The Nature of the Exercise.
1.1 In order to design a satisfactory reform one must analyse the nature of the problem. The questions for trustees in all cases is how they should administer and account for trust receipts and payments so as to carry out correctly the terms of their trust. In technical phraseology the questions are, or depend closely upon, issues of construction. In more ordinary language trustees must consider what their trust means in relation to those items.
1.2 It has always been difficult to find any satisfactory definition of capital and income. The concept of the right to receive the fruits only of property without ownership of the property itself goes back Roman law, which recognised the servitudes such as usufructus and usus. Perhaps the first helpful clue is provided in the 18th century work of Professor Adam Smith 'The Wealth of Nations'. According to him, capital was that part of a man’s wealth which he used to produce more wealth. The Oxford English Dictionary provides this definition of the word as used in economics:-
“The accumulated wealth of an individual, company or community, used as a fund for carrying on fresh production: wealth in any form used in producing more wealth”.
That definition is perfectly appropriate for lawyers as much as for economists in describing the function of capital in contrast to that of income. It may help to explain the basic concept that the distinction derives from the different purposes of capital and income. Capital is that property which is used for the purpose of creating a revenue. A purpose cannot subsist in mere receipts and payments; to find it one must look at the intentions of the owners of the property who cause it to be separated.
The Fallacy in Bouch v. Sproule.
1.3 The fallacy underlying most of the 19th-century decisions, culminating in the House of Lords decision in Bouch v. Sproule (1887) 12 App Cas 385, and followed seventy four years ago by the Privy Council in Hill v Perpetual Trustee Co of NSW [1930] AC 720, is the assumption that a transaction has a single character for both parties to it. The assumption is wrong in theory, because classification depends on purpose, and the parties may have different purposes. More practically, it may be demonstrated to be wrong by examples from the world of commerce. For example,
An individual buying a holding of shares will doubtless have purchased them as capital, but if the seller is a dealer in securities he may correctly regard the proceeds as income.
A building contractor credits payments received for his work to a revenue account, but his client may treat the same payments as capital expenditure.
1.4 Receipts can only be classified properly as capital or income of a trust from the viewpoint of the trustees receiving them. Their purpose is to perform the trust by keeping the corpus intact for the remainderman while providing an income for the life tenant. They must classify the receipt in accordance with that purpose. The viewpoint of the company or other institution making the payment is irrelevant.
1.5 The rule in Bouch v Sproule is wrong. That becomes entirely clear from the judgment of Nichols V-C in Sinclair v Lee [1933] Ch 497, in holding that the distribution by ICI of shares in Zeneca Group upon the demerger could not be treated as income. He said, at page 514:
“… an application of existing principles in their full width would produce a result in this case which would, frankly, be nothing short of absurd”.
1.6 Law reform however is not bound by decisions of the House of Lords, and is allowed to recognise that Sinclair v Lee is in reality a reductio ad absurdum of the rule in Bouch v Sproule itself.
1.7. A corollary is that a particular type of receipt ought occasionally to be treated differently by different trusts. A fictitious example may explain this.
1.7.1 X Ltd over a number of years earned similar profits each year out of which it paid similar dividends. But in 1999 the directors decided to try and acquire other companies over a period, and to finance the intended acquisitions reduced the dividends for five years. In 2004, having made no acquisitions, they reversed the policy. They then paid out two dividends, one of which was described as an ordinary dividend, and the other a special dividend. The special dividend was explained to be in payment of the profits accumulated over the years in which the dividend had been reduced. For unrelated reasons the market price of the shares became depressed, so that the amount of the special dividend was a large proportion of the value of the shares on which it was paid. Immediately that the shares were quoted 'ex dividend' in respect of the special dividend, the market value plunged by an equivalent amount. Two of the shareholdings were those of 'Trust A' and 'Trust B'.
Trust A had acquired the shareholding in 1998, and the same beneficiary had been entitled to the income of the trust throughout the period. The special dividend in this case should clearly be credited to income.
