DPRR/10-12/97
Trusts (Capital and Income) Bill [HL]
Memorandum by the Ministry of Justice
for the House of Lords
Delegated Powers and Regulatory Reform Committee
Introduction
This memorandum describes the purpose and content of the Trusts (Capital and
Income) Bill (“the Bill”). It identifies the general content of the Bill; every provision for
delegated legislation in the Bill with appropriate background information; explains the
purpose of the delegated power proposed; describes why the matter is to be dealt with
in delegated legislation; and explains the nature and justification for any parliamentary
procedures, which apply.
Background of the Bill
The Bill will give effect to the Law Commission’s legislative recommendations in
relation to the classification and apportionment of capital and income in trusts (Law
Commission Report No. 315) subject to minor modifications. The Bill has been
introduced into Parliament under the House of Lords procedure for uncontroversial Law
Commission Bills.
The Bill makes three changes to the current law. First, it disapplies, for new trusts: (a)
the statutory rule requiring the apportionment of income over time imposed by the
Apportionment Act 1870, insofar as it relates to trusts; and (b) three of the rules of
apportionment originating in case law, which require adjustments to be made to the
entitlement to income and capital receipts in certain instances. Secondly, it alters the
classification of shares received by trustees by way of investment receipts when the
company in which they hold shares undergoes a demerger. Where such shares are
currently classified as income, they will be classified as capital. Thirdly, it facilitates
total return investment for charities with a permanent endowment; trustees will be able
to make a resolution opting for new Charity Commission regulations to apply in place of
the investment restrictions that currently prevent total return investment. The Bill
contains delegated powers in relation to classification and total return investment.
There are no delegated powers in relation to apportionment.
More detailed information about the purpose and effect of the Bill and the background
to the proposals can be found in the Explanatory Notes published with the Bill.
Delegated Powers
The Bill contains three delegated powers:
- the Secretary of State may by order specify descriptions of distributions made by
bodies corporate for the purposes of clause 2 and 3 of the Bill (clause 2(3)(b));
- the Charity Commission may make regulations relating to the adoption of total return
investment by charity trustees (clause 4);
- the Secretary of State may bring the Act into force by commencement order (clause
5(3)).
Clause 2(3)(a) – Power to classify certain corporate distributions as capital
Background
The Bill addresses an aspect of the trust law classification of investment receipts from
companies as income or capital: the classification of dividends received by trustee
shareholders which are distributions made in the course of a corporate demerger.
Such demergers can be of two kinds: direct and indirect. In each case Company A
transfers part of its business to a new subsidiary company, Company B, and then
declares a dividend to its shareholders. In a direct demerger the dividend is satisfied by
Company A distributing the share capital of Company B to its own shareholders. In an
indirect demerger the shares in Company B are transferred to a separate holding
company, Company C. In consideration for this transfer, Company C satisfies
Company A’s dividend by issuing its own shares to the shareholders of Company A.
Pursuant to a decision of the House of Lords,1 shares distributed in the course of a
direct demerger have to be classified as income. The result of this is that following a
company reorganisation by way of a direct demerger, the trust fund’s former capital
asset – the original shareholding in Company A – will be effectively split between
capital and income to the extent that the value is now represented by shares in
Company B. The Company B shares passing to the income beneficiary could represent
a substantial percentage of the original shareholding in Company A – far in excess of
normal expectations for an income return. However, exceptionally, it was later decided
in the High Court that shares distributed in the course of an indirect demerger should
be classified as capital.2 Therefore, in such a case the shares in Company C retain the
classification of the original Company A shareholding; the income beneficiary does not
receive a portion of that asset merely by virtue of the corporate reorganisation.
The Bill provides that where the distribution is tax-exempt under section 1076, 1077 or
1078 of the Corporation Tax Act 2010, the shares distributed in direct and indirect
demergers will for the future be treated as capital for the purposes of the trust. This
reform affects both private and charitable trusts, whenever created.
