The question before the court was the liability of the trustee to income tax on the interest. The relevant tax legislation made no provision for the deduction of tax from payments of income out of trust estates. The trustee argued, relying on Baker, that the liability to tax of income received by trustees depended upon the position as regards liability of the beneficiary; that in this case the interest received was treated as capital as a matter of ordinary principles of accounting between trustees and income- beneficiaries; that the beneficiaries would never receive the interest as income and therefore no liability to tax was possible. It was held by the Scottish Court of Session that on construction of the statute the interest was income and the trustees were the persons receiving or entitled to the income.

The trustees in this case were pushing Baker to its logical conclusion that a trust is ‘a mere agency or conduit pipe’ so that it is to be ignored for tax purposes. The court was concerned with tax-avoidance implications of this proposition as any income might be consumed or directed by the trust to be capitalized so that beneficiaries might never receive income as such that might have been subject to income tax. Their response to Baker was to confine it within narrow limits. Dicta from Baker that pointed to the direction of elimination of the trustee would be jealously guarded. Lord Sands suggested that Baker was ’strictly limited to the case where the circumstances are similar, viz., where there is one beneficiary and the estate is already realised and duly invested’. Lord Morison would confine Baker to ‘cases solely to the ascertainment of the income from foreign investments chargeable’ to tax.

FundsAnother attempt was made by a taxpayer to apply Baker in his favour in Macfarlane v. CIR a decision delivered by the Court of Session on the same day as Reid’s Trustees. The beneficiary claimed repayment of income tax. The measure of his relief depended on the proportion between the amount of his income which had borne income tax and the ‘amount of his total income from all sources’. Part of his income arose from two trusts that provided his entitlement after expenses had been met. The beneficiary claimed that the effect of Baker was that the trustee was a mere agent for the beneficiary for tax purposes and accordingly expenses incurred in the administration of the trust were incurred by the beneficiary; and that, therefore, in calculating the repayment the total income should include all expenses of the trusts which the trustees incurred before paying his life interests. The beneficiary was also relying on the fact that the revenue in Baker withdrew’ during argument any claim to tax upon that part of the dividend income which was consumed in the administration of the trust in New York. It was not difficult for the court to reject this interpretation of Baker. It was not bound by a concession of a party. Payment of the expenses of administration was a prior purpose . . . and the [beneficiary] could claim or receive from the trust estates nothing until that prior purpose had been fulfilled.’ The expenses of the trustee therefore could not be included in the total income.

The reluctance to apply Baker continued. In Schalit v. Nadler the question was whether a beneficiary under a declaration of trust of a long lease was a ‘person from time to time entitled . . . to the income . . . of the land leased’ within the Law of Property Act 1925 so that he could distrain the rent reserved under a sublease. Goddard J, delivering the judgment of the court, held that the right of a beneficiary whose trustee has leased property subject to the trust was not to the rent, but to an account from the trustee of the profits received. Baker was not cited in the judgment.

The trend was reversed in Nelson v. Adamson. In this case, the life tenant under an Australian will was resident in the United Kingdom. He was in the same situation as in Baker except that the whole of the trust income was subject to a prior annuity. No appropriation had been made. In Lawrence J’s view, Baker’s ratio decidendi is that ‘the interposition of a trustee does not prevent the income of the cestui que trust arising, within the meaning of the Income Tax Acts, from the stocks and shares held by the trustee‘. Accordingly, he held that the further interposition of an annuitant made no difference. He was prepared to apply Baker to a trust of two beneficiaries. He did not regard Macfarlane v. CIR as relevant and the reservation of Lord Carson was not considered.

In Stannus v. CSD, a daughter was given, subject to a prior annuity, life interests in one-half of the residuary estate of the father, with power to appoint her children to her share. To this point, the facts were similar to Nelson v. Adamson. The daughter, by a deed of appointment, directed the trustee to raise out of her half share a sum in favour of her son, and for this purpose, she released her life interest in this sum so that such life interest should merge with the reversionary interest of the son. This sum was raised out of assets all situated in England. The court found that the release of the daughter’s life interest was a gift. The question was whether that gift was one of an interest in properties located in England or of an interest in an equitable chose in action located in New Zealand. The latter would be subject to New Zealand gift duty.

By a majority of three to one, the Court of Appeal held that, as the daughter was not the sole life tenant of an ascertained residuary trust fund, she did not have any interest in any specific investment of the trusts, but a right to have the trusts performed and to enforce its performance—which was properly described as an equitable chose in action—and the subject matter of the gift was a portion of the equitable chose in action. This conclusion was reached by the majority by supplying an answer to the `questions’ that Lord Carson might have in mind if there were more than one beneficiary.55 Finally summed up the argument best:

. . . If there are more than one, then the trustees have an important, if simple, function to perform—namely, to divide the available balance between the cestuis que trust, according to their respective interests. Those interests may be unequal. In given cases, there may, in respect of individual interests, be allowances and charges to be taken into account, which have relation to those particular interests alone, and permeating such a situation is a duty and a responsibility to the trusts with which they are charged, apart from any possible duty to individual beneficiaries.

Dealing with such a situation is a proper function of trustees in their administrative character. Until those functions are performed, no one of the cestuis que trust could claim to be entitled to any other than . . . a balance sum. ..

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