Trust B acquired its shareholding in 2004, when the likelihood of the special distribution by X Ltd was widely forecast. Shortly after the special dividend was paid the income beneficiary died and trustees sold the shares. In this case it would be open to the trustees to allocate the special dividend to capital. They should take into account, amongst other matters, that the value of the shares had been significantly reduced by the special dividend, and that the purchase and sale of the holding had not caused for the income beneficiary any reduction in income.
1.8. Nevertheless different treatment by different trusts would be extremely rare.
The rule in Bouch v Sproule should be abolished.
1.9 The main problem with this branch of the law will is that equity has produced some rather unfortunate decisions, which remain binding on the courts. Once freed from the existing rules of equity the law will instantly become clearer and easier to apply.
1.10 It is important to analyse the process required of the trustees. Classification is a matter of judgment. That does not require an esoteric science unique to trusts and charities. It is a routine function in accounting for an organisation to classify each receipt and payment according to what the accounting person judges to be its true nature in relation to the organisation and the purpose for which the accounting is required. As in all exercises of judgment the accounting person (director, partner, or trustee) must consider all the circumstances of the case and give weight to those deemed relevant. The experts in this exercise are of course the accountants.
1.11 It is necessary, simply, to abolish all the existing rules of classification. No new legal rules for different types of receipt should be created – not even ‘default’ rules; that would merely allow the same dangers to arise again with novel types of receipt. In the huge majority of cases trustees will get it right. In almost all situations, to quote the words of Sir Donald Nicholls VC in Sinclair v Lee [1993] Ch 497, at page 503,
"no one, unversed in the arcane mysteries I shall be mentioning shortly, would have any doubt over the answer to these questions".
1.12 Quite an interesting sidelight on this may be drawn from the Scottish case of Low’s Trustees (1871) 8 SLR 638 - briefly referred to in paragraph 2.32 of the Scottish Law Commission Discussion Paper 124 (2003). In that case Robert Low had expressly directed in his will that his trustees should be the sole and only competent judges of what should form and be included in the residue of his estate, and of what should form the net rents, interest, dividends and annual profits of the residue. The estate included minerals and forestry. It was argued that the testator’s direction was invalid. No, said Lord President Inglis:
“…. Questions arising between liferenter and fiar are generally questions of detail, better solved by ordinary sound headed men of business than by courts of law. The testator intended that this should be the case here, and that his trustees should not be bound by strict rule of law in the determination of these questions, but should judge in the exercise of their own discretion as boni viri, what was the fair proportion of these sums to place to capital, and what to income. I should be sorry to interfere with such a reasonable intention of the testator, so well expressed”.
That testator’s direction is not far removed from what this paper now suggests should be the law.
Guidance for Trustees
1.13 Nowadays in a large proportion of trusts, certainly of larger trusts, the funds are either handled by investment managers, or trustees arrange for the investments to be registered in the names of professional nominees, with standing instructions to treat differently income and capital receipts. The relevance is that some professional person is likely to notice and draw attention to any receipt which raises a difficult question of classification. But as the answer to such question is likely to be the same for almost all trusts any difficulty will be discussed between professionals -- possibly also in the press -- so that guidance will be available on the correct treatment of the distribution. It must also be noted that company distributions of all kinds are announced several weeks before they are paid, so that trustees and professionals never have to make snap decisions.
1.14 If the exercise were really difficult trustees would occasionally apply to the court for directions. They do not, even under the present tortuous law. Applications to the court nowadays on the topic are not just rare, they are virtually unheard of. Apart from Sinclair v Lee eleven years ago no one in Chancery Chambers can recall any such proceedings at all.
1.15 Because the function required of the trustees is an accounting function trustees should be required by statute to conform to good accounting practice. That is the field in which it is possible to provide some form of authoritative direction to trustees on what they must do in particular situations. This must be of a kind appropriate for directing or guiding accounting procedures. That is to say, it must allow scope for judgment.
1.16 The most formalised framework might eventually be a Statement of Recommended Practice (SORP). "SORP's are recommendations on the accounting practices for specialised industries all sectors. They supplement accounting standards and other legal and regulatory requirements in the light of the special factors prevailing or transactions undertaken in a particular industry or sector. SORPs are issued not by the Accounting Standards Board (ASB) but by industry or sectoral bodies recognised for the purpose by the ASB." (ASB statement: SORPs: Policy and Code of Practice).
