HC Deb 15 July 1958 vol 591 cc1045-55

(1) Chapter II of Part XVIII of the Income Tax Act, 1952 (which relates to settlements on children) shall be amended in accordance with the following provisions of this section.

(2) In relation to a payment to which this subsection applies, the words "at the time of the payment" shall be substituted for the words "at the commencement of that year" in subsection (1) of section three hundred and ninety-seven of that Act (which relates to payments in any year of assessment to or for the benefit of a child who at the commencement of that year was an infant and unmarried) and for the words "at the commencement of the year of assessment in which the sum is paid" in paragraph (b) of subsection (2) of section three hundred and ninety-eight of that Act (which makes provision supplementary to the said section three hundred and ninety-seven).

(3) The reference in the said paragraph (b) to another sum previously paid to or for the benefit of a child who, at the commencement of the year of assessment in which it was paid, was an infant and unmarried, shall be construed, in relation to a payment to which this subsection applies of any such sum, as a reference to a sum so paid to or for the benefit of a child who at the time of the payment was an infant and unmarried.

(4) Subsections (2) and (3) of this section apply to any payment made after the year 1957–58, except a payment made in the year 1958–59 to or for the benefit of a child born after the sixth day of April, nineteen hundred and fifty-eight and so made by virtue or in consequence of a settlement made before the ninth day of July, of that year.

(5) In paragraph (ii) of the proviso to section three hundred and ninety-nine of the Income Tax Act, 1952 (which enables a settlement to be treated as irrevocable for the purposes of the said Chapter II notwithstanding that it provides for its determination, if the determination will not, during the lifetime of such a child as is mentioned in that section, benefit any person other than such a child, or the wife, husband or issue of such a child), for the words from "any person" to "issue of such a child" there shall be substituted the words "the settlor or the wife or husband of the settlor".

(6) In relation to a settlement which would not have been irrevocable within the meaning of the said Part II but for subsection (5) of this section, the reference in paragraph (b) of subsection (2) of the said section three hundred and ninety-eight to the date when it became irrevocable shall be construed as referring to the sixth day of April, nineteen hundred and fifty-eight.—[The Solicitor-General.]

Brought up, and read the First time.

5.0 p.m.

The Solicitor-General

I beg to move, That the Clause be read a Second time.

I am afraid it is necessary to give some explanation of this Clause, but I will try not to be too long about it. The Clause is designed to deal with two points, both of which give rise to anomalies in a branch of the law about which the Committee knows, a branch designed to deal with tax avoidance by way of settlements by parents on their minor children.

If I might recall the principle of the legislation, it is really designed to prevent the parent from diverting some of his income to his children, using it for their support and thus, in effect, getting tax relief, whereas if he had made payments to their maintenance out of his own income he could not have got tax relief in respect of those payments.

The first point which is covered by subsections (2) to (4) of the new Clause is one relating to the criterion as to the cases in which the legislation should apply. The Committee will recall what the general rule is. It is in Section 397 of the Consolidating Measure and it provides, in effect, that where by virtue or in consequence of a settlement income is paid during the life of the settlor to or for the benefit of a child of the settlor in any Income Tax year at the commencement of which the child is an infant and unmarried, then the income is to be treated as the income of the settlor. The criterion is the status of the child at the beginning of the Income Tax year in which the payment is made.

That gives rise to anomalies, because in effect it applies the legislation too late and makes it go on too long in application. I must leave out the child born on 6th April because, since the law takes no account of fractions of a day, the child is held to be in existence at the commencement of that Revenue year. Except for the child born on 6th April, the parent can in the year of the child's birth divert his income in favour of the child without running the risk of having the income treated as his own operating by way of a settlement in the year of the child's birth.

On the other hand, if we take the year when the event happens to the child, namely, that it becomes 21 or gets married, as the case may be, in that year if a parent makes a payment under a settlement straightaway upon the happening of the event, incautiously not waiting till the end of the tax year, he will find that although the payment has been made after the child is 21 or after the child has been married, as the case may be, the law will require it to be treated as his, the settlor's, income. Those who have been caught by that one because their advisers did not know it feel a very natural sense of grievance.

What this Clause does as to the first point is to make the criterion not the status of the child at the beginning of the Revenue year with which we are concerned, but the status of the child as it were at the time when the payment is made. It must be a child for the purpose under 21 and unmarried at the time when the payment is made. That gets rid of the anomalies which have given trouble before. The same principle is applied in connection with the law as to accumulated income under children's settlements.

