ANALYSIS ON WHETHER A FAMILY SETTLEMENT IS STILL RELEVANT AS A
TAX AVOIDANCE TOOL
The Family Settlement
A settlement entails the conveyance of property or of interests in property to provide for one
or more beneficiaries, members of the settlors family, in a way that differs from what
beneficiaries would receive as heirs under the statutes of descent and distribution.1
A family settlement is therefore a kind of trust. A trust is not defined under The Trustees Act
Cap 164 however, it is defined under Section 2(vvv) of the Income Tax Act Cap 340 as any
arrangement affecting property in relation to which there is a trust.
Creation of a family settlement
A trust (family settlement) is created when the absolute owner of property (the settlor) passes
legal title in that property to a person (the trustee) to hold that property on trust for the benefit
of another person (the beneficiary) in accordance with the terms set out by the settlor.2
In Milroy v. Lord,3 Turner LJ stated that a voluntary settlement is valid if the settlor, in
accordance with the nature of the property comprised in the settlement does everything
necessary to transfer the property and render the settlement binding upon him, by either
transferring it to a trustee for purposes of the settlement or declaring himself a trustee for those
purposes.
Trusts and tax avoidance
Tax avoidance is distinguishable from tax evasion. All tax systems are susceptible to tax
evasion― the illegal underpayment of tax, usually by means of fraudulent concealment or
misrepresentation.4 The seriousness of tax evasion was recognized by the Court of Appeal in
the Victorian Supreme Court in DPP (Commonwealth) v. Goldberg,5 where it was held that
tax evasion was not a game or a victimless crime. That it was a form of corruption in the face
of which, honest victims begin to doubt their own values and are tempted to do what others are
Black’s Law Dictionary, 8th Edition.
A “Settlor” is also defined as a person who makes a settlement of property; especially a trust.― also termed
donor; grantor; founder.
2
Alastair Hudson, Equity and Trusts, 6th ed. (Routledge-Cavendish, 2010) at p. 119
3
(1826) 31 LJ Ch. 798, HC
4
Steven Barkoczy, Foundations of Taxation Law, 10th ed. (Oxford University Press, 2018) p. 215
5
(2001) 184 ALR 387
1
doing with apparent impunity. That tax evasion was not simply a matter of failing to pay ones
debt to the government. It was theft and tax evaders were thieves.
Nevertheless, there is no legal requirement for tax payers to arrange their affairs in ways that
produce the greatest tax revenue for their governments.
In IRC v Duke of Westminster,6 the duke employed a gardener and paid him from his post-tax
income, which was substantial. To reduce the tax, the duke stopped paying the gardener a wage
and instead he agreed to pay an equivalent amount at the end of every specified period. Under
the Income Tax Act of 1918 (UK) would then allow the Duke to claim a tax deductions which
ultimately reduced his tax bill towards income tax and surtax. The Inland Revenue challenged
this arrangement in Court as a tax evasion scheme. Tomlin LJ dismissed the case and famously
held that:
“Every man is entitled, if he can, to order his affairs so that the tax attaching under the appropriate Acts
is less than it otherwise would be. If he succeeds in ordering them so as to secure this result, then, however
unappreciative the Commissioners of Inland Revenue or his fellow tax-payers may be of his ingenuity,
he cannot be compelled to pay an increased tax.”7
It is thus quite natural for taxpayers to want to organize their affairs to legitimately minimize
their tax liabilities, and it is generally an acceptable practice for them to seek tax planning
advice on how to achieve this under the law. In many instances, the tax legislation itself gives
taxpayers express choices and options which can lead to quite different tax outcomes. It follows
that taking advantage of such options is not an abuse of the tax system.8
Mugalula writes that a trust is one of the devices that can be used in tax planning for example
by transferring income from a higher rate taxpayer to one who pays tax at a basic rate, for
instance a wealthy grandfather transferring income bearing assets to trustees for the benefit of
his grandchildren by ensuring that the income of the trust belongs to no individual.
He further notes that one of the clear cases of tax avoidance is the use of the family settlement.
This includes any disposition, trust agreement, arrangement or transfer of assets. Where a
person creates a family settlement, their intention may be to keep the family fortune out of
reach of the taxman.
6
[1936] A.C. 1
Ibid.
8
Barkoczy, op. cit., p. 219
7
That although such tax planning may be allowable, the owner of the income has to completely
divest themselves of such income and should not benefit at all from it. The allocation of such
income must be irrevocable if it is not to attract tax. The test is whether the donee enjoys the
disposed income to the total exclusion of the donor.9
Anti-tax avoidance provisions under the Income Tax Act Cap 340.
Tax payers, should take extreme care in structuring their affairs as the tax legislation contains
both general and specific anti-avoidance provisions designed to combat a broad range of tax
avoidance schemes. This is because tax avoidance schemes are often artificial and contrived
seeking to exploit specific loopholes in the tax system. They sometimes involve transactions
or steps that appear to have little or no substantial commercial purpose other than create a
situation that would otherwise give rise to some form of tax benefit.
The Income Tax Act Cap 340 contains provisions aimed at preventing the abuse of a trust for
tax avoidance by deeming income under certain types of settlement income of the settlor or a
qualified beneficiary.
Under section 71 (5) of the Act, a settlor trust or a qualified beneficiary trust – (a) is not treated
as an entity separate from the settlor or qualified beneficiary, respectively and (b) the income
of such a trust is taxed to the settlor or qualified beneficiary and the property owned by the
trust is deemed to be owned by the settler or qualified beneficiary, as the case may be.
