred for the benefit of the trust property as a whole but are nonetheless properly chargeable to income. Thus, for example, as for insurance against loss or damage by fire to a trust building (as to which trustees have a power but not, in general, an obligation), section 19 of the Trustee Act 1925 provided that the premiums may be paid “out of the income thereof or out of the income of any other property subject to the same trusts without obtaining the consent of any person who may be entitled wholly or partly to such income”. Moreover it does so in the context – section 20 – that the fruits of the policy would be for the benefit of the estate as a whole as capital money. I have referred above to section 22(4) of the Trustee Act and section 88 of the Settled Land Act 1925 as illustrating outlay incurred for the benefit of the whole estate being treated, independently of express trust provisions, as chargeable to income.

As an example of the difficulties likely if the passage cited in the second sentence of the second citation in para 27 above as to ordinary outgoings of a recurrent nature were to be regarded as a universal rule, the scope of the word “ordinary” in context is far from clear; the annual fee for the firm of investment advisers to keep under review and advise changes in investments comprised in the trust fund, whilst plainly recurrent, was held in Carver not to be an “ordinary outgoing” but whether that was because it was not an “outgoing” in whichever sense was intended or was not “ordinary”; and, if the latter, by what test it was not was left unclear – see Carver at page 1120h – 1121a.

The fact, if such it is, that it is possible to point to real doubts as to the applicability of Lord Templeman’s “general rule” as to ordinary outgoings of a recurrent nature in that second sentence and the fact also that it is possible to devise cases where an attribution under the second sentence would conflict with one under the third might suggest that Lord Templeman was propounding in the second sentence a rule which, although described as “general”, was nonetheless contemplated as likely to require many exceptions. But the rule or principle as to capital bearing all expenses incurred for the benefit of the whole estate in the third sentence is not dependent or consequential upon the second sentence. It appears as an independent rule and one, unlike that in the second sentence, having its own prior authority as a base. Difficulties with the second sentence thus do not necessarily infect the third, to which I turn.

It is that third sentence – “Capital must bear all costs, charges and expenses incurred for the benefit of the whole estate” – that is, for immediate purposes, the more important rule or principle. Lord Templeman stated that he derived it – see page 1121 – from Bennett supra. He added at 1121g, thus accepting Counsel’s argument as cited at para 26. above:

“In Re Bennett [1896] 1 Ch 778, which has been accepted law for nearly 90 years, affirms the trust principle that expenditure incurred for the benefit of the whole estate is a capital expense.”

He thus cites the rule or principle twice – once at page 1120 in the passage I have called the third sentence and again on page 1121. He impliedly rejected Mr Walker’s submission that the principle which Bennett had stated was too wide. As I read his speech, he regarded sections 19 and 20 of the Trustee Act 1925 – to which he referred at page 1121f-g – and would have regarded the other provisions to which I have referred as particular statutory provisions which, in effect, (though he did not so put it) underlined the general rule he propounded in the third sentence by showing that a statute was needed to overcome it. It may also be that Lord Templeman was not contemplating such statutory provisions as part of the general law.

Very attractive as the “fairness” argument is and powerful as it might otherwise seem to be in supporting some apportionment of some of the Trustees’ expenses between capital and income, I fail to see, to the extent that any particular expense is to be regarded as incurred for the benefit of the whole trust estate, that I am at liberty, with respect to that expense, to ignore a principle which the House of Lords has held to be derivable from Bennett, to have been accepted for nearly 90 years and which the House of Lords itself, by Lord Templeman, twice re-states. Whatever doubts I might otherwise have had as to Bennett as intending to ground a rule of inescapable application, bound, as I am, by Carver, I am not free to read Bennett other than as establishing or re-stating the principle or rule, within the general law of trusts, as to trustees’ expenditure incurred for the benefit of the whole estate which Lord Templeman states, namely that it has to be regarded as a capital expense. Moreover, in a conflict between the second and third sentences, it is the latter, undoubtedly ratio, supported by prior authority and twice stated that has to be preferred as the more binding statement.

Nor does one escape that conclusion by pointing to some ability expressly conferred by a trust instrument to charge a given expenditure wholly or in part to income notwithstanding that, under the general law, it was an expenditure incurred for the benefit of the whole estate. Carver makes it plain – see page 1122e-f – that whichever pocket the trustees may chose as the pocket from which an expense is paid, the expense has, so to speak, an intrinsic nature under the general law, as it were its own DNA, such that, as between the Revenue and the Trustees, if it was incurred for the benefit of the whole estate, it is inescapably assigned to capital. The fact, were it so, that as between one class of beneficiaries and another or in the ultimate internal accounts of the Trustees the 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 because, for immediate purposes, section 686(2AA) requires a look to what the position would be “but for any express provisions of the trust”.