1.17 However guidance from any respected organisation, such as the Society of Trust and Estate Practitioners, might be available sooner and might be more suitable for the present purpose. It is not recommended that legislation should indicate any particular source of guidance.
1.18 This model differs from the tentative proposal in the consultation paper in that it would involve no binding requirement to classify, even tentatively, particular types of distribution in particular ways. It should remain the duty of the trustees to depart from the formal guidance if in all the circumstances of the case, including circumstances relating to the particular trust, that guidance did not produce the result they judge to be correct.
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Here follow answers to the questions summarised in Part VII of the Consultation Paper.
Human rights
7.1 We would welcome the views of consultees on the human rights implications of the provisional proposals described in this Paper. (Paragraph 1.24)
7.1 No human rights implications can be seen..
Regulatory impact
7.2 We would welcome any information or views from consultees about the regulatory impact of our provisional proposals. (Paragraph 1.25)
7.2 One of the drawbacks of the Commission's suggested scheme is that it could involve an additional administrative process. There is another aspect that ought not to be overlooked. In so far as any scheme may require trustees to go through detailed procedures, there is the increased risk of an unmeritorious claim against them should they skip the procedures in arriving at their decision, whether or not those procedures should have been realistic in the particular case. Where a risk of this kind is perceived trustees may inevitably use defensive procedures, by increasing the extent to which they take legal advice or procure their professional advisers to maintain detailed records. It would be a disservice to trusts to impose the cost of defensive action where the tasks in general are extremely simple and the amounts generally quite small.
Classification
7.3 We provisionally propose that the existing rules for the classification of distributions by corporate entities to trustee-shareholders should be abolished. Do consultees agree? (Paragraph 5.12)
7.3 It is emphatically agreed that the existing rules ought to be abolished.
7.4 We provisionally propose that cash distributions to trustee-shareholders by corporate entities (excluding payments made on liquidation or on an authorised reduction of capital), or distributions which trustees could have taken in cash, should be classified as income and all other distributions from corporate entities should be classified as capital. Do consultees agree? (Paragraph 5.12)
7.4.1 This paper respectfully disagrees with the provisional proposal in paragraph 5.12, and with the scheme described in Part V of the Consultation Paper. It is believed that the concept of having specific classification rules at all is misguided, because no such rules can ever be adequate to deal with the difficult cases, which are the only cases in which there is any possible need for rules. It is suggested that the scheme of a 'default' classification, with a power of allocation for the trustees to 'correct' it, is misleading and unhelpful. If it should have been necessary for the trustees to exercise their proposed power of allocation, then by definition the default classification will have been wrong.
7.4.2 The initial 'default' classification does not derive from any discernible principle. Rather, it seems to reflect just a supposed convenient method of 'parking' a receipt until trustees should have had time to think about it. That is not in reality how trust administration works. In fact it might even be said -- no doubt slightly unfairly -- that the process of allocating a distribution according to whether it is receivable in shares or in cash savours of the kind of instruction that a trust administrator, leaving for a holiday, might give to an unintelligent junior clerk. Trustees, including lay trustees, are sophisticated enough not to need a process of this kind.
7.4.3 Company distributions are announced well in advance of payment. Any problem is likely to be aired in advance, so that the trustees may account correctly for the payment as soon as it is received.
7.4.4 Moreover, if the distribution is by a major company with a large number of shareholders it is likely that the company itself may notify its shareholders of any possible problem for trustees on which they should take advice.
7.4.5 This paper keeps stressing that for the great majority of simple trusts distributions involving a problem are extremely rare. They are of minimal importance compared other types of problems with which trustees regularly have to deal. A trustee is there because the settlor trusted his judgment. It makes little sense to allow him a wide discretion in, say, choosing investments or exercising powers of advancement, but to tie him down to detailed procedures for straightforward trust accounting. Problems are seldom likely to arise except in distributions from large family companies or specialised investment vehicles with a few shareholders only. Companies of that kind and their trustee shareholders are likely to have professional advisers.
