SerpApi.Org
The grandchildren of the creator of Thomas the Tank Engine have won a bitter tax battle against HMRC over the multimillion-pound royalties of the series.
The Rev Wilbert Awdry, who wrote the beloved children's books during the Second World War, created a trust 40 years ago setting out how his grandchildren should inherit the proceeds of his work.
Almost 30 years after Awdry's death, the trustees faced having to pay 45 per cent of the trust's income to the tax man, because royalties are usually classified as income for tax purposes.
But in a High Court battle, the trust's managers successfully argued the royalties should be treated as capital rather than income – thus incurring a much lower tax bill.
Awdry, an Anglican clergyman and railway enthusiast, created the talkative train characters to entertain his two-year-old son Christopher when he was sick with the measles.
The stories spawned a global franchise, encompassing television series, films, toys and theme parks, which turns over a billion pounds a year.
Alongside Christopher, Awdry and his wife Margaret had two other children – Veronica and Hilary. Together they gave the couple seven grandchildren.
The trust was created in 1987 – two years after Awdry signed a deal that entitled him to an ongoing stream of royalties, but surrendered the copyright to his publicist.
Half of all the royalties paid to Awdry went straight into the trust for his seven grandchildren.
At the time, Christopher's son and daughter Richard and Verity, Veronica's children Mark and Claire, and Hilary's three children Sara, Simon and Rachel – ranged in age between six and 17.
Under the terms, each of them were entitled to draw their full share of the capital when they reached 45.
Until that point, they could only receive the income generated by investing the royalties.
After all the grandchildren turned 45, a dispute emerged with HMRC over how much they owed.
HMRC’s interpretation was that 'not much would change' when the grandchildren turned 45, because they would already be entitled to receive one seventh of the royalties as income.
But the judge found it 'much more plausible and obvious' that the settlement had intended for the age of 45 to mark a watershed.
Setting out the shape of the case in his judgment, Mr Justice Richards said: 'The trustees... wish to know how the settlement should be administered.
'HMRC... have an interest in the outcome as they are likely to be entitled to more tax if the royalties are categorised as income for trust law purposes.'
Finding against the taxman – and thus sparing the seven grandchildren a potentially massive tax bill – the judge said the royalties were themselves the assets of the trust – meaning they counted as capital rather than income.
He used the common analogy of a tree, which represents capital, and its fruit, which represents the income generated by that capital.
Justice Richards said: 'The royalties received by the settlement are most naturally analysed as "fruit" of the copyrights in the Railway Series... the royalties are the capital of the settlement.'
'The defendants [HMRC] argue that this is the wrong way of looking at matters.
'They submit that the royalties received by the settlement are fruit of the right to receive those royalties, which is an asset of the settlement.
'I acknowledge that this is an alternative way of looking at matters. However, I am not satisfied that trust law principles require the matter to be viewed in that way.
'Overall, I regard it as much more realistic to regard the royalties as fruit of the copyright in the Railway Series rather than as fruit of a right to receive payment.
'Overall, I see nothing to override the intention plainly expressed in the settlement itself.
'I consider that the royalties received by the trustees are capital for trust law purposes.'
A spokesperson for HMRC told the Daily Mail: 'We note the decision and are considering our next steps.'
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