There is one case which requires special treatment. That is the case of the settlement made before the Government's intention was known—that is to say, before 9th July this year—where the child is born since 6th April this year. Obviously in fairness that settlor must be treated as he expected to be treated when the settlement was made, and an exception is made in his favour by subsection (4).

The other point is necessarily a little abstruse and tiresome to explain rapidly, but I will do my best. The Clause alters the definition of what is an irrevocable settlement for the purpose of these provisions. The relevance of an irrevocable settlement in the context is that it affects the law applicable in cases of accumulated income under capital settlements. The general rule is that income accumulated for the benefit of the child in the future is to be treated as paid for his benefit, but there is, as the Committee knows, a limited exception, namely, that where the income is accumulated for the benefit of the child under a settlement of capital and that settlement of capital is irrevocable for the purpose of the relevant provisions, the income escapes being treated as paid out for the benefit of the child. So, as the law is at present, if the income is stored up and not paid out for the benefit of the child in an Income Tax year at the commencement of which the child was under 21 and unmarried, then the payments do not fall to be so treated. The rule as to the criterion applying the status of the child at the commencement of the tax year has been altered by the preceding subsections of the Clause, and I will say no more about it.

There remains the problem that the limited exception is one which works only for capital settlements which are irrevocable within the terms of the legislation. What is an irrevocable settlement for the purpose is defined in Section 399 of the Consolidating Measure: …a settlement shall not be deemed to be irrevocable if the terms thereof provide— (a) for the payment to the settlor… and so on, and (b) for the determination of the settlement by the act or on the default of any person… The Committee will remember that a power to hand out the capital by instalments until none remains in the settlement is a power for the determination of the settlement within the meaning of these provisions. That rule, however, that it shall not be deemed to be irrevocable if the terms thereof provide…for the determination of the settlement by the act or on the default of any person is subject to a qualification set out in provisos. It is the second one that matters here: Provided that a settlement shall not be deemed to be revocable by reason only… (ii) that it provides for the determination of the settlement as aforesaid in such a manner that the determination will not, during the lifetime of any such child as aforesaid, benefit any person other than such a child, or the wife, husband or issue of such a child… Of yore, those provisions were thought to be sufficient to protect the provisions normally put in capital settlements of this kind, but of late there has been a tendency to extend the powers to appoint capital by the trustees largely because there was not confidence that the income would be sufficient. There has also been a tendency to spread wide the class of beneficiaries in whose favour the trustees might appoint capital or income—I suspect in order to avoid a risk of property passing upon a death for Estate Duty purposes.

Those two tendencies have been present, and there are provisions, which modern conveyancers would like to put into settlements and sometimes do, which are caught by the existing provisions of the law, with the result that although there is not the slightest chance of the settlor or the settlor's wife benefiting under the settlement, none the less the whole income arising under it is caught by these provisions.

It is a rule much harsher than the rule applied by Section 404, dealing with revocable settlements, because there the income is caught in effect only if the exercise of power of revocation has the result of the settlor or his spouse benefiting in some circumstances from the application of the property or income under the settlement. The Clause gets rid of this seeming discrepancy and injustice by widening the exceptions allowed for in the second proviso to Section 399. A settlement which can be determined will not, after the enactment of the Clause, be deemed to be revocable if it can be determined only in such a manner that the determination of it will not during the life-time of the relevant child benefit the settlor or the wife of the settlor as the case may be.

The possibility of a benefit on discretionary termination of the settlement going to someone outside the class named in the statute, for instance the spouse of a child of the relevant child, will not of itself bar the settlement from being an irrevocable settlement for the purposes of this legislation. As a result of this, some settlements previously revocable will become irrevocable and subsection (6) provides the date on which they would be so. I should draw attention to the misprint in subsection (6). The reference should not be to Part II but to Chapter I.

Mr. Houghton

The Solicitor General said that the new Clause would remove anomalies. I think that there is rather more in it than that. I was surprised that the right hon. and learned Gentleman did not explain to the Committee why the new Clause has been introduced now. There is nothing new in anything that the right hon. and learned Gentleman has said. This is not the product of the latest imaginative exercise by the Commissioners of Inland Revenue, as in the case of the dividend stripping a little while ago. This is something which the Inland Revenue has known about for a long time.

