IHT and Charities: A matter of interpretation

This article first appeared in the Trusts and Estates Law & Tax Journal: www.lawjournals.co.uk.

The Court of Appeal’s recent decision in Peter Routier, Christine Ann Venables (as Executors of the late Beryl Coulter) v The Commissioners for Her Majesty’s Revenue and Customs [2016] (“Routier”) explores the inheritance tax relief exemption on gifts to charities and the conditions that apply in order to claim the relief.

  

The court considered whether an estate was exempt from inheritance tax by virtue of the residuary estate being ‘given to charities’ for the purposes of section 23 of the Inheritance Tax Act 1984 (“IHTA 1984”), which provides that “transfers of value are exempt to the extent that the values transferred by them are attributable to property which is given to charities.”  The legislation also stipulates that property is ‘given to charities’ if it is given to the charity absolutely or if it is held on trust for charitable purposes only.    

This case is likely to be of interest to probate lawyers and charity law practitioners as it deals with the issues as to whether a charity must be governed by the law of the United Kingdom in order to qualify for the inheritance tax exemption and whether the expression ‘held on trust for charitable purposes only’ meant that the charitable purposes had to be charitable purposes under UK law.
 

Background

Mrs Coulter she died on 9 October 2007, domiciled in Jersey.  Under the terms of her Will, her residuary estate was to be left to be held on trust (“the Coulter Trust”) “to accumulate the income of the Coulter Trust and to distribute the Coulter Trust together with any accumulated income therefrom unto such incorporated body as may be set up by the Parish of St Ouen for the purpose of the provision of homes for the elderly of the Parish…’  The trust would be governed by Jersey law and its trustees were Jersey trustees.    

Mrs Coulter’s will contained a gift in default which provided that if the Parish neglected or refused to set up an incorporated body within three years of her death or failed to accept the conditions of her gift, then her trustees should hold the Coulter Trust and distribute the income and capital to Jersey Hospice Care to assist with capital expenditure.   In the event that capital expenditure was required for the construction of buildings for Jersey Hospice Care, this would be on the same conditions as stipulated for the primary residuary gift.

Although the parties were in agreement that the objects of the Coulter Trust were exclusively charitable purposes accordingly to English law, on 29 May 2013, HMRC issued notices of determination, which determined that the exemption under section 23 IHTA 1984 was not available on the basis that there is an implied requirement under section 23 that the trust is governed by some part of the UK.  As the Coulter Trust was governed by Jersey law, it was not “a trust for charitable purposes” and could not benefit from the exemption.

The Executors appealed to the High Court and in an order made on 18 September 2014, Mrs Justice Rose dismissed the appeal and held that the words ‘held on trust for charitable purposes’ contained an implied requirement that a qualifying charitable trust must be governed by the law of some part of the UK and subject to the jurisdiction of the UK courts.

The Executors appealed against the order of Mrs Justice Rose.

 

The issues before the Court of Appeal

The court considered the meanings of ‘charity’ and ‘charitable purposes.’  The IHTA 1984 states that the words “charity” and “charitable purposes” shall have the same meanings as in the Income Tax Acts (“ITA”).  In 2007, this could be found in section 989 of the ITA 2007 which defined a charity as “any body of persons or trust established for charitable purposes only.”  In 2007, prior to the Charities Act 2006 coming into force, the term “charitable purposes’ was construed in accordance with its English common law meaning.

Having considered the meanings of ‘charity’ and ‘charitable purposes’, the court established that section 23 IHTA could be interpreted as having two limbs:
 

  1. the first limb exempted a transfer if the property becomes the property of any body of persons or trust established for charitable purposes only; and
     
  2. the second limb exempted the transfer if the property is held on trust for charitable purposes only.
     

The parties agreed that the Coulter Trust did was not a ‘trust established for charitable purposes only’ within the first limb of section 23 IHTA 1984 due to the fact that in Camille and Henry Dreyfus Foundation Inc v IRC [1956] (“Dreyfus”) the House of Lords held that this phrase contained an implicit limitation that it includes trusts which are governed by the law of some part of the United Kingdom and are subject to the jurisdiction of the courts of United Kingdom.