The delegated power
There are two categories of distributions that are defined as tax-exempt corporate
distributions for the purposes of clauses 2 and 3 of the Bill. The first category is
distributions that are exempt by virtue of section 1076, 1077 or 1078 of the Corporation
Tax Act 2010 (clause 2(3)(a)). The second category is any other tax-exempt
distribution of assets in any form made by a body corporate where the distribution is of
a description specified by order made by the Secretary of State (clause 2(3)(b)).
The reason for the power
The power to make such an order provides for future developments in tax legislation
that create new exempt distributions. If those exempt distributions gave rise to trust law
classification problems akin to those described for corporate demergers, it could be
appropriate to apply clause 2 to them. The department is not at present aware of any
distributions to which the power could be applied.
1
2
Bouch v Sproule (1887) LR 12 App Cas 385.
Sinclair v Lee [1993] Ch 497.
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Procedure
Any order made by the Secretary of State under clause 2(3)(b) must be made by
statutory instrument (clause 2(3)(b)) and is subject to annulment by a resolution of
either House of Parliament (clause 2(6)).
This negative resolution procedure is appropriate as the power is limited to tax-exempt
distributions (clause 2(4)). Such distributions can only be created by tax legislation.
Clause 4 - Total return investment for charities regulations
Background
Clause 4 inserts two new sections into the Charities Act 2011. New section 104A
enables the charity trustees, if a specified condition is met, to make a resolution
replacing the restrictions with respect to expenditure of capital that are imposed by the
terms applicable to the permanent endowment with the requirements of the regulations
to be made by the Charity Commission under new section 104B. The regulations will
specify the Charity Commission’s requirements in relation to the resolutions and the
investment on a total return basis. The specified condition is that the charity trustees
are satisfied it is in the interests of the charity for the regulations to apply in place of the
restrictions.
Charities with permanent endowment are ordinarily restricted in their investment
decisions, since they must keep separate income available for current use and capital
held to produce future income. Because investment returns that trust law classifies as
capital cannot be spent on current charitable purposes, trustees of charities with
permanent endowment have to pursue an investment strategy which produces
sufficient income yet maintains a balance between capital and income returns.
Trustees must therefore invest with a view to the likely form of the receipt – as income
or capital – in an endeavour to ensure that future investment receipts do not favour
income or capital disproportionately.
By contrast, under total return investment, trustees invest with a view to optimising the
overall investment return, no matter whether that takes the form of capital or income.
The trustees then decide how much of that overall return should be allocated to be
expended on current charitable purposes and how much should be retained to produce
future returns; even if that means retaining returns classified as income. While in taking
those decisions trustees have to balance the need for current expenditure and the
need to maintain the long term capital value of the fund, decisions on investment are
not influenced by the requirement to generate returns that take the form of income or
capital, as the case may be. The usual considerations when trustees invest – in
particular, the need to balance risk and return – still apply.
At present, trustees of charities with permanent endowment can only operate total
return investment if they apply to the Charity Commission for an order enabling them to
do so, in accordance with the Charity Commission’s scheme for total return investment
set out in its Operational Guidance.3
3
Charity Commission, Operational Guidance 83 Endowed Charities: A Total Return Approach to
Investment (available at http://www.charity-commission.gov.uk/About_us/OGs/index 083.aspx).
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The delegated powers
The new section 104B of the Charities Act 2011 (to be inserted by clause 4) gives the
Charity Commission power to make regulations enabling total return investment. This
power is in addition to the existing powers of the Commission to make regulations
under Part 6 of the 2011 Act (see sections 63, 65 and 169).
Section 104B(1)(a) enables regulations to be made concerning resolutions under
section 104A(2). Section 104A(2) enables the charity trustees to pass a resolution in
respect of part or the whole of the permanent endowment fund where they consider
that it ought to be freed from the applicable restrictions to enable investment without
the need to maintain a balance between capital and income returns. The effect is that
the relevant restrictions on capital expenditure no longer apply to the fund affected by
the resolution; instead, the Charity Commission’s total return investment regulations
apply (section 104A(4)). The charity trustees must be satisfied that this is in the
charity’s interests in order to pass a resolution under section 104A(2): section 104A(3).
