Revenue
Law and Practice, 24th edition (2006)
General
Editor: Natalie Lee LLB (Hons), Barrister
Section 4
Inheritance tax [*647]
Chapters
Introduction-from
estate duty to inheritance tax
28
IHT--lifetime transfers
29
IHT--reservation of benefit
30
IHT--death
31
IHT--exemptions and reliefs
32
IHT--settlements: definition and classification
33
IHT-settlements with an interest in possession: the o1d and new regimes
34
IHT--relevant property: settlements without an interest in possession and those
treated as settlements without an interest in possession
35
IHT--excluded property and the foreign element
36 Relief
against double charges to IHT
[*648] [*649]
Introduction-from
estate duty to inheritance tax
Updated
by Natalie Lee, Barrister, Senior Lecturer in Law University of Southampton
and Aparna Nathan, LLB Hons, LLM, Barrister, Gray's Inn Tax Chambers
Most
countries impose some kind of wealth tax. It usually takes the form of a death
duty either levied on property inherited or on the value of a deceased's estate
on death. In the UK estate duty was introduced in 1894 as a tax on a deceased's
property whether passing under a will or on intestacy. Over its long life the
tax was extended from its originally narrow fiscal base (property passing on
death) to catch certain gifts made in the p¨riod before death and at the time
of its replacement by capital transfer tax (CTT) it extended to gifts made in
the seven years before death. By the 1970s estate duty was, however, widely
condemned as an unsatisfactory tax. 'A voluntary tax'; 'a tax on vice: the vice
of clinging to one's property until the last possible moment'--were typical
descriptions.
In 1972
the Conservative Government considered replacing estate duty with an
inheritance tax (Cmnd 4930). The idea was that a beneficiary would keep a
cumulative account of all gifts that he received on death and pay tax
accordingly. Nothing came of this proposal, largely because such a tax would
have been too costly to administer and because the Conservative government fell
from office.
The
Labour government, which came to power in 1974, was committed to achieving a
major redistribution of wealth. As a first stage (without any prior
consultation) it introduced CTT in the 1974 Budget. This tax had '... as its
main purpose to make the estate duty not a voluntary tax, but a compulsory tax,
as it was always intended to be' (Mr Healey, the then Chancellor of the
Exchequer). A proposed wealth tax (Cmnd 5074) was never introduced. In reality
CTT, substantially altered during its passage through Parliament in 1974-_75,
never achieved its espoused redistributive purpose. There was no doubt,
however, that in concept it was a brilliantly simple tax which removed the
arbitrariness of the old estate duty. All gifts of property, whether made inter
vivos or on death, were cumulated with earlier gifts and progressive rates of
tax applied to that cumulative total.
The
advent of Conservative governments in 1979 saw a steady erosion of the
principles underlying CTT. The idea of a fully comprehensive cradle to grave
gifts tax was abandoned in 1981 in favour of ten-year cumulation, thresholds
were raised, and a new relief introduced for agricultural landlords. By 1986,
as a percentage of GNP, CIT yielded less than one-third of the revenue formerly
produced by estate duty.
To some
extent, the changes made by FA 1986 merely completed this process. Ten-year
cumulation was reduced to seven years and the majority of lifetime gifts made
more than seven years before death were removed from charge. As in the days of
estate duty, therefore, tax is now levied on death gifts and gifts made within
seven years of death. In an attempt to prevent [*650] schemes
whereby taxpayers could 'have their cake and eat it' (ie give property away but
continue to enjoy the benefits from it) there was a further echo from estate
duty in the reintroduction of rules taxing gifts with a reservation of benefit.
These changes did not amount to a replacement of CTT by estate duty but did
represent a welding of certain estate duty rules onto the already battered
corpse of CTT The end result is simply a mess and to call this amalgam an
inheritance tax is to confuse matters further since the tax is not levied on
beneficiaries in proportion to what they receive from an estate and neither is
it a true tax on inheritances since certain lifetime transfers are subject to
charge. 'There has been no attempt at reform. The Chancellor has merely given
us some reasons for making a shabby handout to the very rich. Not only has he reverted
to the old estate duty, he has falsified the label' (Cedric Sandford, Financial
Times, 26 March 1986).
Capital
transfer tax was rechristened inheritance tax as from 25 July 1986 and the
former legislation (the Capital Transfer Tax Act 1984) may be cited as the
Inheritance Tax Act 1984 from that date (FA 1986 s 100). Despite the permissive
nature of this provision the new title for this Act will be used in this book
and inheritance tax abbreviated to IHT. All references to CTT take effect as
references to IHT and, as all references to estate duty became references to
CTT in 1975, they subsequently became references to IHT.
As a
further curiosity it may be noted that the removal of a gener. hold-over
election for CGT in the 1989 Budget was justified by the then Chancellor (Nigel
Lawson) on a somewhat inaccurate view of the current scope of IHT. In his
Budget Speech, he stated that:
'the
general hold-over relief for gifts was introduced by my predecessor in 1980;
when there was still Capital Transfer Tax on lifetime gifts, in order to avoid
a form of double taxation But the tax on lifetime giving has since been
abolished, and the relief is increasingly used as a simple form of tax
avoidance.'
The
bizarre position has now been reached whereby what was intended as a general
tax on gifts has been limited (in the main) to gifts on or within seven years
of death whilst a tax intended to catch capital profits may now, operate to
impose a tax charge on any gain deemed to be realised when a lifetime gift is made!