7.5 We provisionally propose that the existing rules for the classification of trust receipts other than distributions from corporate entities should be retained. Do consultees agree? (Paragraph 5.15)
7.5.1 No. It is believed that all rules of classification, in the sense of rules binding on trustees, ought to be abolished. Campbell v Wardlaw itself is not a very happy precedent. That decision held that all returns from minerals should be treated as capital, because once taken away from the land they are never replaced. Though doubtless appropriate in the particular case, as a general proposition that is unrealistic. On many estates there can be limited mineral workings which in no way diminish the value of the estate as a whole. It would be quite unfair to a life tenant to apply all royalties to capital. It ought to be for the trustees to decide whether in the particular circumstances mineral receipts should be credited to capital or to income.
7.5.2 The same considerations apply to forestry and intellectual property.
7.6 We invite the views of consultees on whether the existing rules for the classification of trust receipts other than distributions from corporate entities should be placed on a statutory footing. (Paragraph 5.15)
7.6 Please refer to the answer to 7.5.
7.7 We provisionally propose that the law regarding the classification of trust expenses should remain unchanged. The rule laid down by the House of Lords in Carver v Duncan should continue to apply. Do consultees agree? (Paragraph 5.17)
7.8 We invite the views of consultees on whether the rule in Carver v Duncan should be placed on a statutory footing. (Paragraph 5.17)
7.7-8.1 In general, classification of expenses, just like receipts, should be at the discretion of the trustees. It does not appear that Carver v Duncan does much more than attempt to define the difference between capital and income. In borderline cases the distinction remains as elusive as ever. The particular decision in that case, that the insurance premiums should be charged to capital, ought more properly to be regarded as just a decision for that trust in those circumstances.
7.9 We provisionally propose that the rules of classification for trust receipts and expenses should be subject to any contrary provision in the terms of the trust. Do consultees agree? (Paragraph 5.18)
7.9 The question itself might be seen as a little disquieting. This whole topic is an exercise in how correctly to apply the provisions of a trust to a particular receipt or expense. That is what classification is for. Moreover in this submission classification should not depend on legal rules at all.
The duty to balance
7.10 We provisionally propose that there should not be a non-exhaustive statutory list of relevant factors to help trustees determine whether or not a balance has been struck between the competing interests of income and capital beneficiaries. Do consultees agree? (Paragraph 5.26)
7.10 This is agreed, for the reasons set out in the Consultation Paper. One may respectfully adopt the passage in the Scottish Law Commission Discussion Paper which referred to the detailed list in the USA Uniform Principal and Income Act 1997, and continued as follows: -
"We are not convinced of the need for such a detailed list of factors. Most of them are considerations that trustees would naturally take into account or would receive advice on from their professional advisers. There is in danger that in focusing on the listed factors, the trustees would omit to take into account some other considerations that were relevant in the particular circumstances."
7.11 If consultees do not agree, we invite their views on which factors should be included in such a list. (Paragraph 5.26)
7.12 We invite the views of consultees on whether or not a trustee’s duty to balance the interests of income and capital beneficiaries should be given a statutory basis. (Paragraph 5.28)
.7.12.1 It is not appropriate to codify this single one of the many trustees’ duties; to do so gives it an artificial prominence. It could also tend to encourage unmeritorious claims against trustees for perceived breaches. The duty has always existed and does not need codification.
7.12.2 There would be a serious drafting difficulty also. ‘Balance’ to a judge means the process of selecting circumstances held to be relevant and giving to each interest the weight deemed to be appropriate. However the word could easily be misunderstood to mean that equal weight should be given in favour of each interest.
7.13 We provisionally propose that trustees should be subject to the duty to balance except insofar as the settlor expressly, or by necessary implication, excludes or modifies that duty in the terms of the trust. Do consultees agree? (Paragraph 5.31)
7.13.1 As in 7.9, it is respectfully suggested that the question does not focus correctly on the nature of the exercise. The whole topic concerns how, in particular areas, the trust ought to be administered by the trustees.