Section 104B(1)(b) enables the Charity Commission to make regulations concerning
the investment of the relevant fund on a total return basis, and the expenditure from
such a fund. “Relevant fund” is defined in subsection (6), and includes both the fund
affected by the resolution under section 104A and all investment returns on it, both
capital and income.
Section 104B(2) and (3) contains an illustrative list of requirements and restrictions that
may be included in the regulations; it will be for the Charity Commission to decide on
the specific provisions. For example, the Charity Commission may make regulations
requiring charity trustees to notify the Commission of the making of a resolution within
a specified period of it being passed or imposing restrictions on expenditure or
requiring investment and allocation of investment returns in such a way as to maintain
the long term capital value of the fund, so far as practicable. Nothing in this clause
affects the general duties of charity trustees, for example to have regard to both
present and future needs of the charity.
Section 104B(1)(c) enables the Charity Commission to make regulations about action
the charity trustees need to take in respect of a part or the whole of a fund if a
resolution previously made under section 104A ceases to apply to it. This power could,
for example, be used to require the capital fund of the trust to be replenished in cases
where there is a shortfall.
Provisions for the accumulation of income (that is, converting income to capital) may
be included in the regulations made under section 104B(1)(b) and (c). Section 104B(4)
states that any such provisions are not subject to section 14(3) of the Perpetuities and
Accumulations Act 2009, which restricts any accumulation of income to the statutory
accumulation period of 21 years.
Why the power is necessary
The powers to make regulations in section 104B are necessary so that the Charity
Commission can design and provide support for a detailed total return investment
scheme for charities. Although the Commission authorises total return investment on
an individual basis following application by a charity, it has not yet developed
regulations appropriate for all charities. Any such regulations may be detailed and are
likely to require adjustment from time to time. It would therefore be inappropriate to
include them within primary legislation.
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To help ensure that the regulations ultimately made are suitable the Commission
proposes to consult publically on its proposals for the scheme before finalising the
regulations. However, drawing on its experience of the present system of authorisation
following application, the Commission currently envisages that the principal features of
the regulatory scheme to be implemented under the regulations will be as described in
Annex A.
Procedure
Regulations made under section 104B are not subject to any Parliamentary scrutiny
procedure. This follows the general approach of the Charities Act 2011 (see sections
347 – 349) and is appropriate because the conditions of total return investment are
best determined by the Charity Commission in its general role as the statutory
regulator of charities.
The regulations are to be made in such manner as the Charity Commission determine.
They are not required to be made by statutory instrument. However, under section 347
of the Charities Act 2011 any regulations of the Commission may make different
provision for different cases or descriptions of case or different purposes or areas, and
contain such supplemental, incidental, consequential, transitory or transitional provision
or savings as the Commission considers appropriate. This is appropriate given the
technical content of the regulations and the role of the Commission as statutory
regulator of charities. The Commission must, however, publish the regulations in such
way as it thinks fit (new section 104B(5). This also corresponds with the general
practice of the Commission.
Clause 5(3) - Commencement
The delegated power
Clause 5(3) enables the Secretary of State to bring the provisions of the Bill (other than
clauses 5 and 6 which come into force on the day the Act is passed) into force on such
day or days as he may appoint by order. The order may make such provision as the
Secretary of State considers necessary or expedient for transitory, transitional or
saving purposes in connection with the coming into force of any provision of the Bill.
Why the power is necessary and procedure
The clause 5(3) power is a standard power exercisable by statutory instrument and is
not subject to any resolution procedure. It will enable adequate time for those affected
to make the necessary preparations. It may be the case that the provisions of the
different clauses, particularly clause 4, are brought into force at different times.