The last
Conservative Government under John Major promised to abolish IHT when it could
afford to do so. Not surprisingly, this theme was not one that successive
Labour governments since 1997 warmed to but, it has to be said, until March
2006, they did little to the tax save for a general updating of, some of the
administrative provisions and targeted legislation aimed at closing loopholes
revealed by the Ingram, Melville and Eversden cases. However, substantial changes to the inheritance taxation of
trusts announced out of the blue and without prior consultation in the 2006
Budget, and now incorporated in the FA 2006, clearly seek to thwart the efforts
to minimise IHT of those who are perceived to be wealthy. Whilst government
amendments were made to the Bill during its passage through Parliament, the
main thrust of the government's
original proposals remains substantially the same and, although this
cannot be said to amount to full-scale reform, it is perhaps an indication that
the government has IHT in its sights, and that there might be more changes yet
to come. [*651]
28
IHT-lifetime transfers
Updated
by Natalie Lee, Barrister Senior Lecturer in Law, University Southampton and
Aparna Nathan, LLB Hons, LLM, Barrister, Gray Tax Chambers
I Definition of a 'chargeable
transfer' [28.2]
II What dispositions are not chargeable
transfers? [28.21]
II When are lifetime transfers subject to
IHT? The potentially exempt transfer (PET) [28.41]
IV On what value is IHT calculated? [28.61]
V 'Associated operations' (IHTA 1984 s
268) [28.101]
VI How is IHT calculated? [28.121]
VII Special rules for close companies [28.151]
VIII Liability, accountability and
burden [28.1711
IX Administration and appeals [28.201]
For a
charge to IHT to arise there must be a chargeable transfer. Whether tc is
levied on that transfer then depends upon whether it is:
(1)
potentially exempt in which case IHT will only be charged if the donor dies
within seven years of that transfer: otherwise it is exempt.
(2)
chargeable immediately at 'lifetime rates' but so that if the transferor dies
within seven years a supplemental charge to IHT may arise. [28.1]
I
DEFINITION OF A 'CHARGEABLE TRANSFER'
IHTA 1984
s 1 states that 'IHT shall be charged on the value transferred bra chargeable
transfer'. A chargeable transfer is then defined in IHTA 191 s 2(1) as having
three elements: a transfer of value; made by an individual; which is not
exempt. [28.2]
I A transfer of value
A
transfer of value is defined in IHTA 1984 s 3(1) as any disposition whicla
reduces the value of the transferor's estate. It includes certain deemel
transfers of value ('events on the happening of which tax is chargeable as
transfer of value had been made': see IHTA 1984 s 3(4)). Examples if deemed
transfers of value include death (see Chapter 30); the termination ut an
interest in possession in settled property (see Chapter 33) and transfers ut
value made by a close company which are apportioned amongst its participe-tors
(see [28.152]). [*652]
'Disposition'
is not defined, but the ordinary meaning is wide and include any transfer of
property whether by sale or gift; the creation of a sett1emen and the release,
discharge or surrender of a debt but not, it is thought, a consent (eg to an advancement
of trust property). It includes a disposition effected by associated
operations, a matter recently considered in the Rysaffe case (see [28.104]). [28.3]
2
Omissions
By IHTA
1984 s 3(3), a disposition includes an omission to exercise a right. The right
must be a legal right and the omission must satisfy three requirements:
(1) The
estate of the person who fails to exercise the right must be reduced in value.
(2)
Another person's estate (or a discretionary trust) must be increased in value.
(3) The
omission must be deliberate, which is presumed to be the case in the absence of
contrary evidence.
Examples
of omissions include failure to sue on a debt which become statute-barred;
failure to exercise an option either to sell or purchasi property on favourable
terms; and failure by a landlord to exercise his right's to increase rent under
a rent review clause. The omission will constitute a transfer of value at the
latest time when it was possible to exercise the right, unless the taxpayer can
show (1) that the omission was not deliberate but was a mistake of fact (eg he
forgot) or of law (eg failure to realise that the debt had become
statute-barred) or (2) that it was the result of a reasonable commercial
decision involving no element of bounty (eg failure to sue a debtor who was
bankrupt). [28.4]
3
Examples of transfers of value
(1) A
gives his house worth £60,000 to his son B.
(2) A
sells his car worth £4,000 to his daughter C for £2,000.
(3) A
grants a lease of his factory to his nephew D at a peppercorn rent. The factory
was worth £100,000; the freehold reversion after granting the lease
is worth only £60,000. A's transfer of value is of £40,000.
(4) A is
owed £1,000 by a colleague E. A releases the debt so that his estate
falls in value and E's estate is increased in value. [28.5]
4
Transfers of value and gifts contrasted
It will
be noted that IHT is based on the concept of a 'transfer of value"
curiously, however, the reservation of benefit rules--introduced in 1986--only
come into play if an individual makes a 'gift' (this term is not defined).
Whilst
the two concepts generally overlap (all the examples of transfers of I value in
[28.51 are also gifts) there will be exceptional cases where, for instance,
there will be a deemed transfer of value which will not involve the individual
making a gift (see generally [29.41]).
[28.6]-[28.20] [*653]
WHAT
DISPOSITIONS ARE NOT CHARGEABLE TRANSFERS?
1
Commercial transactions (IHTA 1984 s 10(1))
A
disposition is not a transfer of value and, therefore, is not chargeable if the
taxpayer can show that he did not intend to confer a gratuitous benefit on
another. This excludes from charge commercial transactions which turn out to be
bad bargains. The transferor must not have intended to confer a gratuitous
benefit on any person. Hence any disposition reducing the value of the
transferor's estate may trigger a liability to IHT (by analogy to a crime the
disposition may be seen as the actus reus) unless the taxpayer can show that he did not have
the necessary mens rea for the liability to arise, ie that he had no gratuitous intent.
