More Investment Problems

Tony Sherring is a well-known speaker and author on trust related topics.
He was a found member of the Society of Trust and Estate Practitioners
(taken from Isssue No 4 – Decembner 1999)

In recent years trustees have become more concerned about their responsibility for their investments. As a result quite a number of trustees have found ways of delegating some of their responsibilities, perhaps to an investment manager. This seems reasonable enough because very few trustees have the necessary expertise to assemble and review a reasonable portfolio of equity investments. They have to be advised by a broker and from there it is a short step to delegating their investment management whilst retaining their supervisory function. Not every trust can do this. If the powers are not there in the trust instrument an application to the Court would be necessary to add them.

However, it now looks as if the supervisory function is likely to become more important and trustees will have to be more aware.

The author recently reviewed the accounts of two charities, one with a £2 million equity portfolio, the other around £750,000. Over the last three years these two funds have doubled in value if the unrealised gains are added in. The modern form of accounts for a charity points one in this direction with its statement of financial activities, detailing incoming resources and a statement of funds where income and capital gains both realised and unrealised are brought together. As most charities can spend capital for their work this seems reasonable enough. The fact that both charities had very low incomes is neither here nor there. They will both invest in equities even if there is a `correction` in the FTSE index.

However, what happens in other family settlements? There will generally be a sharp division between income and capital, each with its own beneficiaries. The trustees will have a duty to maintain income at a reasonable level whilst preserving capital. They have to hold the balance. They will still be interested in equity investment. They may, of course, be locked in to equities in the form of shares in a family company which have been settled but which are not realisable in practice. There is guidance as to what is income and what is capital. This is in case law which is really a little bit elderly. The cases on equitable appointment are really old and, intestacies apart, seem not to be used nowadays. However, it is clear that the Courts believe that company law prevails. Company law says that you receive capital on a liquidation, a reduction of capital, a sale of your shares, a bonus issue or a buy back. Anything else is income. This began to look really wrong when the City invented demergers. When ICI demerged Zeneca in June 1993, about 40% of the value was in the Zeneca shares. How could that be income? If the trustees had held shares for 30 or 40 years then perhaps it was income, in that each year ICI would have retained some of its profits and that might have funded their investment in Zeneca. It is known that once the bank trust companies knew of the proposals they ceased to buy ICI shares. After all, what could they have said to a remainderman if, only weeks or months after an investment, 40% of it was deflected to the life tenant? Further, they were ready to sell existing holdings. Fortunately the ICI / Zeneca demerger was the subject of review in Sinclair v Lee and another (April 1993). The Court discovered that there was an indirect demerger in that ICI transferred the Zeneca business to Zeneca and that company then allotted shares to the ICI shareholders. That enabled the trustees to treat the Zeneca shares as capital. Before that, direct demergers had been usual, where the parent company distributed the shares in the new company itself. There were some substantial companies which demerged before ICI, e.g. BAT Industries and Racal had demergers. However, the ICI demerger may have been the biggest. Interestingly, Hanson demerged its U.S. interests as a direct demerger, fortunately worth only a few pence per share and then when it split into four, the demergers were indirect. Therefore at that stage trustee shareholders might have been a little worried to the extent that they had holdings with direct demergers, but that was all. The City had taken note of the problem and was more likely to produce indirect demergers. The trustees probably coped with scrip dividends by taking cash rather than shares. However, there was another novel reorganisation when Northern Electric was the target of a take-over in 1995. The defence consisted of:

  • Special dividend £1 per share
  • Bonus issue of preference shares worth £1 per share
  • Distribution by way of dividend of their National Grid shares
  • Second special dividend of 50p in 1997
  • One or two other improvements in dividends

All this must have totalled around 40% of the value of the shares. What a bonanza for the life tenant. Special dividends are now fairly common (e.g. British Telecom’s special dividend of 35 pence in September 1997). Enough has been said to show that where trustees who face life tenants and remaindermen invest in equities, they have to read all their company circulars if they are to hold the balance between their beneficiaries. It is not always a simple calculation. If an old holding is affected then there must be a CGT consequence if the trustees sell in order to avoid a reorganisation.

What happens if a company pursuing shareholder value buys its own shares? There is no problem if it buys from all shareholders pro rata as, for instance when Severn Trent reorganised its capital in July 1997. But it might well buy in the open market. That money could have come back to the shareholders as a dividend. If the share price rises, as a result what does the life tenant get out of it. That is, perhaps, too sophisticated to be a query in real life.

Next, look at the tax position following the Finance (No 2) Act 1997. The tax credit on dividends is under attack. Charities are quite well treated. They cannot reclaim the 10% tax credit after 5.4.99 but they have a special payment under S.35, starting with 21% in 1999/2000 and finishing with 4% in 2003/2004. Their exemption from CGT is not affected. There are special sections (21 & 33) dealing with estates in course of administration. They do not make life any more difficult for executors although beneficiaries who pay no tax will not be able to recover tax credits where dividends pass to them from the estate. However, trustees of discretionary and accumulation settlements face a problem (Sch 4 – 15). From 6.4.99 there is a schedule F trust rate of 25%. This will be the 10% for which tax credit is given on payment of a dividend plus 15% as a payment under ICTA 1988 S.686. Sch 4 – 15 amends S.687 so that only the 15% goes into the tax pool. It leaves the deduction from income distributions at 34%.

Therefore the settlement which accumulates is not in a very different position than it is at the moment. Compare:




Tax Credit






Rate for Trusts






Tax Credit






Rate for Trusts


An old discretionary settlement which has a decent tax pool can go on paying income to its beneficiaries without running into trouble until it has stripped the tax pool. Thereafter it will face the problem of current input into the pool at 15% and tax under S.687 at 34%.

This can be seen:



Gross dividend received


Less tax credit




Additional tax paid under S.686


Net balance


Summary of disposal of net dividends



Additional tax under S.686


Additional tax under S.687


Net payment to beneficiary


Total net dividend received by trustees


How will this affect trustees of discretionary and accumulation settlements?

Accumulation settlements are not affected. Discretionaries will be. If their shares are in some family company they can do nothing except distribute that much less. If they have a portfolio of equities (and/or preference shares) will they be tempted to invest in interest bearing stocks?

Are charitable trustees likely to prefer interest bearing stocks? What will the City invent next as a method of improving shareholders value?

It is easy enough to set the questions. Probably the only answer is that trustees will have to be infinitely more observant in the future if they are to do a really good job.

© F A Sherring FCA, FTII
November 1997