7.13.2 Problems of balancing usually arise in situations where, for example, the life tenant or the remainderman seem to be enjoying an unfair measure of the trust assets. For example, income from a wasting asset, such as a lease, may unfairly benefit the life tenant, and a non-income-producing asset like an insurance policy may benefit only the remainderman. It should be for the trustees to judge, at their discretion, whether in all the circumstances the trust will be correctly performed by selling or by retaining the asset. They might, for example, be able to compensate for the imbalance in other ways, such as investing other parts of the fund in shares with higher or lower yields. Or they may judge that the whole purpose of the trust is to provide a capital sum only at a future date when a settled insurance policy will mature, or that concerns, perhaps, for the testator’s widow during her life should always predominate. Codification of their duty would not be feasible, nor would it be helpful.
7.14 We provisionally propose that the duty to balance should not be impliedly excluded insofar as it relates to the original trust property because that property constitutes an authorised investment, because it was the subject of a specific gift (including any gift of realty or any gift in an inter vivos settlement) or because there is a power to postpone conversion of the original trust assets. Do consultees agree? (Paragraph 5.31)
7.14 Please refer to the answer to the previous question.
Percentage trusts
7.15 We invite the views of consultees on the advantages and disadvantages of promoting percentage trusts within England and Wales. (Paragraph 5.38)
7.15 No experience is claimed of percentage trusts, nor is it easy to evoke any real excitement to promote them. While they are not impossible under the existing law, they are unlikely to be popular while their complex tax problems are unresolved. As the Commission states they are also inhibited by the accumulation rules.
A new trustee power of allocation
7.16 We provisionally propose that a statutory power of allocation should be made available to the trustees of private trusts to enable them to discharge their duty to balance and thereby to promote total return investment policies. Do consultees agree? (Paragraph 5.48)
7.16.1 Under this approach of this paper there is no place for a statutory power of allocation. As argued earlier, it is necessary only to allow trustees to use ordinary accounting methods.
7.16.2 There could indeed be a place for "total return investment policies", such as might allow a trust fund to be invested partly in markets where dividend yields were negligible but growth strong. No new statutory power would be needed. These policies could be accommodated within the proposed framework, that is to say, the trustees must just follow good accounting practice. Nevertheless, to devise and follow a good accounting procedure for this form of investment policy trustees would require high quality advice and judgment of their accountants, and they would be unlikely to adopt such a policy without at the very least the approval of the main beneficiaries.
7.16.3 If the phrase "total return investment policies" were to imply a scheme under which some proportion of the total trust assets is periodically realised and credited to income, like a drawdown from a personal pension fund, the response would be that there is no need for such a scheme to be available generally to all trusts.
7.17 We provisionally propose that the exercise of the statutory power of allocation, where it is available, should be subject to a time limit from the date of a particular receipt or expense, after which time the default classification would become conclusive. Do consultees agree? (Paragraph 5.48)
7.17.1 A fundamental difficulty with the scheme suggested in the Consultation Paper is that it imposes a mechanistic process of a 'default' classification followed if necessary by a separate decision adjusting that classification. That is unrealistic, not only in the world of investment management, but also in the case of trusts in which lay trustees register investments in their own names and manage them without professional assistance. As mentioned above there is plenty of opportunity to classify a distribution correctly in advance of its receipt.
7.17.2 It is respectfully suggested that the concept of time limits is misguided. Allocation would only be necessary -- or indeed permissible -- if the 'default' classification turned out to be wrong. If wrong, it should be corrected however long it takes. Anyway, trustees have plenty of other incentive to act promptly. Unless they do so the life tenant will be unable to complete his income tax return, and with a larger trust the accountants will be unable to prepare the accounts for the year.
7.17.3 The problem is partly one of terminology. In relation to classification, the use of the word ‘power’, as indicated elsewhere in this paper, suggests a greater element of choice than is appropriate. One would prefer language using the word 'duty', or possibly 'discretion'.
7.18 We invite the views of consultees on the appropriate length of such a time limit. (Paragraph 5.48)
7.18 Please refer to the answer to the previous question.
7.19 We invite the views of consultees on the practical implications of our provisional proposals, particularly in relation to accounting and keeping track of the individual receipts. (Paragraph 5.48)
7.19.1 The practical implications support this submission against the suggested scheme. It would seem to envisage payment of all company distributions into some form of suspense account, from which transfers would be made from time to time in accordance with the decisions of the trustees. In practice, trust administrators would doubtless carry on exactly as at present, simply making adjusting transfers between capital and income in the event that the trustees exercised the proposed power of allocation. That would suggest that literal compliance with the scheme would be pointless.