EXAMPLE
28.1
A
purchases a holiday in the Bahamas in the name of C. A must show that he had no
intention to confer a gratuitous benefit on C which he may succeed in doing if,
for instance, C was a valued employee.
In order
for a disposition between two unconnected persons not to be a transfer of
value, the transferor must show that he had no gratuitous intent and that the
transaction was made at arm's length. In the case of a disposition to a
connected person, in addition to proving no gratuitous intent, the taxpayer
must show that the transaction was a commercial one such as strangers might
make. A 'connected person' is defined as for CGT (IHTA 1984 s 270: see TCGA
1992 s 286 and Chapter 19) and includes:
(1)
spouses, civil partners and relatives, extended for IHT to include uncle, aunt,
nephew and niece;
(2)
trustees, where the terms 'settlement', 'settlor' and 'trustees' have their IHT
meaning (IHTA 1984 ss 43-45, see Chapter 32);
(3)
partners (for certain purposes only); and (4) certain close companies.
EXAMPLE
28.2
(1) T
sells his house valued at £70,000 to his daughter for
£60,000. T will not escape a potential liability to IHT unless he can
show that he never intended to confer a gratuitous benefit on his daughter and
that the sale at an undervalue was the sort of transaction that he might have
made with a stranger (eg that he needed money urgently and, therefore, was
prepared to sell to anyone at a reduced price).
(2) Z
sells his lease to his son Y subject to an obligation on Y to grant Z a
leaseback for 20 years at a peppercorn rent. (This period has been arrived at
on the basis of Z's life expectancy.) The price paid by Y reflects the
existence of the lease and hence is substantially discounted.
Note:
(a) There
will be a substantial loss in Z's estate (namely, a loss of 'marriage value')
which, provided that s 10 applies, is not a PET.
(b) HMRC
apparently accepts that in a case like this a lease for life can be granted to
Z but this practice is open to question since, unless the lease is granted for
full consideration, it will be treated for IHT as a [*654]
settlement with Z enjoying an interest in possession (see Chapter 32).
Hence it
is considered safer to select a suitable term of years.
(c) In
Z's hands the lease is a wasting asset and so this arrangement may be
especially attractive when Z is elderly and unlikely to survive a PET by seven
years.
In IRC
v Spencer-Nairn
(1991) the taxpayer owned an estate in Scotland. He had little experience of
farming and estate management and relied heavily on the family's adviser, a
chartered accountant and actuary. In 1975 one of the farms was leased to a jersey
resident company at a rent which was largely absorbed in the costs of repairs
and maintenance. The jersey company almost immediately demanded that the
piggery buildings on the farm be replaced at the taxpayer's expense. The
adviser obtained a professional report which estimated the cost at in the
region of £80,000. As the taxpayer could not afford this the adviser
recommended that the farm should be sold. He handled all matters connected with
the sale and eventually it was sold for £101,350 to a second Jersey
company. The farm was never advertised for sale and the taxpayer accepted this
offer on the recommendation of his adviser: interestingly, neither the taxpayer
nor the adviser were aware at the time that the company was a 'connected person'.
For CGT
purposes the Lands Tribunal for Scotland determined the market' value of the
farm at £199,000 on the basis that, contrary to the adviser's view,
the taxpayer was not liable to pay for the improvements demanded by the tenant.
In due course (not surprisingly!) the Revenue raised a CTT assessment on the
basis of a transfer of value of £94,000. It was generally accepted
that the taxpayer did not have a gratuitous intention: but the Revenue argued
that the transfer was not such as the taxpayer would have made in an arm's
length transaction with an unconnected person.
For s 10
to be relevant the transferor must be shown to have entered into a disposition
as a result of which his estate has been diminished, and, once that is shown,
the taxpayer is then forced into the position of having to prove that he did
not intend to make any gift and that what he did would satisfy the test of an
objective commercial arrangement. The Revenue had taken a restricted view (some
would say a minimalistic view!) of the section. In effect it had argued that if
there was a substantial fall in the transferor's estate that was the end of the
matter. In Spencer-Nairn the Lord President dismissed arguments of this nature
in summary fashion:
'The fact
that the transaction was for less than the open market value cannot be
conclusive of the issues at this stage, otherwise the section would be deprived
of its content. The gratuitous element in the transaction becomes therefore no
more than a factor, which must be weighed in the balance with all the other
facts and circumstances to see whether the onus which is on the transferor has
been discharged.'
The case
is a curiosity in that a substantially higher value had been determined by the
Lands Tribunal, largely because of the view it took of the relevant Scottish
agricultural holdings legislation. It had concluded that under that legislation
the landlord was not obliged to erect the new piggery buildings. Clearly, had
this burden rested on the landlord the actual sale price which he received
would not have been unreasonable.
In
applying s 10 it was accepted by the Revenue that the vendor had no intention
of conferring a gratuitous benefit on anyone so that the sole question for the
court was whether the sale was such as would have been made with a third party
at arm's length. In applying this test, although it is basically drafted in
objective terms, they found it necessary to incorporate subjective ingredients.
The hypothetical vendor must be assumed to have held the belief of the landlord
that the value of the property was diminished by his obligation to rebuild the
piggeries. A wholly unreasonable (and in the event mistaken) belief will not
presumably be relevant.
The Spencer-Nairn case is unusual in that the
parties did not know that they were connected: in a sense therefore they were
negotiating as if they were third parties on the open market.
'A good
way of testing the question whether the sale was such as might be expected to
be made in a transaction between persons not connected with each other is to
see what persons who were unaware that they were connected with each other
actually did' (Lord President Hope).