Mr Baldry bolsters that conclusion by showing that in Underhill supra, immediately after the reference to the trustees’ duty to keep a fair balance between the interests of income beneficiaries and capital beneficiaries – see paragraph 10. above – the learned editors continue, so far as here relevant:

“and so taking account of the following traditional principles governing the incidence of outgoings (after the trustees have taken advantage of their initial right to resort to capital or income as they find easiest to discharge outgoings);

(a)

the corpus bears capital charges incurred for the benefit of the whole trust estate….”

He draws attention also to the Law Commission’s consultation paper No. 175, “Capital and Income in Trusts; Classification and Apportionment, a Consultation Paper” which at para 2.51 and succeeding paragraphs cites Carver but without doubting either of the principles that work done for the benefit of the whole estate leads to its cost being chargeable to capital or (as has not been in issue before me) that the express provisions of a trust instrument authorising apportionment as between capital and income are irrelevant where what is being considered is whether an outgoing was of an income or of a capital nature for the purposes of a particular statute (a fortiori for the purposes of section 686(2AA) which in terms, as I have mentioned, requires one to look at how expense may be chargeable “but for any express provision of the trust”).

It does not, at any rate at this level, assist the Trustees that the general third sentence rule or principle emerging, if not from Bennett then from Carver, is unattractively inflexible or might in some circumstances be thought unfair. Mr Baldry was entitled to point to the likely impracticabilities if, in every case, the amount of tax depended on assessment of what was “fair” and to point out also that in any event an attribution to capital was in one sense not all-or-nothing as it would affect both those interested in income and those in capital. The principle in Carver is binding as stated. It follows, in my view, that the Special Commissioners erred in law; they were bound, as I am, by Carver and thus 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 section 686(2AA). Not only was that expressly stated in Carver but it is the only conclusion consistent with the House of Lords’ treatment of the annual fees of investment advisers in that case. The Special Commissioners also erred in law in regarding Bennett, as they said in their paragraph 17, as “a case where only the capital was relevant”. The audit in Bennett could have been expected to throw light on both the ability of the wine merchants to continue to pay interest on the outstanding loan as well as the capital of the loan and taking the cost of the audit out of capital affected the income as well as the capital interest as, of course, the life tenant thereby lost the income that would otherwise have been derived from the £213 capital sum that was used to pay the cost of the audit. Had Bennett stood alone it might have been legitimate to doubt whether it did appear to state too widely the relevant principle and have been possible, notwithstanding the impracticalities, to let Counsel argue for such an apportionment as even-handed fairness might generally require. However, in the light of the House of Lords’ conclusion in Carver at page 1121g, it was not open to the Special Commissioners, nor is it open to me, not to apply what I have called the third sentence.

If I am right in holding the Special Commissioners thus to have erred in law then the next stage is for me to examine whether particular outgoings were or were not incurred for the benefit of the whole estate. I am not invited, nor were the Special Commissioners, to go into figures but, as were the Special Commissioners, I am required to come to broad conclusions on different classes of outgoings. There is no dispute between the parties as to accountancy fees and custodian fees; in both of those cases the Revenue have 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 are equally agreed properly to be apportioned. I have not been concerned to inquire into what has led the Revenue to accept that parts at least of such expenses were not incurred for the benefit of the whole estate.

As for the investment management fees, outstandingly the largest type of expense within the overall total – see para 8. above - the Trustees accept that in the main they are properly chargeable to capital but there is an element thereof, says Mr McCall, by way of the Trustees’ cross-appeal, which is properly chargeable to income. The Trustees resolved to accumulate income but there was not an accumulation, properly so-called, he argues, 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. I have not had my attention 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, advice which, surely, redounded for the benefit of the estate as a whole. The Special Commissioners, in my judgment, were right in treating the totality of investment management fees as properly chargeable to capital.

Of the various outgoings which I described in para 8. above, only two broad classes remain so far unmentioned, namely professional fees and trustees’ fees. I have not had my attention drawn to particular difficulties as to professional fees and I would therefore hope that an apportionment, if at all appropriate, can be agreed as to them, no doubt on similar lines, whatever they were, to those adopted as to accountancy fees. But, as to “trustees’ fees”, particular difficulties arise.