7.19.2 This submission argues that proper allocation is almost always very easy, and in the very few cases where it is not, formal rules are likely to be of much less use than ordinary common sense.
7.20 We invite the views of consultees on whether the provisionally proposed power of allocation should be available on an opt-in or opt-out basis. (Paragraph 5.55)
7.21 This paper would be opposed to the introduction of any such power, in the sense that the word is used in the Consultation Paper. Rather, trustees should have a duty to classify receipts and payments at their discretion, and the duty should apply without any option to all trustees.
7.21 We provisionally propose that the personal circumstances of beneficiaries should not be a relevant factor in the exercise of the statutory power of allocation. (Paragraph 5.66).
7.21.1 Whether or not a power of allocation is to be conferred by statute, there remains a real problem on whether and to what extent trustees should take into account the personal circumstances of the beneficiaries. This is important, not perhaps so much for the purpose of allocating trust receipts but rather for indicating how trustees should exercise their investment and other powers, such as the powers of maintenance and advancement under sections 31 and 32 of the Trustee Act 1925. Sometimes, no doubt, the trust deed expressly or by implication directs them to take the personal circumstances into account. But this is not always so, and can never be so in trusts such as intestacies arising by operation of law.
7.21.2 It is agreed that as a general rule the personal circumstances of beneficiaries should not be a relevant factor in balancing the interests of capital and income. If trustees should have unfettered power to choose which beneficiary should benefit most from their investment policy, that power would approach becoming a power to vary the beneficial interests.
7.21.3 There is also a more practical consideration. If the personal circumstances of beneficiaries should indeed be relevant, then trustees ought to make adequate inquiries of each of their beneficiaries about their personal circumstances. There is nothing impossible in such a requirement, but it seems to run contrary to present practice, and would impose additional burdens upon the trustees and costs upon the trust. It is recognised that it is indeed a relevant factor in many states of the USA under the Uniform Principal and Income Act 1997.
7.21.4 There may be a problem in defining what exactly are the circumstances to be disregarded. Where an intestate leaves an elderly widow and sons of working age, it would seem right for the trust fund to be weighted with high-yielding investments, thereby benefiting the life tenant. That seems proper. One formula might be to allow trustees to take account of the general character of the trust, of the ages of the beneficiaries, and of the relationship of the beneficiaries to each other, but not, unless the trust document so permits, of the financial and other circumstances of the beneficiaries individually. If this matter were to be addressed by legislation, the drafting would not be without difficulty. The formula does not seem very attractive.
7.21.5 Trustees have, and must always have, an element of discretion in exercising their investment powers. The yield appropriate for an income beneficiary is not an immutable fixed amount. There is always a range of yields, varying from time to time, which investment advisers can recommend as appropriate for trusts. From within that range trustees must select investments appropriate to their own trust. Where the life tenant is an impoverished widow, trustees will select investments from the top of the yield range. This would seem to be a proper exercise of discretion, and care must be taken in any reform to preserve this.
7.21.6 Perhaps the most helpful approach is to stress the need to look at the provisions of the trust. In the language of an application to the court, trustees must ask themselves whether upon the true construction (the true meaning) of the trust they are required to act in one way or in another. They must take into account all relevant considerations, one of which (at least sometimes) may be the wishes of the settlor – Re Barr’s Settlement Trusts [2003] Ch 409. The meaning of the trust will generally have to be determined by the terms of the trust document, if there is one, or of for example the intestacy, in the context of the circumstances existing at the time the trust was created. That approach would usually exclude the personal circumstances of beneficiaries at a later date, but not always so. For example, if an interest were given to a beneficiary disabled before the commencement of the trust that beneficiary’s later circumstances would usually remain relevant.
7.22 We invite the views of consultees on whether or not the Nestle approach (that personal circumstances of the beneficiaries are a relevant factor in discharging the duty to balance through the formulation of investment policy) is correct. (Paragraph 5.76)
7.23 If consultees believe the Nestle approach to be incorrect, we provisionally propose that the duty to balance should be statutorily redefined to exclude the personal circumstances of beneficiaries as a relevant factor. Do consultees agree? (Paragraph 5.76)
7.22-23. Please see the reply to 7.21.