The
following conclusions are suggested:
(1)
whether the transferor has a gratuitous intent is entirely subjective;
(2) there
can be a sale at arm's length for the purposes of the second limb of s 10 even
though the price realised is not approximately the same as the 'market value';
(3) in
considering what amounts to an 'arms length' sale, features of the actual sale
(such as the reasonably held beliefs of the vendor) must be taken into
account-this limb is not a wholly objective test. [28.21]
There are
special rules in the following cases:
a) Reversionary
interests
A
beneficiary under a settlement who purchases for value any reversionary
interest in the same settlement may be subject to IHT on the price that he pays
for the interest and s 10(1) cannot apply to the transaction (IHTA 1984 s
55(2): for the rationale of this rule see Chapter 33). [28.22]
EXAMPLE
28.3
Property
is settled on A for life, remainder to B absolutely. B has a reversionary
interest. A buys B's interest for its commercial value of £50,000. A
has made a potentially exempt transfer of £50,000.
b) Transfer
of unquoted shares and debentures
A
transferor of unquoted shares and securities must show, in addition to lack of
gratuitous intent, either that the sale was at a price freely negotiated at
that time, or at such a price as might have been freely negotiated at that time
(IHTA 1984 s 10(2)). In practice, such shares are rarely sold on an open
market. Instead the company's articles will give existing shareholders a right
of pre-emption if any shareholder wishes to sell. Provided that the right does
not fix a price at which the shares must be offered to the remaining [*656] shareholders, but leaves it open
to negotiation or professional valuation at
the time
of sale, HMRC will usually accept that the sale is a bona fide commercial
transaction satisfying the requirements of IHTA 1984 s 10(1). [28.23]
EXAMPLE
28.4
The
articles of two private companies make the following provisions for share
transfers:
(1) ABC
Ltd: the shares
shall be offered pro rata to the other shareholders who have an option to
purchase at a price either freely negotiated or, in the event of any dispute,
as fixed by an expert valuer.
(2) DEF
Ltd: the shares
shall be purchased at par value by the other shareholders.
Position
of shareholders in ABC Ltd: they will be able to take advantage of IHTA 1984 s 10(1) since the
price is open to negotiation at the time of sale.
Position
of shareholders in DEF Ltd: s 10(1) will not be available with the result that if the estate of
a transferor falls in value (if, for instance, 1 shares have a market value of
1.50 at the time of transfer) IHT may be charged even in the absence of
gratuitous intent. (Note that articles like those of DEF Ltd may also cause
problems for business property relief, see [31.52] and that valuing shares in
such circumstances is subject to an artificial rule, see [27.72].)
c) Partnerships
Partners
are not connected persons for the purpose of transferring partnership assets
from one to another. [28.24]
EXAMPLE
28.5
A and B
are partners sharing profits and owning assets in the ratio 50:50. They agree
to alter their asset sharing ratio to 25:75 because A intends to devote less
time to the business in the future. Although A's estate falls (he has
transferred half of his partnership share to B), he will escape any liability
to IHT if there is a lack of gratuitous intent. Assuming that A and B are not
connected otherwise than as partners, lack of gratuitous intent will be
presumed, since such transactions arc part of the commercial arrangements
between partners.
2 Other
non-chargeable dispositions
Excluded
property (IHTA 1984 s 6) No IHT is charged on excluded property (see Chapter
35). The most important categories are property sited outside the UK owned by
someone domiciled outside the UK and reversionary interests under a trust.
Although not excluded property, business or agricultural property which
qualifies for 100% relief will not attract any IHT charge (see Chapter
31). [28.25]
Exempt
transfers (IHTA 1984 Part 11) Exempt transfers are not chargeable transfers and
hence are not subject to charge (see Chapter 31). Examples are:
(1)
transfers between spouses and civil partners, whether inter vivos or on death; [*657]
(2)
transfers up to £3,000 in value each tax year;
(3)
outright gifts of up to £250 pa to any number of different
persons. [28.26]
Waiver
of remuneration and dividends (IHTA 1984 ss 14, 15) A waiver or repayment of salaries
and other remuneration assessable as employment income by a director or
employee is not a chargeable transfer; the remunenration is formally waived (by
deed) or if paid, repaid to the employer xho adjusts his profits or losses to
take account of the waiver or repaymenciilt should be noted that HMRC take the
view that the waiver must occur before the salary is paid to or put at the
disposal of the employee -- see Revenue Manual EIM 42705.
A person
may, in the 12 months before the right accrued (which time is identified in
accordance with usual company law rules), waive a dividend on shares without
liability to IHT. A general waiver of all future dividends is only effective
for dividends payable for up to 12 months after the waiver and should,
therefore, be renewed each year.
[28.1]
Voidable
transfers (IHTA 1984 s 150) Where a transfer is voidable (eg for duress or undue
influence or under the rule in Hastings-Bass) and is set aside, iiiuie treated
for IHT purposes as if it had never been made, provided that a chatte is made
by the taxpayer. As a result any IHT paid on the transfer may be reclaimed. Tax
on chargeable transfers made after the voidable transfer, IHT before it was
avoided, must be recalculated and IHT refunded, if necessatry. [28.28]-[28.40]
III WHEN
ARE LIFETIME TRANSFERS SUBJECT TO IHT? THE POTENTIALLY EXEMPT TRANSFER (PET)
If the
taxpayer makes an inter vivos transfer, IHT may be charged at once--alternatively the
transfer may be potentially exempt (a PET). In the latter case, IHT is only
levied if the taxpayer dies within seven years of the transits: otherwise the
transfer is exempt. During the 'limbo' period (being ii: period of seven years
following the transfer or, if shorter, the period ending with the transferor's
death) the PET is treated as if it were exempt (IHTA 19, 1 s 3A(5)) so that
despite the legislation calling the transfer potentially exempt it would be
more accurate to refer to it as potentially chargeable. With the exception of
transfers involving discretionary trusts and transfers to companies (and by
close companies), the majority of lifetime transfers are PETs. [28.41]
What is a
PET?
