The Trusts and Succession (Scotland) Bill and the abolition of the ‘accumulation of income’ rules
Section 41 of the Trusts and Succession (Scotland) Bill provides, for trusts established after any new law comes into force, that the ‘accumulation of income’ rules will be abolished. While other variants are available, the rule means that after 21 years of a trust being in existence trustees can no longer ‘accumulate’ income. This is known as the accumulation period.
What is ‘accumulation’ and what is a trust permitted to do with its income?
What does it mean to accumulate income? Well, the Scottish Law Commission in its Discussion Paper on Accumulation of Income and Lifetime of Private Trusts (DP142) (para 2.4) gives this overview:-
“Income from trust assets must either be distributed, retained as income or accumulated. If it is accumulated it becomes additional capital of the trust, in turn (usually) generating future income.”
After the end of the accumulation period, trustees need to distribute (pay out) all of the annual income to at least one beneficiary or retain it. Accumulating income with capital is by this point off the table.
Distributing the income to beneficiaries is clear cut. It is paid out of the trust.
Retaining the income can be a bit more interesting in practice. One might see trust accounts recording income held over time as an unexpended revenue balance. The unexpended revenue balance then effectively becomes a form of accumulation as the income might actually be invested. The accounting records however show that there is the unexpended revenue balance – i.e. that it has been ‘retained’. Through the unexpended revenue balance, the income is accounted for as being retained, but in terms of the actual assets of the trust that income sits, in reality, within the invested capital.
If income is indeed ‘retained’ in the form the income was generated, then the income would literally just sit there… doing nothing. But it would not be accumulated and therefore, on the face it, no contravention of the rule against accumulation after the end of the accumulation period.
But the abolition of the ‘accumulation of income’ rules is not to apply to charities
Section 41(5) of the Bill however does not extend the abolition of the accumulation of income rules to charitable trusts. The explanatory notes to the Bill say:-
“the repeals do not apply to charitable trusts, in implementation of recommendation 93(2) [in the Scottish Law Commission Report on Trusts]. Such trusts will remain subject to the current law. In practice, those setting up charitable trusts almost invariably want the income to be made available for charitable purposes in the near future and are not interested in directing its accumulation for long periods. The current restrictions will therefore continue to apply.”
The background to recommendation 93(2) is found in the Commission’s Report (at para 18.43):-
“The repeal of the existing rules restricting accumulation and successive liferents met with universal support, subject to one qualification [which] pointed out that public and charitable trusts were in a different position, in that there was a risk that a truster might direct long term accumulations for the fulfilment of grandiose charitable purposes [this was the view of the (English) Law Commission ahead of the aftermentioned 2009 Act] which would not materialise for many years. That would create undesirable uncertainty. [It was] pointed out that the reforms in the Perpetuities and Accumulations Act 2009 in England and Wales made special provision for charitable trusts. We consider that this point is well made, and we accordingly propose that public and charitable trusts should be excluded from the abolition of the rules restricting accumulation and successive liferents. We do not think that this will cause any difficulty; in practice trusters who set up public or charitable trusts almost invariably wish the benefits to be provided immediately. The restriction of successive liferents has, of course, no application to the purposes of a public or charitable trust per se. Proposal 5(a) set out just above, that Scots law should not adopt the rule against perpetuities or anything similar, met with universal support. On that basis question 5(b) did not arise.”
I think that Commission’s statement that “in practice trusters who set up public or charitable trusts almost invariably wish the benefits to be provided immediately” is inaccurate. Creating something that is not going to be spent immediately is usually the reason someone would set up a charitable trust (especially a grant-giving charity). If funds were to be spent “immediately”, then such an individual could find an operational charity or other project and simply given the money directly to it. A trust would often have been chosen as the appropriate home for the funds in order to provide a longer-term platform for the funds.
And if “the benefits to be provided immediately” is looking solely at the issue of income generated being used immediately, it gives a focus to only part (the income) of the charity’s funds. A focus that will be likely to make only marginal effects (if indeed any real effect) on the deployment of money to further charitable activities (especially if we look at all charitable trusts together).
A rule about the use of income may not fit with the investment strategies of modern charities. Charities are ‘purer’ investors in the sense that the tax consequences of the generation of income and realisation of capital should not trouble them. Charities can seek to produce their annual needs (an ‘income’) from a mix of investment income and capital growth. Indeed, they might be investing for capital growth over income in the knowledge that capital can be accessed to provide their annual needs.
Why might a charity not pay out all of its annual income?
Where a charitable trust is generating income, there might be reasons (consistent with the charity’s purposes) why income should not be distributed and might be accumulated:-
- there might not be sufficient projects that meet eligibility criteria to support in a given year
- there might be desire to re-invest income to help support future funding
- build towards a particular larger project
- there may be a longer term desire or need to build the capital base of the charity for longer term plans
Bijurality: charity law v trust law
Charity trustees have a duty to act in the interests of the charity (section 66 of the Charities and Trustee Investment (Scotland) Act 2005). We accept that is stated to be “without prejudice to any other duty imposed by enactment or otherwise on a charity trustee in relation to the exercise of functions” of a charity trustee.
There could be situations where charity trustee duties say it is better not to pay out and also accumulate whereas trust law rules say that is not permitted. That is an unhelpful position for charity trustees.
The permitted retention of income: accumulation by another name and the mischief is not addressed
The rule prohibits accumulation. It allows, it seems, retention of the income at the complete discretion of trustees.
