The family of Thomas the Tank Engine creator Rev W Awdry have won a High Court battle with HM Revenue and Customs (HMRC) over how royalties from the children's books should be treated for tax purposes.
Mr Justice Richards ruled royalty payments received by the Awdry family trust should be classified as capital rather than income under trust law.
The ruling means that the High Court rejected HMRC’s interpretation of the trust arrangement. If HMRC had been favoured, the beneficiaries could have faced tax of up to 45% on royalty payments, as royalty payments are typically treated as income for tax purposes.
Background of the trust and dispute
The Anglican priest created the Thomas the Tank Engine stories during World War 2, after making them to entertain his son as he recovered from measles. The stories were then developed into books, followed by a television series.
In 1987, Rev Awdry established a trust to manage, and two years later, an agreement was entered into between himself and his publisher that entitled him to receive ongoing royalties from the books.
Under the terms of the trust, half of the royalties paid to Rev Awdry were to be held for the benefit of his seven grandchildren. Beneficiaries were only entitled to the income generated from investing those royalties until the age of 45. After reaching 45 years of age, each grandchild became entitled to their share of the trust capital and future royalties.
The dispute between the beneficiaries and HMRC arose over whether the royalty payments should be treated as income or capital once they reached age 45. According to HMRC, turning 45 made little practical difference, as each grandchild had already been receiving one-seventh of the royalties as income from the age of 21.
Court ruling and next steps
Mr Justice Richards rejected that interpretation, though. He said it was "much more plausible and obvious" that the trust intended a beneficiary reaching the age of 45 to mark a significant change in their entitlement.
Another notable aspect of the case is that the trustees do not and never did own the copyrights to the Railway Series books. The royalties were generated under the agreement with the publisher after the copyright had been assigned.
The judge concluded that, because the trust never owned the underlying copyrights, the royalty payments should be treated as capital under the trust's terms rather than as income.
An HMRC spokesperson said: “We note the decision and are considering our next steps.”