a) Gifts
made by individuals prior to 22 March 2006
A PET is
defined in IHTA 1984 s 3A(1). Prior to the changes made by FA 2006, Sch 20
which, in effect, alters fundamentally its definition, a PET had to satisfy two
preliminary requirements: first, it must have been made by na individual on or after 18
March 1986; and secondly, the transfer must, apart from this section, have been a chargeable
transfer (hence exemptions--such
[*658] as the annual £3,000 exemption--are deducted first). If
these preconditions for gifts made prior to 22 March 2006 are satisfied, the
following transfers then fall within the definition: [28.42]
i)
Outright gifts to individuals
A
transfer which is a gift to another individual is a PET so long as either the
property transferred becomes comprised in the donee's estate or, by virtue of
that transfer, the estate of the donee is increased (s 3A(2)). [28.43]
EXAMPLE
28.6
(1) Adam
gives Bertram a gold hunter watch worth £5,000: this is a PET.
(2)
Claude pays Debussy's wine bill of £10,000. Although property is not
transferred into the estate of Debussy, the result is to increase Debussy's
estate by paying off his debt. Accordingly this also is a PET.
(3) Edgar
who owned 51% of the shares in Frome Ltd transfers 2% of the company's shares
to Grace who had previously owned no shares in the company. Edgar suffers a
substantial drop in the value of his estate (since he loses control of Frome
Ltd) which exceeds the benefit received by Grace. The whole transfer is a PET.
ii)
Creation of accumulation and maintenance trusts or trusts for the disabled
These trusts are discussed in Chapter 34. In both cases until the Finance Act
2006, the transfer which established the trust was treated as a PET to the
extent that the value transferred was attributable to property which l virtue
of the transfer becomes settled. Whilst the tax treatment for trusts for the
disabled remains the same for post-22 March 2006 trusts, that for accumulation
and maintenance trusts ('A&M trusts') has changed (see Chapter 34
below). [28.44]
EXAMPLE
28.7
In
November 2005:
(1) A
settles £100,000 in favour of his infant grandchildren on A&M
trusts. This transfer is a PET.
(2) B
settles an insurance policy, taken out on his own life, on A&M trusts.
(This transfer is a PET.) He subsequently pays premiums on that policy and,
although the payments are transfers of value, they do not increase the property
in the settlement and are not, therefore, PETs. B should, therefore, consider
making a gift of that sum each year to the trustees to enable them to pay the
premiums on the policy (alternatively the problem will be avoided if B's
payments are exempt from IHT as normal expenditure out of income: see [31.3]).
iii)
Interest in possession settlements
As will
be seen in Chapter 33, a beneficiary entitled to an interest in possession is
treated as owning (for IHT purposes) the capital of the trust in which that
interest subsists. Hence, the inter vivos creation of such a trust is treated as a transfer
of value to that person and the inter vivos termination of his interest as a
transfer of value by him to the person or persons next entitled. In Example
28.8(1) below, for instance, Willie is treated as if he had made a gift to
Wilma (the next life tenant). Taking different facts, if on the termination of
the relevant interest in possession the settled property is then held on
discretionary trusts, the lifetime termination of his interest cannot be a PET,
since the PET definition excludes the creation of trusts without interests in
possession (see [28.46]). [28.45]
EXAMPLE
28.8
In
December 2005, Wilbur Wacker settles £100,000 on trust for his
brother Willie for life, thereafter to his sister Wilma for life, with
remainder to his godson Wilberforce. Wilbur's transfer is a PET. In February
2006, he settles a life insurance policy on the same trusts and continues to
pay the premiums to the insurance company (as in Example 28. 7(2), above). The
premiums (if not already exempt) will be PETs since the more restrictive
definition of a PET in the context of an A&M trust does not apply to
interest in possession trusts. Assume also that the following events occur:
(1)
Willie surrenders his life interest on 10 March 2006, his fiftieth birthday:
this deemed transfer of the property in the trust is a PET made by Willie.
(2) Wilma
purchases Wilberforce's remainder interest on 19 March 2006 for
£60,000 (see Example 28.3, above); this transfer by Wilma is a PET.
iv) The
limits of PETs for pre-22 March 2006 gifts
Although
the majority of lifetime transfers made prior to 22 March 2006 are PETs, there
are two main types of transfer which were immediately chargeable and, because
of the wording of s 3A, there are a number of traps which may have caught other
transfers. Those traps which also affect post-22 March 2006 gifts are dealt
with below (see [28. 48]).
(1) The
creation of no interest in possession trusts. Hence, a charge was levied on the
creation of, eg discretionary trusts and, in addition, ten-year anniversary and
exit charges may occur during the life of the trust (see Chapter 34).
(2)
'Where, under any provision of this Act other than s 52, tax is in any
circumstances to be charged as if a transfer of value had been made, that
transfer shall be taken to be a transfer which is not a PET.'
This
provision ensures that PETs are limited to lifetime gifts because it excludes
the transfer deemed to take place immediately before death and it also means
that tax charges will arise when close companies are used to obtain an IHT
advantage (see [28.151]).