Territorial Extent
The Bill extends to England and Wales only. The Bill does not deal with provisions
within the legislative competence of the National Assembly for Wales and does not
affect the functions of Welsh Government Ministers.
Ministry of Justice
February 2012
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Annex A The draft regulations
Charities Act 2011
The Charities (Total Return) Regulations 20xx
Made xx xxxxxx
Coming into force xxxxxxxxxxxxxx
In exercise of the powers conferred on it by section 104B of the Charities Act 2011 the Charity
Commission for England and Wales makes the following regulations:
Part 1 – General Provisions
1.
These regulations may be cited as the Charities (Total Return) Regulations 20xx and
come into force on xxxxxxxx.
2.
In these regulations:
“the 2011 Act” means the Charities Act 2011;
“expendable endowment” means a capital fund which the trustees may convert into
income;
“investment return” means the return from investments which represent the assets given
to the charity on a trust for investment and includes:
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
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
any interest receivable; plus
any net rent and other income or gains derived from the use or exploitation of
assets; plus
any dividends; plus
all forms of capital gain resulting on, or from, the disposal, redemption, or
revaluation of investment assets (including the issue or repayment of share or loan
capital); less
any capital losses resulting on or from the disposal, redemption, or revaluation of
investment assets;
“negative total return” means that the total return represents a reduction in the value of
the relevant fund;
“relevant fund” has the same meaning as in section 104B(6) of the 2011 Act;
“relevant percentage” is the percentage equivalent to the rise in the retail price index or in
the consumer price index for the financial year in which the allocation is made;
“relevant value” is the value of the trust for investment having deducted from that value
the amount of any unapplied total return included within it;
“total return” means the whole of the investment return received by a charity, regardless
of when it has arisen;
“total return approach to investment” means an approach to investment which gives
trustees flexibility in the way they allocate the total return arising from the trust for
investment between the trust for application and the trust for investment;
“trust for application” means a trust that attaches to charity property which the trustees
have to apply for the purposes of the charity within a reasonable period of receipt;
“trust for investment” means a trust that is created when a gift to a charity is made on the
condition that it should not be applied directly for the purposes of the charity, but instead
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should be invested to produce a return. This return is then to be applied for the purposes
of the charity;
“unapplied total return” means that part of the total return which has not been allocated to
either the trust for application or the trust for investment.
Part II – Adoption of a total return approach to investment
3.
(1) These regulations apply where the trustees of a charity with an available endowment
fund (as defined in section 104A(5) of the 2011 Act) make a resolution under section
104A(2) of the 2011 Act.
(2) The trustees shall identify and record, at the time when a resolution under section
104A(2) is made, which part of the existing assets of the charity represents its unapplied
total return.
(3) The trustees may decide, at any time, and from time to time, subject to these
regulations but otherwise at their discretion, what part of the unapplied total return should
be held on the trust for application and, subject to regulation 5, what part of the unapplied
total return should be accumulated as part of the trust for investment.
(4) The unapplied total return which is not allocated to the trust for application nor
accumulated in the trust for investment shall be dealt with in the same way as the trust for
investment until it is so allocated or accumulated.
4.
The trustees may, in exercising their powers in respect of a relevant fund, allocate part of
the relevant fund not exceeding 10% of the total value of the relevant fund (deducting the
amount of any unapplied total return) to the trust for application subject to its recoupment
on a pound for pound basis over a period to be reasonably determined by the trustees.
When exercising this power trustees should have regard to the duty set out in regulation
6 (2) below.
5.
The trustees may, as part of the exercise of their powers in respect of a relevant fund
accumulate in the trust for investment an amount from the investment return which does
not exceed the relevant percentage of the relevant value.
6.