My understanding has been that this was a form of tax avoidance and that the attraction of taking advantage of Section 397 of the Income Tax, 1952, was the benefit in the first year. It rather looks as though the draftsmen of Section 397, when it was first enacted in the Finance Act before the war, overlooked what might be done under a provision which dealt only with the status of a child at the commencement of the year of assessment. Where there was no child at the commencement of the year of assessment and a child was born after the beginning of that Income Tax year, it seemed that it escaped altogether the overriding provision that the income which the settlor had assigned to the child would be regarded for tax purposes as the income of the settlor.

5.15 p.m.

The origin of this, if my recollection is correct, is the step which the Chancellor of the day took to deal with the widespread dispositions in favour of minors, which at the time were increasing rapidly in number and which on any reasonable basis the Chancellor was entitled to think were largely bogus. The tax avoidance was in disposing of income to children, which probably in many cases never actually passed. Even if it did, it was devoted to the maintenance of the children which, as the Solicitor-General has pointed out, gave a tax relief to the parent, who was the settlor, in circumstances in which payments made in the ordinary way for the maintenance of children would atract no tax relief beyond the normal child allowance. It was to stop that tax avoidance device that Section 397 of the 1952 Act came into being.

A friend of mine told me that several years ago when his wife gave birth to a child a very reputable firm of solicitors suggested that there was something he could do to get a substantial advantage in the first year. It seems that at present, if a child is born after 6th April in the tax year, a settlement can be made by the parent on the child for any amount and for that year, but for that year only, the income will be treated for tax purposes as the income of the child, because at the commencement of that year it was neither a minor nor unmarried because it was not born.

In that case, a settlement of £1,000 a year on a child would relieve the parent, who obviously in these circumstances would be a Surtax payer, of Income Tax and Surtax on the £1,000 in that year. It would be assessable on the minor, who would be entitled to normal allowances, but no surtax would be payable on that £1,000 income. In more modest cases a parent could settle on a child just enough in the first year not to disqualify the parent from the normal child allowance but which would give tax exemption on the amount of income settled on the child in the first year.

It could be £99, so that the child would not have an income of £100 and therefore disqualify the parent from the child allowance. The £99 would be exempt from tax in the hands of the minor. It would be regarded as a charge on the income of the parent for tax purposes, and the parent would enjoy the benefit of the child allowance on top. The attraction of adopting this form of settlement has been to get a benefit in the first year.

The Solicitor-General has pointed out that unless the taxpayer or his advisers were wary and the settlement endured to the time when the child ceased to be a minor or got married the taxpayer might then get caught. I do not want to impute unworthy motives to people, but do these settlements endure? What happens to them after the first year? I strongly doubt whether many of them ever see the light of day after the Inland Revenue has received them in order to determine tax liability in the first year. Therefore, if the Solicitor-General had said that the new Clause was intended not only to correct anomalies but to stop something of a racket, the Committee would have understood better what the new Clause was about.

If my interpretation of the situation is incorrect; if I am wrong in saying that in some organisations this benefit of tax relief in these circumstances is made widely known amongst the top-ranking executive officers, will the Solicitor-General explain why the Chancellor has brought forward this Clause at this stage? I mentioned to some of my hon. and right hon. Friends, in discussions we were having on the Finance Bill, that I was minded to ask the Chancellor of the Exchequer a question as to how many of these settlements were now being dealt with, and whether they were showing any significant rise.

Had I had time to ask the question before the Chancellor came forward with his remedial Clause, we might have learned a little more clearly the origins of the action the Chancellor has taken. Of course, I am not rebuking him in any way. I am merely inviting the Solicitor-General to tell the Committee a little more clearly the underlying purpose of this Clause beyond the correction of anomalies as he described them when moving its Second Reading.

I understand that the definition of irrevocable settlements has probably been a litle harsh and could be amended without any unfairness to the Revenue, but I am still puzzled to know why we have this Clause before us in these circumstances today. Why was it not thought of at the time of the Finance Bill? Have developments taken place in recent months which led the Chancellor to feel that action cannot be taken while the Finance Bill is still before the Committee?

