Ownership and tax issues – HMRC guidance on constructive and resulting trusts

It is straightforward in most cases to establish an individual’s income entitlement for tax purposes. However, there are exceptions. HM Revenue andCustoms (HMRC) recently issued new guidance in its Trusts Settlements and Estates manual on the concepts of ‘resulting trust’ and ‘constructive trust’ for income tax purposes. These are 'implied trusts', which are created by operation of law, as opposed to 'express trusts' which a settlor normally creates expressly by trust deed.

Resulting trusts
A ‘resulting trust’ is a legal concept. It basically means that property reverts back to the settlor. HMRC guidance provides various examples of a resulting trust, one of which is reproduced below in the context of a joint saving account (see TSEM9620): Example “A contributes 100% of the funds in a saving account in the name of A and B. There is presumption of a resulting trust, whereby A holds 100% of the beneficial interest in the funds. A is taxable on all the income.” [Note – the example points to separate guidance in the case of property held jointly by married couples and civil partners (TSEM9800 onwards) which deals with the ‘50/50’ rule and the ‘form 17 rule’ and the specific tax legislation for spouses and civil partners in ITA 2007, ss 836–837.] It is presumed that the settlor had an intention that the property would revert back to him or her. However, HMRC accepts that this presumption can be rebutted, such as by the following:

(a) Gift or loan – if there is evidence to that effect;
(b) Other factors – if they show evidence that the ‘contributor’ did not intend to take an interest in the property;
(c) Express trust – such trusts can include oral trusts;
(d) Presumption of advancement – this mainly applies in the family context of purchases or contributions by (say) father for child or husband for wife (but not where a wife provides money for property for her husband) (Note – The presumption of advancement may be abolished from a date to be appointed – see Equality Act 2010, s 199).

The 'presumption' is that the husband/father etc intended the 'advancement' (i.e. the purchase or contribution) to be a gift. HMRC considers that further principles relating to resulting trusts may apply for income tax purposes in the context of land and buildings. Firstly, an agreement following the acquisition of property cannot give rise to a resulting trust, as it must be there from the outset. Secondly, establishing a resulting trust requires a direct contribution to the purchase price of the property at or from the date of purchase (e.g. cash, contribution to the deposit, mortgage payments).
Constructive trusts
HMRC's guidance acknowledges that a constructive trust is a legal concept, which can apply in a non-tax context (e.g. home ownership by unmarried couples, or where a shareholder receives an unlawful dividend and thus holds it as a 'constructive trustee' for the company. In a tax context, HMRC states that a constructive trust arises where "...there is an alleged agreement or 'common intention' that the parties should share beneficial ownership of the property in some way that differs from the legal ownership or from the normal presumption of resulting trust, with the result that the income tax liability is not entirely on the legal owner." HMRC provides the following illustration.

Example
"For example, A has legal ownership of property, but claims that A and B have an agreement that the beneficial ownership is to be shared 50/50. Or A has provided all the funds, but claims there is an agreement that the property is to be shared between A and B." In the case of land, a disposal cannot generally be effected except by a signed document. The same applies to a declaration of trust in respect of land. However, this requirement does not apply to constructive (or resulting or implied) trusts (Law of Property Act 1925, s 53(2)). HMRC will require taxpayers to establish that a constructive trust exists, by considering the following questions (TSEM9710):
1) Was there an agreement or "common intention" that the parties should share beneficial ownership of the property? HMRC will require evidence that at the time of purchase there was an agreement or common intention that the beneficial interests should not follow the legal interest (e.g. Mr A is to be the legal owner, but beneficial ownership is to be 50:50 between Mr A and Mrs A). The agreement may be express or implied by conduct.
2) If so, did the parties act to their detriment (disadvantage) in reliance on that agreement or common intention or change his or her position? HMRC defines 'detriment' in this context as something which he or she could not reasonably be expected to have done unless they were to have an interest in the property, and considers that the detriment must be 'significant' (TSEM9730).
3) If so, what is the size of the beneficial interest to which the claimant is entitled? This will be a question of fact, but is not necessarily confined to looking at contributions towards the purchase price. HMRC will require taxpayers who argue for a constructive trust to present their claim as if it was being presented to a court of law (TSEM9750).