It will be remembered that, broadly speaking, that which can be attributable to income under section 686(2AA) so as thereby to reduce the amount of income chargeable at the higher rate is income applied in “defraying the expenses of the Trustees…. which are properly chargeable to income (or would be so chargeable but for any express provisions of the trust)”. Two points arise.

The first is this. I mentioned to Mr Baldry that (short of an award under the inherent jurisdiction as mentioned in Norfolk supra at para 17) then, but for an express provision of the trust, the Trustees would not be able to receive remuneration at all. The point had not been taken below and Mr Baldry confirmed that it was not taken by the Revenue before me. I do not need to investigate whether the point was sound or not.

Secondly, one would not ordinarily speak of a trustee’s remuneration as an “expense” of the Trustees any more than, say, a businessman carrying on a business on his own account would describe the drawings he chose to make as an “expense” of his business. The phrase used in section 686(2AA) is not the “expense of the trustees” nor is it “the expenses of the trust fund” but, rather, “the expenses of the trustees”. It would be proper to distinguish between the expenses of the Trustees in the sense, for example, of their outlay in travelling to meetings between themselves, travelling to meet investment advisers, bankers or solicitors and so on, on the one hand, and remuneration for their service or services on the other. Moreover, it is possible to suppose a fear in the legislature that if all trustees’ remuneration were to be deductible there might be abuse in the over-remuneration of family members and friends who were trustees and thereby an abusive over-reduction of the amount of higher rate tax otherwise payable. Such a fear could be another reason to justify a reading of “expenses” which excluded trustees’ own remuneration.

However, in approaching any question of the construction of section 686(2AA), it is to be borne in mind that its language is very difficult to construe. The judgment of Oliver LJ in the Court of Appeal in Carver shows the immense difficulties which were encountered in giving sense to all words in the then forebear of section 686(2AA), either on the construction preferred by the taxpayer or the construction preferred by the Crown, and I have already referred to high judicial comment on the delphic nature, ineptitude and obscurity of the draftsmanship of the section. Where the draftsmanship is of that quality it may be too much to expect that a distinction was intended to be drawn between expenses of the trustees properly-so-called – their being paid back all that they had had to pay out - see, for example, Re Grimethorpe [1958] Ch 615 at 623 - on the one hand, and an outlay of a kind which the Trustees had not been obliged to pay out but which they themselves decided upon, fixed in amount and gave to themselves. Moreover, if there truly had been a fear in the legislature of possible abuse of the kind I supposed one could reasonably expect that the draftsman, however inept, would have felt a need to go on to distinguish between the remuneration of professional trustees and the remuneration of trustees who happen to be family or friends and between expenses properly-so-called and remuneration. In the context of an inept section it would, in my judgment, be wrong to treat the expression “the expenses of the trustees” as excluding their remuneration.

In relation to the Trustees’ remuneration, Mr McCall advanced three particular arguments. The first drew attention to in Re Roberts’ Will Trusts, Younger v Lewins [1937] Ch 274. In that case Crossman J dealt with the case of a testatrix who had appointed a bank as one of her executors and trustees and had declared that the bank should be entitled to remuneration “in accordance with the bank’s scale of fees now in force”. That scale – see page 276 – provided for three kinds of fee, an “acceptance fee” which was a capital fee charged when the bank took over the trust, an “income fee” which was charged on income actually received whilst the trust continued and the third was a “withdrawal fee”, a capital fee charged when the trust came to an end and the trust fund came to be distributed. Crossman J held that the income fee must come out of the income of each settled legacy and the withdrawal fee out of the capital of each settled legacy. The decision was internal to the trust and was very much on its own facts and in the light of the particular terms of engagement which had been agreed. There is nothing in it, in my judgment, to suggest that but for the express provision of the trusts (the situation which section 686(2AA) requires me to consider) the general rule would not have applied, namely that outlay incurred for the benefit of the whole estate was a capital expense.

The second argument advanced by the Trustees was to emphasise the remarks of Walton J in the Norfolk case cited supra at para 17. But the Norfolk case was decided in 1979, six years before Carver. No example of the application of the practice spoken of by Walton J being adopted after Carver was drawn to my attention and Norfolk had been cited in argument in Carver. I have no reason to suppose that the practice has survived Carver.