I shall be prepared to accept any statement by the Minister that in the interests of the protection of the Revenue it was considered desirable to make this correction. On these benches we are all in favour of checking artificial arrangements for tax avoidance, as some of these undoubtedly are, and we shall certainly support the Clause, which in my opinion has, among other objects, very definitely the purpose of checking a form of tax avoidance which has been opened by the words in Section 397: …at the commencement of that year the child was an infant and unmarried"— and which the Clause proposes to amend.

Mr. Page

Before my right hon. and learned Friend answers those questions, may I say that the hon. Gentleman the Member for Sowerby (Mr. Houghton) is exaggerating when he refers to this practice as a racket or as a plan for avoidance of the present law. He must know that the numbers of cases in which the windfall comes in the first year are very small compared with the numbers of cases in which the axe falls in the twenty-first and twenty-second years. Most settlements are made after the child's first few years and not in that first year, and it is to give relief to those who have suffered tax in the twenty-first year that this Clause is introduced. Of course, a well-drawn settlement could avoid that axe by directing the accumulation to the twenty-second birthday instead of the twenty-first. My right hon. and learned Friend in this Clause is assisting the bad draftsman as it were, whereas the good draftsman could get round the law without his assistance.

In his admirably lucid exposition of this Clause, my right hon. and learned Friend omitted to deal with one point, unless I did not grasp it. Does this Clause have any effect on the payment of the accumulated income after the child becomes twenty-one or married if there is direction for accumulation of the income under the irrevocable settlement during the infancy of the child, and that income is not paid out in the maintenance, education or benefit of the child, and it is then paid to the child or paid on the child reaching majority?

Mr. Diamond

Before the Minister replies, I want to underline the request made by my hon. Friend the Member for Sowerby (Mr. Houghton), for slightly different reasons. I should have thought that, as the law stands, one gains on the swings what one loses on the roundabouts, except for the fact that the settlements—that is, the swings—where benefit is obtained during the first eleven and a half months of the child's life were less than the benefits lost during the period when the child is twenty but not quite twenty-one.

I should have thought, therefore, that the effect of this Clause would certainly be to stop the smaller racket to which my hon. Friend referred, that is to say, the rather gentle racket of obtaining the benefit during the first eleven and a half months of the child's life—in other words, where the child was born some time after 6th April of the relevant year; but, on the other hand, was adjusting the situation in favour of the much larger number of taxpayers who are desirous of entering into new settlements as soon as their eldest son is 21 and have found that they cannot usefully do so until their son is not only twenty-one but until the 5th April after his twenty-first birthday.

So, although it is rather a matter of swings and roundabouts, I should have thought the accent was on the second set. Therefore, I underline my hon. Friend's request for information as to why this Clause is introduced now. Speaking from memory, I believe this practice has been going strong since about 1937, when the relevant provisions were introduced. From that time the textbooks drew attention to the fact, for the whole world to see and for practitioners to take advantage of, that one can provide usefully by way of a deed of covenant in favour of a minor child, in the first year of its birth, if born after 6th April. I hope, therefore, that we shall have an explanation.

The Solicitor-General

In answer to the question of my hon. Friend the Member for Crosby (Mr. Page), perhaps I was trying to go too fast and so did not contribute more than a sentence to his point. The answer is that the Clause affects the matter of payments out of accumulated income because it changes the criterion in relation to them in an exactly parallel way. I think I said that but, if not, I apologise because I meant to do so.

I note that the hon. Member for Sowerby (Mr. Houghton) does not quarrel with our treatment of the definition of an irrevocable settlement. On the other point, I do not know of any sinister reason for this matter suddenly arising. I have admired the memory of the hon. Member for Gloucester (Mr. Diamond). I think it was 1936 and not 1937, but it is impressive that he should be so nearly right straight off the cuff.

As far as we know, this is a matter purely of swings and roundabouts. The Revenue will lose at one end of the period and gain at the other end. I am not prepared to advance at this Box any view as to profitability one way or the other. It was not done for that reason or because of any significant increase in the number of such settlements or the lack of them, as far as I know. It is just that, faced with representations of grievance from people who had been, as it were, caught out in the year of the event of the child becoming twenty-one or married, it seemed on reflection to the Revenue that a much more outwardly fair result would be obtained by adopting this system. We have adopted it, and I believe that it will seem to the taxpayer to be a fairer way of operating it, and it will not make much financial difference to what the Revenue derives from settlements of this kind.

Question put and agreed to.

Clause read a Second time, and added to the Bill.