Capital and Income In Trusts: Classification and Apportionment

Current project status

• Initiation: Could include discussing scope and terms of reference with lead Government Department
• Pre-consultation: Could include approaching interest groups and specialists, producing scoping and issues papers, finalising terms of project
• Consultation: Likely to include consultation events and paper, making provisional proposals for comment
• Policy development: Will include analysis of consultation responses. Could include further issues papers and consultation on draft Bill
• Reported: Usually recommendations for law reform but can be advice to government, scoping report or other recommendations

This project is completed. Our legislative recommendations were implemented by the Trusts (Capital and Income) Act 2013, which received Royal Assent on 31 January 2013

This project considered ways of clarifying and simplifying the rules governing the treatment of trust receipts and outgoings as capital or income, and options for reducing the limitations preventing trustees who have to distinguish between income and capital from investing on a “total return” basis.  In particular, the project was concerned with the implications of those rules and limitations for trusts for interests in succession and charitable trusts with permanent endowment.

The project

Terms of reference and consultation

The project was referred to the Law Commission by the Lord Chancellor as a result of concerns expressed during the passage of the Trustee Act 2000 through Parliament. Our terms of reference asked us to consider:

• the rules governing the classification of trust receipts as income and capital;
• the circumstances in which trustees must apportion receipts and outgoings between income and capital;
• the circumstances in which trustees must convert and re-invest trust property; and
• the rights and duties of charity trustees in relation to investment returns on a charity’s permanent endowment.

We published a consultation paper in July 2004 and received 42 responses.

Report

On 7 May 2009 we published our report. It recommended that receipts following tax-exempt corporate demergers should be classified as capital, subject to a limited discretion to make a payment to income. It also recommended the abolition of the equitable and statutory rules of apportionment for all new trusts. Finally, it recommended a new statutory provision that will make total return investment more easily accessible to charitable trusts with a permanent endowment.

The Law Commission’s recommendations were welcomed by the Trust Law Committee who stated:

“The Trust Law Committee gives its unqualified support for the recommendations in the Law Commission’s report and for the Bill to implement those recommendations.  We offer our whole-hearted congratulations to the Law Commission for having addressed an area which has been of major concern to trust practitioners for a very long period and for the manner in which that concern has been addressed.”

Implementation

On 17 January 2011 the Government announced its decision to take forward reforms based on the three legislative recommendations made in our report.  The Trusts (Capital and Income) Bill was introduced in the House of Lords on 29 February 2012; the text was based on the draft attached to our report, with minor modifications arising from responses to the Ministry of Justice’s public consultation on the Bill.

The Bill followed the procedure for uncontroversial Law Commission Bills.

The Trusts (Capital and Income) Act received Royal Assent on 31 January 2013.  Three principal reforms are included in the Act:

• disapplication, for new trusts, of certain technical rules requiring the apportionment of receipts and outgoings between income and capital, so that they only apply where the creator of the trust has specifically incorporated them;
• rationalisation of the trust law classification of receipts from tax-exempt corporate demergers by ensuring that all such receipts are treated as capital, together with a power for trustees to redress an income beneficiary’s position in appropriate circumstances;
• simplification of the procedure for the trustees of charities with permanent endowment to adopt a total return approach to investment within a framework determined by the Charity Commission, so that the amounts retained for further investment and applied for immediate spending are determined by looking across the whole investment return rather than the technical trust law classification of receipts as capital or income.