Thirdly, Mr McCall based an argument on the unlikelihood of a double taxation having been intended. Suppose that a sum paid by the Trust to one of its professional trustees as remuneration for his services was, for the purposes of section 686(2AA), to be taken (as the Revenue contended) to be a payment chargeable to capital. On that basis it would not be deductible in computing the income tax payable by the Trustees yet would be liable to income tax in the hands of the professional trustee concerned. That, though, as it seems to me, is very far short of being offensive double taxation; one of those liabilities to tax falls to all the Trustees and in their capacity as trustees of a particular trust and is computed by reference to the income of the Trustees as such. The other separately falls to an individual in his quite separate capacity as, say, a practising solicitor, accountant or stockbroker and is computed by reference to his own separate income. There is nothing in the point.

It is not necessary that I should state, as if a rule without possible exception, that trustees’ remuneration in discretionary trusts falling within section 686 should in total and always be regarded as having been incurred for the benefit of the estate as a whole and hence, falling within the rule in Carver, such as to be taken to be capital in total and, in turn, as thus non-deductible for the purposes of section 686(2AA). It may be that in exceptional circumstances and on particular evidence some exceptions may be discovered with respect either to some particular remuneration ascribable to the doing of a particular task, to an unusual trust provision or to the activity of some particular trustee such that it could clearly be seen that the service rendered and remunerated was not incurred for the benefit of the estate as a whole and was of an income character. However, I have not understood there to have been any such evidence before the Special Commissioners in this case.

Moreover, the very “even hand” requirement emphasised by the Trustees and to which I have referred in paras 9-11 above assists the Revenue as it may tend to show how, at the level of the Trustees in a properly administered trust, consideration of the respective interests of capital and income are often inseparable. Even a decision which has seemed at first glance to relate only to capital will, if considered properly in an even-handed way, be likely to have involved a consideration of who, if anyone, for the time being is or should be entitled to income, what his, her or their needs are and whether, having regard to them, it is nevertheless right to do as was being considered with capital. Of course, the test, in relation to a trustee’s expense, is whether it was incurred for the benefit of the whole estate not whether its outlay involved consideration of both the interests of capital and income but that the whole estate falls to be considered will often point also to the whole estate being intended to be benefited.

The starting point, as it seems to me, should be 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 starting point would be consistent with Carver’s treatment of investment management fees. At lowest, there must be a heavy evidential burden (not satisfied in the case before me) upon those who assert some other conclusion.

In order for a deduction from the income otherwise liable to tax at the higher rate to be made in any year of assessment by reason of trustees’ expenses, does the expense have to be actually defrayed within that year or does it suffice (irrespective of when it was defrayed) for it to have been incurred within that year? For convenience I shall repeat the relevant part of section 686(2AA) as follows:

“The rate at which income tax is chargeable on so much of any income arising to trustees in any year of assessment as—

(a)

…

(b)

is treated in accordance with section 689B as applied in defraying the expenses of the trustees in that year which are properly chargeable to income (or would be so chargeable but for any express provisions of the trust),

Because of that reference to section 689B it now is necessary to set out part at least of that section as follows:-

"(1)

The expenses of any trustees in any year of assessment, so far as they are properly chargeable to income (or would be so chargeable but for any express provisions of the trust), shall be treated—

(a)

as set against so much (if any) of any income as is income falling within subsection (2) [Schedule F income], (2A) [Case V savings income] or (3) below [other savings income] before being set against other income; and

(b)

as set against so much (if any) of any income as is income falling within subsection (2) or (2A) below before being set against income falling within subsection (3) below and

(c)

as set against so much (if any) of any income as is income falling within subsection (2) below before being set against income falling within subsection (2A) below."

It is unnecessary to set out yet more of section 689B.

It is accepted there is ambiguity; do the words “in that year” in (2AA)(b) relate to the point of time at which the income is applied or treated as applied in defrayal of expenses (which leads to what Mr Baldry calls the “cash basis”) or do the words, instead, (or perhaps as well) qualify the date the trustees incur or are treated as incurring the expense (an “accruals basis”)? The Revenue contend for the former, the Trustees for the latter.

The Special Commissioners deal with this question in their paragraphs 20-22. Their conclusion was that, although the legislation was not prescriptive on the point and hence that a cash basis could not be said to be wrong, the fairer course, especially in the case of larger trusts, was the accruals basis. Before me the Revenue argue that that is wrong. On a true construction, says Mr Baldry, the legislation offers the Trustees no choice; the true construction ineluctably requires the use of a cash basis and hence “fairness” is not required to be considered. The Trustees, whilst doubtless welcoming their ability, under the Special Commissioners’ decision, as trustees of a “larger trust”, to elect for the perceived fairness of the accruals basis, also argue that on a true construction it is the accruals basis which alone is strictly required.