The first and key issue for the Court of Appeal was whether the phrase ‘held on trust for charitable purposes only’ in the second limb of section 23 IHTA 1984 is subject to an implicit limitation that the trust must be governed by the law of the UK and subject to the courts of the UK. 

The second issue arose out of the appellants’ assertion that HMRC and Mrs Justice Rose’s interpretation of section 23 IHTA 1984 constituted an unlawful restriction on the free movement of capital between member states and third countries within the meaning of Article 63 of the Treaty on the Functioning of the European Union (“the TFEU”). 

Whilst the parties accepted that following the decision in Roque v Lieutenant Governor of Jersey [1998], relations between the UK and Jersey cannot be treated the same as relations between two member states, they were in disagreement as to whether Jersey could be treated as a third country for the purposes of free movement of capital.

As the parties were unable to develop their submissions in relation to the second issue during the hearing, the court directed that it would deal with the appeal in two parts.  It would give judgment in relation to the first issue and then if required give directions relating to the second issue.

 

Camille and Henry Dreyfus Foundation Inc v IRC [1956] (“Dreyfus”)

In dealing with the first issue, the court examined the principles established in the decision of Dreyfus, a case in which a foundation based in New York applied to HMRC for exemption from income tax in respect of royalties earned in the UK.   The exemption they relied on was section 37(1) (b) of the Income Tax Act 1918 (‘ITA 1918’) which applied to income “forming part of the income of any body of persons or trust established for charitable purposes only or which, according to the rule or regulations established by Act of Parliament, charter, decree, deed of trust, or will, are applicable to charitable purposes only, and so far as the same are applied to charitable purposes only . . .” 

The Court of Appeal focused on the requirement that the body of persons or trust must be “established” for charitable purposes and determined that the word “established” meant established in the UK.  The court noted that the reference to “charitable purposes” in section 37 meant UK charitable purpose and observed that the words ‘charities’ or ‘charitable institutions’ in an ordinary context in an English statute must mean institutions that are regulated by and subject to the laws of the UK and constituted for carrying out objects which would be held to be charitable in the courts of the UK. 

The court explained that it would be ‘awkward and artificial’ to find that a body established under the laws of a foreign country fell within the scope of UK legislation.  Whilst it held that the Foundation’s purposes were indeed UK charitable law purposes, it found that the foundation could not benefit from the exemption as it was not established under and in accordance with the laws of the UK.  It would be impractical to state on the one hand that the reference to “charitable purposes” meant UK charitable purposes and then evaluate the purposes of a body governed by non-UK law according to that test. 

In reaching its decision, the court considered that the Commissioners would be faced with a difficult task if they had to apply the law of any country in order determine whether the purposes for which a particular body was established before then turning to consider whether those purposes were charitable within the meaning of the United Kingdom.

The court argued that Parliament’s intention when referring to ‘a body of persons established for charitable purposes only’ meant that the body was subject to the jurisdiction of the courts which could define and regulate those purposes.  As the foundation was not subject to the jurisdiction of the UK, it did not benefit from the exemption.   

The House of Lords upheld the decision of the Court of the Appeal that the phrase ‘any body of persons or trusts established for charitable purposes only’ should be construed as being limited to bodies of persons or trusts established in the UK.

 

The High Court’s reasoning in Routier

Having considered the decision in Dreyfus, the court turned to examine Mrs Justice Rose’s reasons for finding that the Coulter Trust failed to qualify for exemption under the second limb of the section 23 test.  These reasons can be summarised as follows:

  • There was a fundamental‘incongruity’ in requiring a court to determine whether the purposes of a body governed by foreign law were charitable purposes in accordance with UK law;
     
  • Whilst the term ‘trust’ was used elsewhere and in other contexts of the IHTA 1984 to refer to overseas trusts, this did not override the established principle that where a statute uses words with a previous legal history, these may be relevant to its interpretation. The question is whether or not Parliament intended to use the words in the context given by the history.  In Mrs Justice Rose’s view, Parliament must have been aware of how the phrase ‘body of persons or trust established for charitable purposes only’ had been interpreted in Dreyfus and must have intended the phrase should have the same meaning in section 23 IHTA 1984.
     
