Trust Exit Tax: Update due

Ahead of the UK Autumn Budget on Monday Assistant Trust Manager Migle Virbalaite looks back at the judgement made by the European Court of Justice (CJEU) on the Panayi case and outlines the Exit Tax payment plan proposal.

In a judgement of the Panayi case (Case C-646/15) delivered last year the CJEU for the first time considered the notion of a trust and acknowledged that trusts like companies can enjoy the freedom of establishment under the EU law. Needless to say this was an important and long-awaited ruling for the European trust industry which will strengthen the recognition of trusts across all member states.

The case had even far more significant impact on the UK as its outcome triggered the need for the revision of the country's domestic capital gains tax legislation. Hence it is well worth remembering how the dispute arose which subsequently landed on the CJEU's desk:

In 1992 a Cypriot national Panico Panayi created four trusts while he and his family were still resident in the UK. The original trustees of the trusts were Mr Panayi and a UK-resident professional trustee company while Mr Panayi's wife was added as an additional trustee in 2003. In 2004 Mr and Mrs Panayi made plans to return to Cyprus however before leaving the UK they both resigned as trustees of the trusts and appointed three new Cyprus resident trustees. Following this appointment the majority of trustees of the trusts were no longer resident in the UK which prompted the HMRC to assess the UK trustees to tax under section 80 of the Taxation of Chargeable Gains Act 1992 (TCGA). The Act states when the majority of trustees cease to be resident in the UK they are deemed to have disposed of and immediately reacquired the trust assets at market value. The CJEU was requested to clarify whether the taxation of unrealised gains on trust assets upon a trust transferring its place of management to another member state (so-called 'Exit Tax') was compatible with the fundamental freedoms of movement under the EU law.

Having confirmed trusts can indeed enjoy the free movement within the European Internal Market the CJEU held that there was a clear difference in treatment provided for in the UK's disputed tax legislation of trusts which retained their place of management in the UK and trusts that transferred their place of management to another member state. Evidently had the newly appointed trustees been UK resident the trusts in question would have not been subject to the Exit Tax. The difference in treatment was regarded by the Court as discouraging the trustees from transferring the place of management of the trust to another member state and the settlor from appointing the new non-resident trustees so constituted a restriction on the freedom of establishment.

Nevertheless the CJEU did not say that member states are not permitted to tax gains which have arisen within their territory prior to a migration of a trust. On the contrary it affirmed the restriction on the freedom of establishment could be justified on grounds related to the preservation of a balanced allocation of powers of taxation between the member states. It was held though that the UK's legislation went beyond what was necessary to achieve the objective of preserving the country's taxing rights. More specifically it was a requirement for immediate payment of Exit Tax imposed by section 80 of the TCGA which was considered disproportionate and lead to the court's conclusion the restriction was unjustified. In other words had there been a provision allowing the trustees to defer the tax payment the UK's tax legislation may have passed the proportionality test.

The deficiencies of the UK's Exit Tax regime outlined by the CJEU in the Panayi case were addressed in the draft Finance Bill 2018-2019 published on 6 July 2018. Among a number of significant measures suggested in the draft bill which is subject to confirmation at the Autumn Budget due to be delivered on Monday 29 October 2018 the UK Government put forward a proposal for a payment plan of the Exit Tax which the trustee is liable to pay by virtue of section 80 of the TCGA. If approved the measure will allow the trustees to enter into an Exit Tax payment plan for payment of an exit charge over six equal annual instalments provided immediately after the trustees of the trust cease to be resident in the UK those trustees 'become resident in another EEA' and 'use the asset or assets for an economically significant activity carried on there'* .

The imposition of the proposed option to defer the Exit Tax payment shall ensure compatibility of the UK's tax provisions with the freedom of establishment. It also goes in line with the Brexit Withdrawal Bill which provides for the supremacy of the EU law over the pre-exit domestic legislation.

The draft Finance Bill indicates the said measure will not be applied retrospectively and shall take effect only when the Exit Tax is triggered on or after 6 April 2019. Which begs a question: will the trustees incur a tax liability upon transferring the place of management of the trust to another member state before this date? The principle of primacy of the EU law states when there is a conflict between the EU law and the law of a member state the latter is dis-applied. Based on this consideration one may anticipate that no exit charge will occur if the appointment of non-UK resident trustees takes place before the 6 April next year. Whether or not this is the stance the HMRC is going to take we shall see shortly.

* Draft Finance Bill 2018-2019 Schedule 15 Provision 3