7.24 We invite any further views of consultees on factors which should be relevant (or irrelevant) to the duty to balance or to the exercise of the statutory power of allocation. (Paragraph 5.77)
7.25 We provisionally propose that the exercise (or non-exercise) of the statutory power of allocation should be subject to review by the courts on the same basis as any other discretionary power conferred upon trustees. Do consultees agree? (Paragraph 5.82)
7.25.1 It is agreed that classification of a receipt (whether or not under a 'power' of allocation) must be reviewable by the court. As with all reviews of an exercise of discretionary powers, this remedy should be available only on the grounds that the trustee misdirected himself in principle, by taking into account matters that he should not or by failing to take into account matters that he should. It would not be sufficient to show that a court would have exercised the discretion differently.
7.26 We provisionally propose that, in principle, an action for breach of trust should lie against trustees who fail to discharge their duty to balance. Do consultees agree? (Paragraph 5.82)
7.26.1 This is a necessary corollary to the existence of the duty. But the duty is not new, and potential liability for breach of trust has always existed.
7.27 We invite the views of consultees on whether a special protocol concerning the resolution of disputes over the exercise of the proposed power of allocation would be of assistance to trustees and beneficiaries. (Paragraph 5.82)
7.27 No. Firstly, a protocol belongs to the field of dispute resolution and litigation, and provision for it belongs in the field of litigation practice and procedure, not in trust law. Secondly, a protocol is suitable in situations where a number of similar claims arise, so that facts and arguments can be usefully coordinated and assembled before being put to a defendant. Disputes over classification of trust receipts are virtually non-existent. Any that might arise in future are likely to be wholly diverse, as indeed is the case with almost all trust litigation. A protocol would be wholly unhelpful.
The equitable rules of apportionment
7.28 We provisionally propose that all the existing equitable rules of apportionment should be abrogated. Do consultees agree? (Paragraph 5.85)
7.28 Yes.
The Apportionment Act 1870
7.29 We provisionally propose that the statutory apportionment rule contained in section 2 of the Apportionment Act 1870 should not apply to trusts except insofar as the terms of the trust (expressly or by necessary implication) express a contrary intention. Do consultees agree? (Paragraph 5.87)
7.29 Yes.
7.30 We provisionally propose that when trustees receive a payment of income in respect of a period during which two (or more) individuals (or classes of individuals) were entitled to income, they should have a statutory power to apportion when, and in the manner in which, they, in their absolute discretion, deem it just and expedient. Do consultees agree? (Paragraph 5.88)
7.30. This matter should be treated in exactly the same way as classification of trust receipts. Trustees should be required to apportion receipts – and outgoings – between successive interests at their discretion and in accordance with good accountancy practice.
Trusts for sale
7.31 We provisionally propose that where a settlor expressly creates or statute imposes a trust for sale (without a power to postpone sale), trustees should continue to be under a duty to convert the trust property and reinvest the proceeds. Do consultees agree? (Paragraph 5.89)
7.31 No, there should not be any general duty to convert. Trustees should remain under a duty to do what they judge to be required of them by the particular trust in the particular circumstances.
7.32 We provisionally propose that the first branch of the rule in Howe v Earl of Dartmouth should be abrogated. Do consultees agree? (Paragraph 5.91)
7.32 Yes.
Scope of the provisional proposals
7.33 We provisionally propose that the scheme set out in this Part should be made applicable to all private trusts which are governed by the law of England and Wales and in which there is a division of the capital and income interests. Do consultees agree? (Paragraph 5.92)
7.33 If, contrary to the proposals in this paper, such a scheme should be introduced, it is agreed that it should so apply.