  • The fact that some of the contextual indicators in the second part of section 37(1)(b) ITA 1918 relied upon the Court of the Appeal and the House of Lords in Dreyfus were not included in the wording of section 23 IHTA 1984 did not mean their reasoning was no longer relevant.
     
  • There was no good reason why the second limb of section 23 IHTA 1984 should be so much broader than the first.
     
  • If Parliament has wished to extend the scope of the exemption to overseas trusts, it would have made this clear in section 23(1) IHTA 1984. 

 

The Court of Appeal’s decision

In reaching its decision, the court considered the various submissions put forward on behalf of the Executors, including the argument that the differences between the statutory language of section 37 ITA 1918 and section 23 IHTA 1984 supported the appellants’ interpretation of the phrase ‘body of persons or trust established for charitable purposes’ as section 23 IHTA 1984 had been drafted so as to avoid the terms that were found to denote a UK link in Dreyfus. The court rejected this submission and found it was irrelevant given that the appellants did not suggest the phrase in point had a different meaning in section 23 IHTTA 1984 from that which it had in section 37 of the ITA 1918.

The court held that the second limb of section 23 of the IHTA 1984 must be read in the context of the entire provision, including the first limb which it is agreed, does require the relevant body of persons or trust to be governed by the law of the UK.  It agreed with the decision of Mrs Justice Rose that the Executors had failed to demonstrate any good reason why Parliament would have intended the second limb of section 23 was so much broader than the first, to include trusts governed by foreign law but limited to charitable bodies established under UK law.    

Whilst the court accepted that the word “trust” covers both UK and overseas trusts in other aspects of inheritance tax law, it noted that the relevant phrase in the present circumstances was ‘held on trust for charitable purposes’ and it agreed with HMRC’s view that this meaning included a requirement that the charitable trust must be governed by the law of some part of the UK and subject to the jurisdiction of the UK courts.

The court observed the Court of Appeal’s comments in the judgment in Dreyfus regarding the administrative difficulties that would arise in considering whether a foreign trust holds property for charitable purposes only or is established for charitable purposes only.   This provided further doubt as to whether Parliament would have intended section 23 IHTA 1984 to have the broad meaning contended by the appellants. 

Accordingly, the Executors’ appeal was dismissed and upheld the decision of the High Court that the words “held on trust for charitable purposes” contained a requirement that a qualifying charitable trust must be governed by the law of some part of the UK and subject to the jurisdiction of the UK courts.

Given the court’s finding in relation to the first issue, it would be necessary to deal with the second issue relating to the appellants’ assertion that section 23 IHTA 1984 as construed by HMRC constituted an unlawful restriction on the free movement of capital between member states and third countries within the meaning of Article 63 of the TFEU.  The court invited the parties to propose directions in this regard.

 

Conclusion for Practitioners

Practitioners should note that whilst there is no requirement in statute that a charity must be subject to the jurisdiction of the UK courts in order for the gift to be exempt from IHT, the court was reluctant to interpret the second limb of section 23 IHTA 1984 broadly and took the view that Parliament would not have intended the wording in the statute to cover charities governed by foreign law.  Therefore, probate practitioners should proceed on the basis that the inheritance tax charity relief only applies to charities that meet the jurisdiction condition.

It is important to bear in mind that this gift took effect in 2007, and since then the law has developed such that it would seem that UK taxpayers are entitled to the exemption under section 23(1) IHTA 1984 if the gift has been made to an EU charity or a charity in Iceland or Norway.  The requirement remains that in order to qualify for the relief, the charity’s purposes must be exclusively charitable under UK law.

It remains to be seen whether how the court will deal with the issue as to whether its interpretation of section 23 IHTA 1984 constitutes an unlawful restriction on the free movement of capital between member states and third countries within the meaning of Article 63 of the TFEU.