When is a legacy charitable for inheritance tax relief?

It is a fairly well known aspect of estate planning that donations to charities are generally not considered to be subject to inheritance tax ("IHT"). That said, the recent Supreme Court case of Routier and another v Her Majesty's Revenue & Customs [2019] UKSC 43 ("Routier") dealt with that very issue, specifically whether or not a gift to a charitable trust (giving effect to the terms of a will) would be subject to IHT.

Why does Routier matter?

It matters for charities and individuals who wish to benefit charities because the case was about whether or not a legacy for establishing a charitable trust was charitable for IHT purposes. It shows that legacies and bequests need to comply with the requirements for IHT charitable relief. We should remember that the definition of what is 'charity' or 'charitable' for tax purposes is different from that for OSCR registration purposes. The case also highlights that currently UK law must be compatible with EU law.

What is the background?

Mrs Beryl Coulter ("Mrs Coulter") died in Jersey on 9 October 2007. Her left the residue of her estate to a trust (the "Coulter Trust") with purposes which were exclusively charitable under English law. However, the law governing the Coulter Trust was specified in Mrs Coulter's will as being that of Jersey.

What was the problem?

Her Majesty's Revenue and Customs ("HMRC") came to the conclusion that Mrs Coulter's gift to the Coulter Trust could not benefit from IHT relief. It claimed that:

i. on Mrs Coulter's death, the Coulter Trust was governed by Jersey law; and

ii. the IHT Act only allows relief to trusts governed by UK law. HMRC argued that as Jersey is not a part of the UK for the purposes of charitable donation relief under the IHT Act, the relief was not available. The lack of relief created an IHT bill of approx. £567,000.

Mrs Coulter's executors (the "Appellants") claimed HMRC was wrong, arguing that its decision was incompatible with European legislation: the then article 56 of the Treaty Establishing the European Community (the "EEC") which prevents restrictions on the free movement of capital between member states of the European Union ("EU"), and between member states and third countries (the "Free Movement of Capital Rules").

The question(s) for the court

This case was a complex one where rules relating to EU and UK law needed careful thought, boiling down to two key questions for the Supreme Court (the "Court"):

Is Jersey part of the UK under EU law?

It was agreed between HMRC and the Appellants that while the Free Movement of Capital Rules apply to the UK they do not apply to Jersey. Further, it was not in dispute that those rules apply to gifts to charities and if IHT relief was not available for the gift to the Coulter Trust then, assuming those rules applied, there would be a restriction on the free movement of capital. Given that Jersey is not a member state of the EU the Free Movement of Capital Rules between member states were not relevant. However the issue for the Court was whether Jersey was a 'third party' under those rules.

The Court was dealing with strong competing arguments:

• The Appellants claimed that the gift to the Coulter Trust should benefit from IHT relief (as a gift to a charitable trust) as it is a transfer of capital from a member state of the EU to a third country. The Appellants argued that Jersey was regarded as a third party under article 56 (a point accepted by the Court of Appeal (the "CoA")).
• HMRC claimed that relief from IHT was unavailable as the gift of money to the Coulter Trust was an internal transaction in a single member state of the EU, the UK. HMRC relied on the fact that while Jersey is technically not part of the UK it is not an independent state, arguing that it is a European territory that the UK is responsible for and the transfer of monies into the Coulter Trust should be treated no differently than a transfer between Edinburgh and London.

The Court highlighted that the answer to this question (relying on many decisions of the Court of Justice of the European Union) was dependant on the circumstances and whether or not the relevant EU law applied to the territory in question. The Court concluded that while the Free Movement of Capital Rules did not apply in Jersey, there had been a transfer "...from a member state where article 56 applies to a territory where it does not and that cannot be considered a purely internal situation". Therefore Jersey could not be considered part of the UK under EU law and was therefore a third country.

Can HMRC withhold IHT relief for the gift the Coulter Trust under EU law?

The Court noted how this case had been dealt with in the CoA where the judges thought that the refusal of IHT relief was justifiable, when it decided that the Coulter Trust could not benefit from IHT relief unless (i) it was governed by UK law and (ii) subject to the jurisdiction of the UK courts (the "Relief Criteria"). The Court was confused by the CoA's reasoning:

• It pointed out that there is nothing in the IHT Act requiring either of these criteria to be met. The CoA relied on the 'Dreyfus decision' - a case decided long before the UK's entry into the EEC - where the judges concluded that the IHT legislation, as it then was, must be read as only granting relief from IHT to trusts governed by UK law and subject to its courts. On that basis, the CoA found that the gift to the Coulter Trust could not benefit from IHT relief.
• HMRC accepted on appeal that this interpretation violated the Free Movement of Capital Rules but maintained that the refusal of relief was still justified owing to a lack of a 'mutual assistance agreement' being in place between Jersey and the UK to allow HMRC to check that the Trust's activities were indeed charitable.
• Again the CoA took an unexpected decision as there is nothing in the IHT Act requiring any such agreement to be in place before a donation to a charitable trust will be saved from having to pay IHT. The CoA 'read in' the Relief Criteria as a matter of interpretation, which prevented the Coulter Trust from benefiting from IHT relief.

What did the Court decide?

The Court reminded the parties that ultimately EU law (until such time as the UK leaves the EU) takes precedence over UK law, and needs to be given priority over inconsistent UK rules. It was true that Jersey was not part of the UK but the Court noted how the Free Movement of Capital Rules can apply between member states of the EU and third countries. The IHT Act did not impose the Relief Criteria, which had been incorporated by the CoA judges. In doing so, the CoA had created a restriction that breached the Free Movement of Capital Rules which could not be allowed to remain.

The Court ruled that the Freedom of Movement of Capital rules applied to Mrs Coulter's gift of assets to trustees in Jersey, and that the refusal of relief from IHT breached those rules.

What does this mean?

This case is important for a number of reasons! There are many technical points that could be teased out but they key issues to note are:

• Donations to charities are an important aspect of charity funding. It is notable that there was a move to restrict the availability of a tax relief which is often relief upon by charities to continue to carry out their activities: many charities rely on gifts of money in wills in order to fund their work. The background to Routier shows that wording used in such gifts or in wills could lead HMRC to challenge the application of IHT relief.
• This case serves as a reminder of the role that EU law (currently) plays within the UK's legal system. Given that the UK looks set to leave the EU before long, it is likely that we will encounter more cases of conflicting laws in the future and it is likely that the settlement of those disputes will need to be approached on a case-by-case basis.
• In an increasingly international environment it is vital that individuals who are highly mobile and may be considering estate planning that involves multiple jurisdictions take appropriate guidance. The availability of tax reliefs is something which can change on a regular basis. Engaging with an adviser who can deal with the various aspects of your plans reduces the risk of unexpected surprises!
• Finance Act 2010 brought in a new definition for charitable tax recognition in the UK (following Court of Justice decisions). In part Finance Act 2010 introduced the Relief Criteria into legislation (it does not need to be 'read in' as noted above). The Court's decision in Routier raises the question of whether or not Finance Act 2010 is compatible with EU law.