7.34 We invite the views of consultees on whether there are any specific types or categories of private trust to which the provisional proposals in this Part should not apply (or to which they should apply in modified form). (Paragraph 5.92)
7.34 No comment is offerred on this question..
Transitional provisions
7.35 We invite the views of consultees on whether our provisional proposals should apply to trusts created before the proposals come into force if the proposed statutory power of allocation applies on an opt-out basis. (Paragraph 5.96)
7.36 We invite the views of consultees on whether or not the trustees of pre-existing trusts should be able to opt in to the statutory power of allocation. (Paragraph 5.98)
7.37 We invite the views of consultees on whether or not the trustees of pre-existing trusts, if they are able to opt in to the statutory power of allocation in order to adopt a total return investment policy, should be required to seek the approval of the court before adopting such policies. (Paragraph 5.98)
7.38 We provisionally propose that any legislative reform based on our provisional proposals should take effect on the first day of the tax year following the enactment of any implementing legislation. Do consultees agree? (Paragraph 5.99)
7.35-38 The raising of these questions would seem to imply that the proposed power of allocation involves some variation of the terms of the trust. This would seem a strange way to clarify the correct classification of trust receipts. It is argued that the questions tend to demonstrate the correctness of the central submissions in this paper.
Tax implications of the provisional proposals
7.39 We would welcome comments of any nature on the tax implications of the provisional proposals contained in this Paper. (Paragraph 5.101)
7.39.1 If contrary to the preferences argued above new powers are to be conferred by statute, it is agreed that the legislation should not be implemented unless the Revenue give an assurance that they will recognise the exercise of the power for tax purposes. It would be patently unreasonable for scrip dividends passed to the life tenant to be subject to possible CGT in the hands of the trustees, and taxed as income in the hands of the life tenant; this last even more unreasonable if the trustees allocate the dividend to capital! Unless the Revenue follow the trustees’ exercise of these powers there will be inevitably substantial unfairness between beneficiaries.
7.39.2 Because of the tax implications it is agreed that the first day of a new tax year is an appropriate time for implementation. Even this would not solve the problem arising if a receipt were able to be reallocated in a later tax year. Would the Revenue tax the “capital” element in year 2 as the life-tenant’s income; if the rate liability in year 1 was materially different from year 2 would the Revenue make adjustments, and if not would the beneficiary complain that the trustees discretion had been wrongly exercised? Does this mean that the trustees would have to know and take into account the beneficiary’s tax rates in both years, though his personal circumstances are not otherwise to be taken into account? These and other anomalies show the practical problems associated with the proposed power of allocation.
7.39.3 If the trustees have just a duty to classify receipts, as is recommended, many of these tax problems disappear.
Charities
7.40 We provisionally propose that charity trustees should not be subject to any duty to balance. Do consultees agree? (Paragraph 6.35)
7.40. Please refer to the earlier comment that the duty to balance is in reality the duty to carry out correctly the purposes of the particular trust. Although the successive interests are not those of the charity on the one hand and other person on the other, there may well be successive interests in terms of the ultimate beneficiaries. It may well be that the trust is so constituted to ensure that future generations as well as the present generation should benefit. If the statutory power of allocation (or, preferably, the duty of classification) were to be removed in the case of charities, that purpose of the trust would be frustrated. It would appear to amount to a variation of the ultimate beneficial interests, which ought not to be brought about in this manner.
7.41 We provisionally propose that the statutory power of allocation which is proposed for private trusts should not be available to charitable trusts. Do consultees agree? (Paragraph 6.35)
7.41 Please refer to the reply to 7.40.
7.42 We invite the views of consultees on whether the duty of charity trustees to consider the present and future needs of the charity and its objects should be placed on a statutory footing. (Paragraph 6.35)
7.43 We provisionally propose that our proposed rules of classification for the receipts and expenses of private trusts should also apply to charitable trusts but should apply to give conclusive rather than default classifications. Do consultees agree? (Paragraph 6.36)
7.44 We provisionally propose that charity trustees should have a general statutory power to invest on a total return basis. If the trustees chose to invest on a total return basis, they would be required to report this decision and submit the charity’s accounts to the Charity Commission each year. Do consultees agree? (Paragraph 6.61)
7.45 We invite the views of consultees on whether or not, if the current system of individual authorisations by the Charity Commission is maintained, the procedure for applying for and obtaining authorisation should be placed on a statutory footing. (Paragraph 6.61)
7.42-45 This paper makes no further submissions on these matters.
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