(3) In
the case of A&M and disabled trusts property must have been transferred
directly into the settlement if the PET definition is to be satisfied (see
Example 28.7(2)). [28.46]
b) Gifts
by individuals made on or after 22 March 2006
The
result of the changes made by FA 2006 Sch 20 is that, whilst gifts made before
22 March 2006 remain subject to the regime that operated prior to the changes,
a gift made by an individual on or after 22 March 2006 can only be a PET if (i)
it is an outright gift to another individual or (ii) it is a gift into a
disabled trust (see [32.22] for the definition of a disabled trust). [28.47] [*660]
EXAMPLE
28.9
If, in
example 28.8, Wilbur Wacker settles the £100,000 on 24 November 2006,
this no longer qualifies as a PET, but gives rise to an immediate chargeable
transfer.
c) The
limits of PETs generally
For gifts
made either before or after 22 March 2006, the following traps should be noted:
(1) Jack
pays the school fees of his infant grandson Jude or Simon buys a holiday for
his uncle Albert. In neither case does property become comprised in the estate
of another by virtue of the transfer, and neither Jude's nor Albert's estate is
increased as a result of the transfer. Accordingly, both Jack and Simon have
made immediately chargeable transfers of value (by contrast, a direct gift to
each donee would ensure that the transfers were PETs).
(2) The
reservation of benefit provisions are analysed in Chapter 29 and it should be
noted that, when they apply, property which has been given away is brought back
into the donor's estate at death. The original gift will normally have been a
PET (provided that, if it was made on or after 22 March 2006, it was either an
outright gift to an individual or a gift into a disabled trust) and, therefore,
there is a possibility of a double charge to IHT should the donor die within
seven years of that gift at a time when property is still subject to a
reservation. (This double charge will normally be relieved by regulations
discussed in Chapter 36.) [28.48]
d) CGT
tie-in
CGT
hold-over relief continues to be available in cases where a gift falls outside
the PET definition (je is an immediately chargeable transfer) provided that it
is made by an individual or trustees to an individual or trustees (TCGA 1992 s
260). Both the creation and termination of a discretionary trust will generally
satisfy this wording so that the CGT that would otherwise be levied on the
chargeable assets involved may be held over. By contrast, gifts to close
companies do not involve gifts between individuals and trustees so that, unless
the property given away is business property within the definition in TCGA 1992
s 165, hold-over relief will not be available (for the CGT position on gifts
generally, see Chapter 24 and note that hold-over relief is no longer available
on gifts of shares to companies).
[28.49]
e) The
taxation of PETs
As
already noted there is no charge to tax at the time when a PET is made and that
transfer is treated as exempt unless the transferor dies within the following
seven years. There is, therefore, no duty to inform HMRC that a PET has been
made and for cumulation purposes it is ignored. All of this, however, changes
if the donor dies within the following seven years: the former PET then becomes
chargeable; must be reported; and the transfer must be entered into the
taxpayer's cumulative total at the time when t was made. As a result, IHT on
subsequent chargeable lifetime transfers may need to be recalculated
(these
transfers may in any event attract a supplementary charge). These consequences
are illustrated in Example 28.10 and explained further in Chapter 30. [28.50]-[28.60]
EXAMPLE
28.10
(1) On 1
May 1999 Ian gave £3,000 to Joyce.
(2) On I
May 2000 he settled £500,000 on discretionary trusts in favour of his
family.
(3) On 1
May 2001 he gave £60,000 to his daughter.
(4) On 1
May 2006 he died.
Ian died
within seven years of all three transfers. The transfer in 1999 ((1) above) is,
however, exempt since it is covered by his annual exemption (see [31.3]).
Transfer
(2) was a chargeable lifetime transfer and attracted an IHT charge when made.
Because of Ian's death within seven years a supplementary IHT charge will arise
(the calculation of this additional IHT caused by death is explained in Chapter
30).
Transfer
(3) was a PET. Because of Ian's death it is rendered chargeable and is subject
to IHT. Further, Ian's cumulative total of chargeable transfers made in the
seven years before death becomes (if we assume the non-availability of the
£3,000 annual exemption in both 2000 and 2001) £560,000.
Had Ian lived until 1 May 2007 this PET would have become an exempt transfer
(ie free from all IHT).
IV ON
WHAT VALUE IS IHT CALCULATED?
1 What is
the cost of the gift?
a) General
When an
individual makes a chargeable disposition (including a PET rendered chargeable
by death within seven years) IHT is charged on the amount by which his estate
has fallen in value as a result of the transfer. A person's estate is the
aggregate of all the property to which he is beneficially entitled (IHTA 1984
s5(1)). [28.61]
b) Meaning
of 'property' (IHTA 1984 s 272)
Property
'includes rights and interests of any description'. It includes property (other
than settled property) over which an individual has a general power of
appointment (IHTA 1984 s 5(2), because he could appoint the property to
himself), but not property owned in a fiduciary or representative capacity: eg
as trustee or PR. Melville v IRC (2001) decided that a general power exercisable over
settled property amounted to a 'right or interest' and was property within the
definition in s 272 (see further on this case [32.52]) but FA 2002 reversed
this decision by adding to s 272 the words 'but does not include a settlement
power' and a settlement power is then defined in IHTA 1984 s 47A as 'any power
over, or exercisable (whether directly or indirectly) in relation to settled
property or a settlement'. [28.62]
EXAMPLE
28.11
Mac
transfers property worth £500,000 into a discretionary trust. He
retains a power to revoke the trust after (say) three months. Although Mac can
recover the [*662] entire £500,000 by exercise
of this power his estate falls in value by the full £500,000. The power
to revoke is a 'settlement power' and so not 'property' for IHT purposes.
