The Supreme Court’s decision in Penny and Hooper v Commissioner of Inland Revenue (SC, 24/08/11) demonstrates how one can easily overstep the line between legitimate trust structures and tax avoidance. In that highly-publicised case two surgeons sold their practices to companies they had established, and which their own trusts would be the sole shareholders of. The two surgeons were to be both the directors and employees of the companies. Each surgeon also appointed their accountants and solicitors to be the trustees of the trusts whilst they and their families were to be the beneficiaries. Each surgeon received a significantly reduced income from what they received before the establishment of the trusts and companies. The balance of the annual net income of the company was distributed to the trust as a dividend and taxed at the rate of 33% (the rate for trustee income). The benefit from the established structures was the 6% difference in tax rates between the maximum personal tax rate (39%) and the trustee income rate.
The Supreme Court held that transferring their businesses to companies owned by family trusts was a legitimate action and that the adoption of their trading structure was not, per se, tax avoidance. So where did the surgeons overstep the mark? The Court held that the surgeons acted in a way that constituted tax avoidance when they set artificially low levels of income in their capacities as sole directors. Of particular significance to accountants and solicitors, the Court stated that, “Although neither taxpayer was a trustee, each could naturally expect that the trustees whom they had chosen [their accountants and solicitors] would act as they in fact did, and that the benefits of the use of the funds would thereby be secured without the impost of the highest personal tax rate”. The inescapable implication here is that “professional” trustees will not prevent a court from finding that trusts are being used for tax avoidance. There is also a remote possibility that these accountants and solicitors, in their capacities as professional trustees, could be subject to an unlimited liability to pay tax, penalties, and interest for trusts caught in tax avoidance.
This case should send a strong warning to those who organise their affairs using trust and company structures, to minimise their tax exposure, as well as those solicitors and accountants who have agreed to become the professional trustees of trusts which are used to sidestep tax.