For more information about the taxation of offshore trusts, see Practice note, Taxation of offshore trusts: overview.

Mr Bowring and his sister, Miss Bowring, were UK resident and UK domiciled beneficiaries of an offshore trust established by their father in 1969. By 2001 the trust had stockpiled gains of about £3 million. A UK resident trust, in similar terms was established in 2002 with Mr Bowring and his sister being principal beneficiaries. The trustees of the 1969 trust sold some trust assets at market value to Mr and Miss Bowring who had borrowed funds from another family trust to pay for them. The 1969 trustees used the cash proceeds to buy gilts. They then took out a bank loan secured on the gilts and paid an amount equivalent to the loan to the 2002 trust. The trustees of the 2002 trust made distributions to Mr and Miss Bowring. Mr and Miss Bowring used some of the distributed capital to repay their loans. The trustees of the 1969 trust subsequently sold the gilts and repaid the bank loan, leaving a balance in the trust fund of £300. Mr Bowring paid £400,000 of the funds that he had received as a distribution from the 2002 trust to two cousins who were also beneficiaries of both the 1969 and 2002 trusts. It had always been the intention that he would use part of the distribution to pay them with the purpose of avoiding any possibility of a charge to tax on the cousins.

HMRC issued closure notices amending the amount of tax payable by Mr and Miss Bowring through their self assessment tax returns on the basis that they were liable to pay CGT under the beneficiary charge on the distributions received from the 2002 trust as well as a supplemental charge under section 91. Mr and Miss Bowring appealed to the First-tier Tribunal (tribunal)

The tribunal judges, Barbara Mosedale and Richard Thomas, dismissed Mr and Miss Bowring's appeals, applying the conclusions of the Special Commissioner (Sir Stephen Oliver QC) in Herman and another v HMRC [2007] UKSPC 609. In Herman, although it was accepted that the flip-flop II planning was effective to prevent the realised gains in the original trust transferring into the new settlement, section 97(5) was said to apply very widely so that the beneficiaries who received distributions from the transferee trust were treated as receiving capital payments indirectly from the original trust. They were therefore subject to tax under sections 87 and 91.

The tribunal judges also had to determine whether the payments made by Mr Bowring to his two cousins were assessable on Mr Bowring or on the cousins as beneficiaries of both trusts. This had to be decided because, if the cousins were liable to pay the tax, HMRC would be out of time to assess them. The tribunal judges held that the two cousins were not liable as they did not receive the funds directly from the 2002 trust or indirectly from the 1969 trust. This was on the basis that the distributions made to Mr Bowring had been made with no strings attached so that Mr Bowring was not legally bound to pass on the £400,000 to the cousins. Tracing did not apply to the cousins' money because the trustees of the 2002 trust had not distributed the funds to Mr Bowring to hold on trust for the cousins. Once the funds had passed to Mr Bowring they were no longer imprinted with a trust and causation was broken. Even if the cousins could be said to have received the funds indirectly from the 2002 settlement, it was UK resident and so the section 87 beneficiary charge did not apply.

For most, this case is something of a history lesson and will only be relevant to those who implemented a flip-flop II scheme before anti-avoidance legislation was introduced to block it in the Finance Act 2003. Special Commissioners’ and First-tier tribunal decisions do not set a binding precedent, but they do indicate the approach that a tribunal properly directed in the relevant law is likely to take on the point at issue. In this case the reasoning used by the special commissioner in Herman (who in turn adopted the methodology set out in the House of Lords judgment in West v Trennery [2005] UKHL 5) was thoroughly tested from a number of angles and found to be robust. However, the conclusions reached about the distribution made by one beneficiary to another outside the trust are novel. On similar facts, a beneficiary who receives a direct distribution but passes some of that distribution on to another beneficiary will not be able to pass on some of the associated CGT liability. This seems to be the case even where it has always been the intention that the other beneficiary should also get something from the trust. This seems odd given that, in this case, there was evidence that it had always been the intention that the cousins should share in the original act of bounty effected by the 1969 and 2002 trusts and, the tribunal itself found (at paragraph 91 of its judgment) that section 97(5) was intended to catch the many different ways in which a person could obtain a benefit from a trust other than by a simple transfer of money from the offshore trustees. HMRC was not anxious to put forward a contrary argument because it would have been unable to collect the tax from the cousins.

Bowring v HMRC [2013] UKFTT 366 (TC).