So, if the ‘bad’ person setting up a trust (and they have been thought of as bad, even ‘evil’ (see Law Reform Committee, Fourth Report, The Rule against Perpetuities (1956))) wanted to squirrel away funds for a charitable ‘grandiose’ or otherwise project, they are allowed* to do that. As long as they do not accumulate the income. [*standing the rules and processes we mention below that could be used to ensure trustees act properly.]
If the mischief is that the funds are not put to useful application, the prohibition on accumulation misses the point. If this is the problem, then not only should there be a rule against accumulation after a certain point, there should be a positive requirement to pay out and distribute the income. On one view (which we do not tend towards), the Trusts and Succession (Scotland) Bill needs to incorporate a new rule about charitable trusts paying out income. Indeed some might argue (something considered in other countries) that the not only must income be paid out, but a charity must spend and run down its capital over a set period. Again, we remain to be convinced about such rules. Charity trustees using their discretions within a proper regulatory framework seems a more appropriate approach.
Someone who really wanted to avoid the rules would also consider investing for capital growth rather than income yield.
The job OSCR does not want or need: policing the accumulation of income rules
We suspect there is currently widespread breaches of the accumulation of income rules. That would, on the face of it, be charity trustee misconduct. Does it really make sense for charity regulator, OSCR to add this to their list of things to check? We think not. But to not add it to the list, we are saying it is OK to breach a statutory rule.
Addressing the mischief by other means
If someone does indeed squirrel the money away and does not use it properly, does the law say we just have to sit idle and watch this happen?
We would say no. Trust and charity law would have enough measures to address such a situation. Indeed, the proposed new OSCR powers on positive directions to charities would provide a further way of dealing with such a situation. But even without that, OSCR has stepped in to deal with charities not using funds (see the Wick Academy Development Trust OSCR Inquiry (it does not detract from the point here that WADF was not a trust)).
A pause to reflect
So, (1) the ban on accumulation of income does not ensure charitable funds actually get used and (2) there are other means to compel trustees to do the right things.
When is income not income?
In some charities that receive legacies and donations, there might also be an ongoing accumulation period applying. The accumulation of income rules apply to income generated on trust assets. New legacies and donations might ‘feel’ like income but they are not – they are newly introduced capital. It is only after 21 years that the income on that newly introduced capital is affected by the accumulation of income rules. Admittedly legacies and donations being received by charities that are trusts are less common to happen. Charities set up as trusts tend to be giving funds to other charities rather than receiving new money.
But again, it shows that the accumulation of income rules do little to speed up the overall application of charitable funds. If that is indeed the aim of the rules.
We’ve been here before
The Commission’s Discussion Paper on Accumulation of Income etc notes (in a footnote to para 2.32) previous caution being about restrictions on the accumulation of income and charities. The Commission referred to observations during consideration of the Trusts (Scotland) Act 1966 that “on the merits, he [Lord Guest, a Law Lord] was apprehensive that its effect would be to require charitable trusts to disburse all their income, even in years where they found it unnecessary to do so.”
But England does it
Alignment of charities rules with English and Welsh requirements features in the call for evidence on the Charities (Regulation and Administration) (Scotland) Bill. For us, alignment with a neighbouring jurisdiction is relevant and not relevant at same time. Alignment is helpful… unless there is reason not to be aligned.
As touched upon above, the English Perpetuities and Accumulations Act 2009 also removes English charitable trusts from the wider freeing of trusts from accumulation of income rules. We think the same points about the Scottish rules would apply to the English rules. Yes, accumulation of income is prohibited in English charitable trusts, but does that address the mischiefs of grandiose projects locking away funds or charitable money being used with insufficient immediacy? We are unconvinced.
This will not be a growing problem… and when any law change could apply
It is unlikely that there will be many more charitable trusts created after the date on which any law change could happen. Most new charities, including ones that in the past would have been set up as trusts, are now set up as SCIOs and so not affected by the restriction on accumulation of income (look here for more on SCIOs).
It means that if the abolition of the accumulation rules was to apply to charities, it needs to have this effect for charitable trusts already in existence and not just for any new ones.
What next?
For us, probably three things can happen:-
- Do nothing and section 41(5) of the Bill remains as is. The accumulation of income rules will continue for charities. Trustees will continue to do as they always have and nothing will change. It will not lead to any more immediate application of funds to charitable endeavours. Widespread breaches of the rules will continue. And maybe no-one will care.
- Section 41(5) is removed and section 41 crafted in a manner that will cover existing charitable trusts. Charitable trustees will be able to accumulate income but will continue to be subject to other rules and duties to ensure they are managing and applying charitable funds correctly. That does feel attractive. Especially if retaining the rule perhaps adds little or does much about breaches. Is that the type of rule the Scottish Parliament should be positively resolving to retain?
- Introduce a positive rule about spending income. We are not attracted to this. There might be good reason why trustees do not wish to pay out all the annual income of a charity.
- Anything else? Well, there could be, but they get complicated. Ideas such as new formulations about paying out funds over certain rolling year period or rules on the spending of trust capital.
For more about trusts or charities and to follow the parliamentary process of the Bill, get in touch with Alan Eccles: alaneccles@bkf.co.uk / 07359001038.
“Alan is highly experienced in advising third sector organisations on governance and constitutional issues, including charity establishment and modernisation… He blends excellent technical advice with both pragmatism and plain communication.” Chambers and Partners 2023
“Alan advises on a range of issues and has particular experience in charities work. A source notes: “Alan is a professional, dedicated and passionate private client lawyer.” Another interviewee enthuses: “Alan has excellent experience and technical knowledge, and he is very generous with his time.” Chambers High Net Worth 2022
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