― 460 ―

Life Estates

24.A27. The Committee has come to the conclusion that, in determining the tax base, property the taxpayer did not own but whose yield of income he had the right to enjoy ought to be included. In the case of a life estate, this means that the corpus supporting the life estate should be taxed as part of the estate of the life tenant on his death. It can be argued that such a principle is too wide, that it is unfair to tax the corpus in the hands of the life tenant since he did not have the right to dispose of the corpus during his life and he was never the owner of it. A fairer solution, in the case of a life estate, might be to tax the life tenant on his death on part of the corpus, such part being the actuarial interest of the life tenant in the corpus when he first became entitled to the life estate. However, this solution would permit part only of the wealth subject to successive life estates held by members of successive generations to be taxed. If the life tenant is taxed on part only of the trust estate on his death, there is unlikely to be anyone else to whom the balance may be appropriately attributed. One cannot tax the persons ultimately entitled to the corpus, as they may not be known. To tax the trustee on the balance, the whole of the estate will be brought to charge but the aggregate of duty payable will usually differ from what would have been payable had the whole estate been taxed in the hands of the life tenant. The actual difference will depend on the rates. Unless a special rate is imposed on trustees, there will be a tax advantage in creating a life estate or a number of life estates. In the Committee's opinion, an estate bequeathed by X to his son for life and then to the son's children, should bear broadly the same duty as the estate would have borne had it been bequeathed by X to his son and had the son then bequeathed it to his children. The Committee recommends that, on the death of a life tenant, the assets supporting his life estate should form part of his dutiable estate and the duty on it should be paid out of those assets.

24.A28. A life tenant may bring his life estate to an end while he is alive by a surrender or a partition or by some other means. It would hardly be fair to tax assets subject to a life estate on the death of a life tenant but not to tax assets where a life tenant has surrendered his interest immediately before his death. In the Committee's opinion, where a life estate is teminated other than by disclaimer the life tenant should be taxed as if he had disposed of the whole of the assets subject to the life estate for a consideration equal to the consideration in fact received by him. The difference between the value of the assets and the consideration should be taxed as a gift.

24.A29. Where a life interest (whether vested or contingent) is disclaimed, there should be no such deemed disposal. A disclaimer is a rejection of an interest by a beneficiary before he takes any benefits to which he may be entitled by virtue of the interest. The Committee considers that this treatment of a disclaimed interest should be extended to a surrender by a beneficiary of an interest where the surrender is made within six months of the date on which the beneficiary receives the first benefits to which he was entitled under the interest. This treatment should only be available if all benefits received by virtue of the interest are repaid to the trustee to be held by the trustee as if the interest had been disclaimed.

24.A30. It seems arbitrary to treat an assignment differently to a surrender or a partition. An assignment, other than by charge, should be treated on the same basis as a surrender or partition; that is to say, the life tenant should be deemed to have disposed of the assets supporting his life estate for a sum equal to the consideration, if any, received by him from the assignee. The difference between the value of the assets and the consideration should be taxed as a gift.

  ― 461 ―

24.A31. The foregoing principles need to be supported by other rules:

  • (a) If there is a merger of the life estate by reason of the life tenant acquiring the remainder, the transaction should not attract any duty (unless the consideration paid is greater or less than the value of the remainder). Provided the assets comprising the corpus are still owned by the life tenant on his death, the whole will then be taxed.
  • (b) Sometimes a life estate is not in the whole of the assets held subject to the trust, but in part only of those assets. Where the part is a fraction of the whole, for example an interest in half the income from the estate for the life of X, the same fraction can be used to determine the extent of any liability for duty when the life tenant dies or deals with his interest in some way. Thus, if X is entitled to half the income from Blackacre during his life, half the value of Blackacre will be taxed on X's death. Sometimes the entitlement is fixed in money terms. For example, a settlor may direct that the first $5,000 of the income derived by the estate each year be paid to his daughter for her life, that half the balance be paid to his son for his life and that the remainder of the income be accumulated. The income from the estate may vary and, in a particular year, be less than $5,000. Where the entitlement is fixed in this way, the fraction A ÷ B should be employed to determine the interest in the corpus of the life tenant on his death or at some earlier point of time, where A is the total income that the life tenant became entitled to receive from the trust over the previous N years (or, if the entitlement has been for a lesser period, then that lesser period) and B is the total income derived by the estate during this period. The period of N years should be reasonably long—say ten years—to enable a clear picture to emerge. In applying the fraction, the income of the trust estate should be determined by principles of trust law rather than income tax law.
  • (c) For the purpose of applying the foregoing rules, distributions out of corpus should be disregarded unless there is undistributed income in the trust. Where there is undistributed income, applications from corpus should be deemed to be distributions of income to the extent of the amount of the undistributed income.

24.A32. If the assignment or surrender relates to a contingent life interest, that is to say, if a person assigns or surrenders his life interest before the interest vests, the transaction ought not to attract duty under the provisions recommended in paragraphs 24.A28 and 24.A30. If the consideration received on the assignment or surrender is greater or less than the value of the contingent interest at that time, there will be a gift of the difference.

24.A33. Once a life interest has been taxed, no further tax should be payable in relation to any subsequent dealings with the life interest for full consideration or on the death of the life concerned.

24.A34. The recovery of duty from the trustee of an estate in which a life interest is held is considered in paragraphs 24.64–24.65. Where the life tenant has died, it will be necessary to calculate what part of the estate duty is referable to the settled estate. In the Committee's view, the duty applicable to the settled estate should be the average rate of tax charged on the whole of the property owned or deemed to be owned or to have been disposed of by the deceased life tenant on his death. Where the person entitled to the estate next following that of the life tenant is a person in respect of whom an exemption is available, then so much of the exemption as is not absorbed by

  ― 462 ―
the actual estate of the deceased life tenant should be available against the duty charged on the corpus of the settlement.