A settlor trust is defined under section 70 (f) to mean a trust in relation to a whole or part of
which, the settlor has – (i) the power to revoke or alter the trust so as to acquire a beneficial
entitlement in the corpus or income of the trust or (ii) a reversionary interest in the corpus or
income of the trust.
Under section 70(d), a “qualified beneficiary trust” means – (i) a trust in relation to which a
person, other than a settlor, has a power solely exercisable by that person to vest the corpus or
income of the trust in that person or (ii) a trust whose sole beneficiary is an individual or an
individual’s estate or appointees, but does not include a trust whose beneficiary is an
incapacitated person.
Under section 70(e) a “settlor” means a person who has transferred property to, or conferred a
benefit on, a trust for no consideration or for a consideration which is less than the market value
9
John Mugalula, Anti-tax avoidance provisions under the Income Tax Act Cap 340: A perspective analysis, p.4
of the property transferred or benefit conferred at the date of the transfer or conferral. These
provisions give no chance to persons attempting to use a trust as device of tax avoidance.
In Prof. Emmanuel Tumusiime Mutebire and 7 others v. URA,10 the Tribunal noted that there
are tax avoidance schemes where persons set up trust and vest their property to them with the
intention of avoiding taxes. Sections 70 and 71 are anti-avoidance mechanisms targeting
persons who create trust but remain the beneficial owners of the settlements.
Suffice to note that trust income tax is chargeable at the hands of either the trustee or the
beneficiary. Section 71(1), (5) and (8) are to the effect that income of a trust is taxed either to
the beneficiary or the trustee.
In William v. Singer,11 it was held inter alia that on examining income tax Acts, the person
charged with tax is neither the trustee nor the beneficiary but the person found in actual receipt
and control of income which is sought to reach the object being to secure for the state a
proportion of the profits chargeable by the simple and expedient taxing of the profits where
they are found. That if the beneficiary receives and controls them he is liable to be assessed
upon them.
From the foregoing, it is evident that family settlements, like any other trusts, have been
rendered ineffective as tax avoidance vehicles. A settlor cannot avoid any taxes by means of a
trust because under the Income Tax Act Cap 340, the Uganda Revenue Authority is empowered
to tax such a settlor if for instance he created a reversionary trust in an attempt to evade income
tax.
This means that the settlor cannot obtain any tax advantage by creating a trust because if they
truly wish to create a trust and not account for any income tax, they have to completely divest
themselves of any interest or control over the trust property and any income therefrom. Even
then, the taxman has power to charge income tax either to the trustee or the beneficiary of the
family settlement, whoever is in immediate control of the income therefrom. It follows that the
family settlement is no longer a relevant means of tax planning through tax avoidance.
In addition, the Income Tax Act Cap 340 empowers the Uganda Revenue Authority to recharacterize transactions in order to unearth their true commercial effect in order to apply the
stipulated tax rates in assessing the taxpayer.
10
11
Tax Appeals Tribunal Application No. 32 of 2018
[1921] 1 A.C. 65
Section 91(1) of the Income Tax Act Cap 340, empowers the Commissioner (a) to recharacterize a transaction or an element thereof that was entered into as part of a tax avoidance
scheme; (b) disregard a transaction that does not have any substantial economic effect or recharacterize a transaction the form of which does not reflect the substance.
Section 91(2) of the Act defines a “tax avoidance scheme” in subsection (1) to include any
transaction, one of the main purposes of which is the avoidance or reduction of liability. These
broad provisions virtually render the formation of a family settlements and other trusts alike
ineffective as a tax avoidance tool provided the sole purpose thereof was to avoid paying taxes
or paying a lesser amount of taxes owing.
In effect Courts are also obliged to look beyond the wording of the statutes and inquire into the
whole transaction to determine whether or not the intention was to avoid tax. In W.T. Ramsay
v. CIR,12 the taxpayers had entered into a tax avoidance scheme to remove the value from shares
to produce an allowable loss to set off against the gain arising out of sale of a farm.
Lord Wilberforce held inter alia that:
“While the techniques of tax avoidance progress and are technically improved, the courts are not obliged to stand
still. Such immobility must either result in the loss of tax to the prejudice of other tax payers or to parliamentary
congestion or both. To force courts to adopt in relation to closely integrated situations a step-by-step dissecting
approach that the parties themselves may have negated would be a denial rather than an affirmation of the judicial
process.”13
This authority is embodied in the anti-avoidance provisions under section 91 of the Income
Tax Act Cap 340. The impact of this is that tax avoidance by whatever name called shall not
be relied upon to deprive the nation of taxes that are rightfully due to it. This includes creation
a family settlement by the taxpayer with the sole aim of avoiding taxes or reducing the tax
liability.
Conclusion
In light of anti-tax avoidance provisions and increasing regulatory scrutiny as discussed above,
family settlements have significantly diminished in relevance as tax avoidance tools. The
introduction of anti-avoidance measures would make it increasingly difficult to exploit family
settlements for tax advantages without attendant legal consequences. Consequently tax payers
are compelled to seek more transparent and compliant tax planning strategies, rendering family
settlements less effective and increasingly obsolete in the realm of tax avoidance.
12
13
[1918] 1 ALL ER 865
Ibid.