(similarly a reversionary interest acquired in the circumstances set out in s
55 does not form part of the taxpayer's estate: see [28.221.)
c) Calculating
the fall in value of an estate
In theory
the transferor's estate must be valued both before and after the transfer and
the difference taxed. In practice, this is normally unnecessary since the
transferor's estate will only fall by the value of the gift (and, as discussed
in Example 28.12 below, by the costs of making the gift). However, in unusual
cases the cost to the transferor of the gift may be more than the value of the
property handed over (see Example 28.14).
EXAMPLE
28.12
A gives
£500,000 to a discretionary trust. His estate falls in value by
£500,000 plus the IHT that he has to pay, ie £500,000 must
be grossed up at the appropriate rate of IHT to discover the full cost of the
gift to A (see [28.124]).
Were he
to give the trust land worth £500,000 his estate falls in value by
the value of the property (£500,000) and by any CGT and costs of
transfer (such as conveyancing fees) that A pays. It will also fall by the IHT
payable.
However,
IHTA 1984 s 5(4) provides that, for the purpose of calculating the cost of the
gift, the transferor's estate is deemed to drop by the value of the property
plus the IHT paid by the transferor but not by any other tax nor by any
incidental costs of transfer. Thus, in Example 28.12, A's estate falls only by
the value of the land and by the IHT that he pays.
Where the
donees (the trustees in the above example) agree to pay the IHT, the overall
cost of the gift is reduced since A's estate will fall only by the value of the
property transferred. The trustees will be taxed on that fall in value. [28.63]
EXAMPLE
28.13
A gives
property worth £50,000 to the trustees. If A pays the IHT, the
£50,000 is a net gift and if A is charged to IHT at 20% (rates of tax
are considered at [28.122]: for the purpose of this example it is assumed that
A has used up his nil rate band and annual exemption for the year) then that
rate of tax is chargeable on the larger (gross) figure (here £62,500)
which after payment of IHT at 20% leaves £50,000 in the trustees'
hands.
.
---------------
Fall in A's |
| £50,000 (net of IHT) to
estate
charged ---->|
£62,500
|/ discretionary
trustees
to IHT at
20%
|
|\
.
---------------
£12,500 IHT paid to the
.
Revenue
[*663]
If, in
this example, the trustees paid the IHT the result would be:
.
---------------
Fall in
A's |
|
estate
charged ---->|
£50,000
|-----> £50,000 (gross)
to IHT at
20%
| | paid to trustees
.
--------------- |
.
|
.
£100,000 IHT paid by
.
the trustees
d) Relationship
between the fall in value of the donor's estate and the increase in value of
the donee s estate
IHT is
generally calculated on the fall in value of the transferor's estate not on the
increase in value of the transferee's estate. This can work to the taxpayer's
advantage, or disadvantage.
EXAMPLE
28.14
Compare
(1) A
gives B a single Picasso plate value £20,000; B agrees to pay any IHT
that may fall due. B owns the remaining plates in the set (currently worth
£150,000) and the acquisition of this final plate will give B's set a
market value of £200,000. Although B's estate has increased in value
by £50,000, IHT will only be charged on the fall in value in A's
estate (20,000).
(2) A
owns 51% of the shares in A Ltd. This controlling interest is worth
£100,000. He gives 2% of the shares to B who holds no other shares.
2% of the shares are worth (say) 2 but A, having lost control, will find that
his estate has fallen by far more than 2-say to £80,000. It will be
the loss to A (20,000) not the gain to B (2) which is taxed.
Note that
for an omission to exercise a right to be chargeable another person's estate
must be increased in value (see s 3(3) and [28.4]). [28.64]
2
Problems in valuing an estate
Any
calculation of IHT will require a valuation of the property transferred (see
generally IHTA 1984 Part VI Chapter 25). As a general rule it is valued at the
price that it would fetch on the open market. No reduction is made for the fact
that the sale of a large quantity of a particular asset might cause the price
to fall (IHTA 1984 s 160). [28.65]
a) Examples
of the value transferred
Liabilities
Except in the case of a liability imposed by law, a liability incurred by a
transferor will only reduce the value of his estate if it was incurred for a
consideration in money or money's worth (IHTA 1984 s 5(5)) and even in this
case artificial debts are non-deductible (FA 1986 s 103 see [30.14]). [28.66] [*664]
EXAMPLE
28.15
A gives
his house to his son B. The market value of the house is £80,000, but
it is subject to a mortgage to building society of £25,000 which B
agrees to discharge. Hence, the property is valued for IHT purposes at
£55,000. This position will commonly arise when a death gift of a
house is made since, in the absence of a contrary intention stated in the will,
the Administration of Estates Act 1925 s 35 provides that debts charged on
property by the deceased must be borne by the legatee or donee of that
property. Note also, the stamp duty consequences when a debt is taken over by a
donee.
Co-ownership
of property If land worth £100,000 is owned equally by A and B, it
might be assumed that the value of both half shares is £50,000. In
fact the shares will be worth less than £50,000 since it will be
difficult to sell such an interest on the open market (see the Lands Tribunal
cases of Wight v IRC (1984) and Charkham v IRC (2000)). Whoever purchases will have to share the
property with the other co-owner and in practice a discount of 10-15% is
reasonable. Because of the related property rules--see [28.70]--there will,
however, be no discount when the co-owners are husband and wife. Co-ownership
of chattels poses other problems and it may be argued that because of the
difficulty of enforcing a sale a larger discount is in order. [28.67]
Shares
and securities When listed shares and securities are transferred, their value
is taken (as for CGT; see Chapter 19) as the lesser of the 'quarter-up' and
'mid-price' calculation.