The trustees shall comply with the following directions as to matters connected with, or
arising out of, the exercise of their powers in relation to a relevant fund:
(1) When using those powers, and when discharging the duties set out in regulation 3 (2)
and (4) above and 6 (2) and (3) below, each of the trustees has a duty to exercise such
care and skill as is reasonable in the circumstances, having regard in particular:
(a) to any special knowledge, or experience that he or she has or holds himself out
as having, and
(b) if he or she acts as trustee in the course of a business or profession, to any
special knowledge or experience that it is reasonable to expect of a person acting in
the course of that kind of business or profession.
(2) The trustees shall only exercise their powers in relation to a relevant fund in such a
way as not to prejudice the ability of the charity to meet the present and future needs
which are designated by its trusts.
(3) Before using their powers in relation to a relevant fund, trustees must (unless the
exception applies) obtain and consider proper advice about the way in which, having
regard to the duty expressed in regulation 6 (2) above, the power ought to be used.
(a) the exception is that the trustees need not obtain such advice if they reasonably
conclude that in all the circumstances it is unnecessary or inappropriate to do so.
(b) proper advice is the advice of a person who is reasonably believed by the
trustees to be qualified to give it by his or her ability in and practical experience of
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investment and actuarial matters relevant to the proper use of the power conferred by
clause 1.
(4) The trustees shall in their annual report for each financial year:
(a) state the policy adopted by the trustees for making the identification required by
regulation 3 (2) above, and state the date from which the analysis required by that
sub-clause was performed if different from the date when the charity was established.
(b) give an explanation of the consideration and policies relevant to the trustees’
determination in that financial year of:
(i) the allocation of the charity’s investment return between the trust for
application and the trust for investment
(ii) any allocation of part of the permanent endowment to the trust for
application under the power in regulation 4 above.
(c) identify the person(s) who provided the advice referred to in regulation 6 (3)
above.
(d) if the trustees of the charity concerned are not, or may not be, required to prepare
an annual report, the information required by this sub-clause should be provided in
the notes to the charity’s accounts in the relevant financial year.
(5) The trustees shall, in notes to their accounts for each financial year, give particulars
of:
(a) the aggregate value of the assets representing the value of the unapplied total
return at the beginning of the financial year;
(b) any increase or decrease during the year in the value of the assets representing
the unapplied total return;
(c) the part of the unapplied annual return which the trustees have, in the financial
year, allocated to the trust for application or the trust for investment;
(d) the aggregate value of the assets representing the unapplied total return at the
balance sheet date;
(e) any part of the permanent endowment allocated to the trust for application under
regulation 4 above and any repayments to the permanent endowment by way of
recoupment.
7.
(1) This regulation applies where the Charity Commission for England and Wales has,
prior to the commencement of section 104A(2) of the 2011 Act, conferred on the trustees
of a charity a power enabling them to decide which part of the unapplied total return from
the assets of the charity given to it on trust for investment should be held on trust for
application for the purposes of the charity by way of an order under section 26 of the
Charities Act 1993 or section 105 of the 2011 Act.
(2) Where the trustees make a resolution under section 104A(2) of the 2011 Act, they
may take these regulations as discharging that order subject to the continued payment of
any amounts agreed to be repaid by way of recoupment.
Part III – revocation of a resolution made under section 104A(2)
8.
(1) This clause applies where the trustees who have made a resolution under section
104A(2) of the 2011 Act, wish to revoke that resolution.
(2) Where there is a negative total return, before revoking a resolution under section
104A(2) of the 2011 Act, the trustees shall make provision for an amount equivalent to
the negative total return, together with such amount (not exceeding the relevant
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percentage of the relevant value) that the trustees consider to be appropriate, to be paid
to the available endowment fund over such period as the trustees consider reasonable
provided that such a period shall not exceed 10 years.
(3) In other circumstances, before revoking a resolution under section 104A(2), the
trustees shall consider what part of the unapplied total return should be allocated to the
trust for investment provided that the amount allocated shall not increase the value of the
trust for investment over its value as at the date the total return approach was adopted by
more than the relevant percentage.
(4) The remainder of the unapplied total return remaining after giving effect to any
decision of the trustees under (3) shall be dealt with as expendable endowment.
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