Capital gains tax
Resulting and constructive trusts are also potentially relevant in a capital gains tax (CGT) context. For example, private residence relief is available to trustees on the disposal of a property which has been the only or main residence of a person entitled to occupy it under the terms of a settlement (TCGA 1992, s 225). HMRC's Capital Gains Manual contains further guidance on resulting and constructive trusts (at CG65415-CG65426). HMRC considers that a claim for private residence relief under TCGA 1992, s 225 is most likely to depend on the taxpayer establishing that there is a "common intention constructive trust" (for cases in England and Wales), by reference to nontax cases, Oxley v Hiscock ([2004] EWCA Civ 546) and Stack v Dowden [2007] UKHL 17. More recently, in Kernott v Jones [2011] UKSC 53, unmarried cohabitants bought a house in 1985, and jointly owned it, without making any declaration as to how their beneficial interests should be apportioned. The relationship ended, and Mr Kernott moved out. Ms Jones had originally contributed £6,000 of the £30,000 purchase price, and the balance had been funded by an interest-only mortgage. Following the separation, Ms Jones continued to live in the property, and assumed sole responsibility for the mortgage and outgoings. Mr Kernott later demanded his half-share of the house. However, the County Court awarded Ms Jones 90% of the equity. Mr Kernott unsuccessfully appealed to the High Court. Subsequently, the Court of Appeal held that each party had a 50% beneficial interest in the property. However, the Supreme Court overturned that decision, stating that an initial presumption of joint tenancy in law and equity can be displaced if the parties changed their intentions, and that a court can deduce their common intention from their conduct. The land registry form (TR1) includes a 'declaration of trust' box. If it has been completed, HMRC will treat it as an express trust, which will be binding on the parties who make the declaration. Whilst this does not prevent a claim by a third party that there is a constructive trust, HMRC indicates that this may be difficult to establish, and illustrated this point in the following example (CG65420): "For example, a husband and wife buy a house and complete the TR1 showing that they own the property as tenants in common in equal shares. They allow their daughter to live in the house rent-free but she has to maintain the property and pay for the property insurance. When the house is sold the parents claim that they held it on constructive trust for the daughter. The fact that they declared they held the property on trust for themselves is good evidence that they did not intend to hold in on trust for anyone else. A constructive trust would have to arise later as a result of a fresh agreement or some further act of detriment by the third party such as a very substantial contribution to improvements. Such a later agreement would be exceptional."

Taxpayers wishing to claim private residence relief under TCGA 1992, s 225 on the basis of a constructive trust will probably need to convince HMRC that two conditions were satisfied. Firstly, that there was a common intention that both parties (i.e. the trustees as legal owners and the beneficiary) would have an interest in the property (i.e. by express agreement, or inferred from their conduct). Secondly, the beneficiary acted to his or her detriment on the basis of that common intention (such that it would be inequitable to deny that interest). In the context of CGT relief under s 225, HMRC points out (CG65422): "When applied to TCGA92/S225 this means that the legal owners of the property will claim they held the property as trustees of a constructive trust under which a person occupies the property as a beneficiary of that trust. The legal owners will also be the settlors of the trust as they will have provided the property either by buying it so it can be occupied or by providing a property they already own. The terms of the trust will usually be that the beneficiary had a life interest in the property."

If an individual uses his or her own money to buy an asset (e.g. a property) in the name of someone else, HMRC considers that a bare trust should generally be regarded as existing in favour of the purchaser (CG34400). However, if the other person is the purchaser's wife or child, the purchaser will be presumed (in the absence of evidence to the contrary) to have made a gift to the wife or child. In the recent case Singh v HMRC [2011] UKFTT 584 (TC), four properties were held to have been bought and sold by the taxpayer on trust for himself and one of his brothers equally. The First-tier tribunal in that case made the following distinction between resulting and constructive trusts: "The Tribunal’s view is that, under a resulting trust, the interest held under trust must have been created at the date of acquisition of the property and, in the case of a constructive trust, prior to the property’s disposal." The tribunal added: "A distinction must be drawn between resulting and constructive trusts when calculating the parties’ beneficial shares. A resulting trust only recognises the actual payments made. For a constructive trust there must be a finding of either an implied common intention resulting from a substantial contribution or an express common intention between the parties, of shared beneficial ownership in the property, plus an act of detrimental reliance on that intention by the party or parties not on the title. Only where such a common intention cannot be found can a resulting trust be inferred from financial contributions towards the acquisition of the property. If a common intention and thus a constructive trust is found, a court can ascertain the individual beneficial shares at its discretion."

Conclusion
Whereas an express trust generally operates according to a trust deed, resulting and constructive trusts apply by operation of the law. Of course, HMRC guidance does not carry the force of law, and its approach may be called into question. Indeed, in the Singh case, the tribunal commented: "HMRC says that, ‘whilst an agreement could initially be made orally, it must be followed up in writing prior to the disposal of the asset’. No case law authority for this particular proposition was offered by HMRC and it is not one with which the Tribunal would necessarily agree.” However, an awareness of HMRC's approach to implied trusts will be useful if seeking to demonstrate that one exists. The common thread running through HMRC's income tax and CGT guidance is the importance of evidence where it is claimed that legal and beneficial ownership differs. Such evidence may include direct contributions to the purchase price, the payment of regularmortgage contributions, or possibly significant contributions by way of manual labour (CG65425). It may also be relevant whether (say) the legal owners of a property have made it clear (e.g. to banks
or mortgage lenders) that they own the property subject to an agreement that an occupier has an interest in it (CG65426). The onus of proof will be on the person who asserts that there is a difference between the legal and beneficial ownership to show how it differs.

Written by Ellie MacKenzie

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