Judge rules royalty payments from the Railway Series trust should be treated as capital rather than income

The descendants of Rev Wilbert Awdry have won a High Court battle with HM Revenue and Customs (HMRC) over how royalties from the author's Thomas the Tank Engine 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 decision means HMRC's interpretation of the trust arrangement was rejected by the High Court.

Had HMRC succeeded, the trustees could have faced tax of up to 45 per cent because royalty payments are generally treated as income for tax purposes.

The ruling is a significant victory for Rev Awdry's seven grandchildren, who are beneficiaries of the trust established to manage royalty payments from the Railway Series books.

Rev Awdry, an Anglican priest, created the stories that became Thomas the Tank Engine during the Second World War after inventing them to entertain his son while he was recovering from measles.

The stories later became the Railway Series books before being adapted into the television series, which was narrated in its early years by Beatles drummer Ringo Starr.

In 1987, Rev Awdry established a trust setting out how his seven grandchildren would benefit from future royalty payments.

The trust was created two years after he reached an agreement with his publisher that entitled him to receive ongoing royalties from his books.

Under the terms of the trust, half of the royalties paid to Rev Awdry were to be held for the benefit of his grandchildren.

Until reaching the age of 45, beneficiaries were entitled only to income generated from investing those royalties.

Once they turned 45, each grandchild became absolutely entitled to their share of the trust capital as well as future royalty payments.

The dispute centred on whether those royalty payments should be treated as income or capital once beneficiaries reached the age of 45.

HMRC argued turning 45 made little practical difference because each grandchild had already been receiving one-seventh of the royalties as income from the age of 21.

In his judgement, 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.

The judge also considered previous legal authorities, including a 2014 tax tribunal involving royalties from the estate of PL Travers, the author of Mary Poppins.

However, he found there was an important distinction between the two cases.

Unlike the trustees in the PL Travers case, Rev Awdry's trustees never owned the copyrights to the Railway Series books.

Instead, the royalties were generated under an agreement with the publisher after the copyrights had already been assigned.

Tim Stovold, head of tax at accountancy firm Moore Kingston Smith, said the judgment turned on a well-established legal distinction between capital and income.

He said: "The tree is normally the capital and the fruits are the income generated from that capital. In most cases, it is the person who owns the tree who can enjoy the fruits.

"In this case, Mr Awdry had previously assigned the copyrights to his publisher in return for the royalties so the trust had an entitlement to the fruit without owning the tree."

The judge concluded because the trust never owned the underlying copyrights, the royalty payments should be treated as capital under the terms of the trust rather than as income.

An HMRC spokesperson told GB News: “We note the decision and are considering our next steps.”