It is important to note that (2AA)(b) is not, it seems, expressly concerned with actual application of income in defrayal of expenses but with such income “as … is treated in accordance with section 689B as applied” in defrayal. One thus has to turn to section 689B to see what treatment it applies to income and, in particular, to whether it requires any income to be treated as applied in defrayal in some particular way or as at or within some particular time or period. So far as concerns any particular way, it does apply a sequence, working through 689B(1)(a), (b) and (c). But it does not, as it seems to me, require a treatment linking defrayal to some particular time or period.

Then one might next ask whether section 689B requires any expense of trustees incurred in any year to be treated as if expenses attributable for tax purposes to some particular time or period? Again the answer would seem to be “No”. So reference to the effect of the words “is treated in accordance with section 689B” does not, in my judgment, resolve the question of whether the words qualify application in defrayal on the one hand or the incurring of the expenses of the trustees on the other. However, the reference to “treating” and the “but for” provision in 686(2AA)(b) does seem, as Mr McCall argued, to indicate a shift away from actual events and circumstances to deemed events or circumstances. One has to move away from the express provisions of the trusts to what would be the case, for example, “but for” any express provisions of the trust. And reference to the “but for” situation is repeated in section 686(2A)(a). Mr McCall therefore argues that the actual is to be disregarded in favour of a notional set of facts but it is not clear to me why, if I move away from the actual so far as concerns defrayal, I should not be at liberty or be required also to move away from the actual in relation to the timing of the incurring of the expenses of the trustees. This shift from actual to notional does not, of itself, as it seems to me, provide an answer.

But why should it be supposed that the legislation itself must have contained an answer to so detailed an issue as to whether the cash or accruals basis should be applicable? Had an answer to that issue been intended to be provided by the legislation itself one can reasonably expect a clearer answer to have been given, even in “very inept” provisions, than anything that emerges from 686(2AA) and the provisions to which it refers. It respectfully seems to me that there is good sense underlying the Special Commissioners’ conclusion that the legislation was not trying to be prescriptive on this detailed issue. I have failed to see anything unreasonable or inconsistent with the provisions of the legislation about the conclusion I reach, namely that so long as trustees consistently year-by-year use either the accruals basis or, alternatively, the cash basis and so long as any movement from one to the other can be demonstrated to have been done for good reason (and not predominantly for the reduction of liability to tax) that it should be left open to trustees to choose which they should use.

The Special Commissioners concluded that:

“The accruals basis adopted here is a proper way of allocating expenses to a particular year of assessment.”

That suggests to me that there was nothing inconsistent in the Trustees’ use of the accruals basis for the year of assessment in issue and, on that footing, I see no error of law in the Special Commissioners’ conclusion.

For the reasons I have given, I allow the Revenue’s appeal in respect of the £46,712 described as “trustees’ fees”. I dismiss the Revenue’s appeal against the Special Commissioners’ decision that the accruals basis was proper. So far as concerns the Trustees’ cross-appeal, it had two limbs. Under the first, the Trustees argued that the Special Commissioners had been wrong to hold that no part of the remuneration paid to what were called non-executive trustees was properly chargeable to income. I have not seen any ground to distinguish between non-executive and other trustees for the purposes of applying the Carver test; if I am right, for the reasons I have given, to include trustees’ remuneration within what can be expenses of trustees for the purposes of section 686(2AA) then the incurring of such remuneration, being in my judgment to be taken to have been for the benefit of the trust as a whole, must be chargeable to capital under Carver and, to that extent, that first limb of the Trustees’ cross-appeal fails.

As to the second, investment management fees relating to how income is to be invested in order to accumulate it, or pending an expected decision to accumulate it, is, for the reasons given in para 38, advice for the benefit of the estate as a whole and, again, under the Carver rule, the fees are here chargeable only to capital. No error of law, in my judgment, is to be found in the Special Commissioners’ conclusion to that effect. I thus dismiss both limbs of the Trustees’ cross-appeal.

At a late stage in the relevant year of assessment – that to 5^th April 2001 – the Trustee Act 2000 came into force on 1^st February 2001. Section 34 of that Act substituted a new section 19 into the Trustee Act 1925 which enables trustees to insure trust property against risks of loss or damage due to any event and (subsection (5)) to pay the premiums out of "any income or capital funds of the trust". Although I was referred to the provision, neither side claimed that it affected their arguments.

I shall need to discuss with Counsel the appropriate form of Order to give effect to the conclusions which I have reached.