Valuation
of unquoted shares and securities is a complex topic. A number of factors are
taken into account, eg the company's profit record, its prospects, its assets
and its liabilities. The percentage of shares which is being valued is a major
factor. A majority shareholding of ordinary voting shares carries certain
powers to control the affairs of the company (it will, for instance, give the
owner the power to pass an ordinary resolution). A shareholding representing
more than 75% confers greater powers, notably the power to pass special
resolutions. Correspondingly, a shareholder who owns 50% or less of the voting
power (and, even more so, a shareholding of 25% or less) has far fewer powers
(he is a minority shareholder). In valuing majority and substantial minority
holdings HMRC takes a net asset valuation as the starting point and then
applies a discount (between 10-15%) in the case of minority holdings.
When
shares are subject to a restriction on their transfer (eg pre-emption rights)
they are valued on the assumption of a sale on the open market with the
purchaser being permitted to purchase the shares, but then being subject to the
restrictions (IRC v Crossman (1937) and see [28.72]). [28.68]
b) Special
rules
IHTA 1984
Part VI Chapter 1 contains special valuation rules designed to counter tax
avoidance. [28.69]
Related
property (IHTA 1984 s 161) IHT savings could be engineered by splitting the
ownership of certain assets (typically shares, sets of chattels, and interests
in land) amongst two or more taxpayers. The saving would occur [*665] when the total value of the individual assets resulting from
the split was less than the value of the original (undivided) asset. A pair of
Ming vases, for instance, would be worth more as a pair than the combined
values of the two individual vases. When it is desired to split the ownership
of such assets, however, it should be remembered that the transfer needed to
achieve this result will normally be potentially chargeable and, as any tax
will be charged on the fall in value of the transferor's estate, no tax saving
may result. Inter-spouse transfers are, however, free of IHT and hence, were it
not for the related property provisions, could be used to achieve substantial
savings by asset splitting. To frustrate such schemes the related property
rules provide that, in appropriate circumstances, an asset must be valued
together with other related property and a proportion of that total value is
then attributed to the asset (compare the CGT provisions on asset splitting:
[19.24]).
EXAMPLE
28.16
X Ltd is
a private company which has a share capital of £100 divided into 100
£1 shares. Assume that shares giving control (ie more than 50%) are
worth £100 each and minority shareholdings £20 per share.
If Alf owns 51% of the shares the value of his holding is £5,100
(f100 per share). Assume that Alf and Bess are married. Alf transfers 26% of
the company's shares to Bess. Alf becomes a minority shareholder with shares
worth £500 but pays no IHT because transfers between spouses are
exempt. Bess also has a minority holding worth £520. If AIf and Bess
then each transfer their respective holdings to their son Fred, they may be
liable to pay IHT on a value of £1,020, whereas if Alf had
transferred his 51% holding to Fred directly he would be potentially liable to
tax on £5,100.
To
prevent this IHT saving AIf and Bess's holdings are valued together as a
majority holding worth £5,100. Accordingly, when Alf transfers his
25% holding to Fred this is 25/51 of the combined holding and is valued,
therefore, at £2,500 (ie 25/51 of £5,100). Once A1f has
disposed of his holding, Bess's 26% holding is then valued in the normal way on
a subsequent transfer: ie as a minority holding worth £520 (in
certain cases the associated operations rule or the 'Ramsay principle' might be invoked; see [28.101]).
Inter-spouse/civil
partner transfers are the main instance of transfers which attract the related
property provisions. However, the rules also catch other exempt transfers (eg
to a charity or political party) in circumstances where the transferor could
otherwise obtain a similar tax advantage.
EXAMPLE
28.17
As
Example 28.16, Alf owns 51% of the shares in X Ltd. He transfers 2% to a
charity paying no IHT because the transfer is exempt. He then transfers the
remaining 49% to Fred. Alf is a minority shareholder and the loss to his estate
is only £980 compared with £5,100 if he had transferred the
entire 51% holding directly to Fred. Some time later Fred might purchase the 2%
holding from the charity for its market value of £40. Unless the two
transfers (ie to the charity and to Fred) are more than five years apart, the
charity's holding is related to All" s so that his 49% holding is valued
at £4,900 on the transfer to Fred.
The
related property rules apply to the deemed transfer on death subject to the
proviso that if the property is sold within three years after the death for a
price lower than the related property valuation, it may be revalued on death
ignoring the related property rules (see Chapter 30). [28.70] [*666]
Property
subject to an option (IHTA 1984 s 163) When property is transferred as a result
of the exercise of an option or other similar right created for fun
consideration, there is no liability to IHT.
Where an
option is granted for less than full consideration, however, there, will be a
chargeable transfer or a PET at that time and there may be a further charge
when the option is exercised. A credit will be given against the value, of the
property transferred, when the option is exercised, for any consideration
actually received and for any value that was charged to IHT on the grant of the
option. [28.71]
EXAMPLE
28.18
(1)
Harold grants Daisy an option to purchase his house in three years' time for,
its present value of £120,000. Daisy pays £30,000 for the
option which represents full consideration. When Daisy exercises the option
three years later the house is worth £250,000.
Harold
has not made a transfer of value and is not liable to IHT since (as the option
was granted for full consideration) the house is only worth £120,000
to him.
(2)
Assume instead that Daisy gives no consideration for the option which is worth
£30,000. IHT may, therefore, be chargeable on that sum. On the
exercise of the option IHT may he payable on £100,000
(£250,000-£120,000) minus the sum that was chargeable on
the grant of the option (30,000)).
Property
subject to restrictions on transfer In IRC v Grossman (1937) the testator owned shares
in a private company the articles of which imposed restrictions on alienation
and transfer. By a bare majority the House of Lords held that in valuing those
shares for estate duty purposes the basis to be taken was the price which they
would fetch on the open market on the terms that a purchaser would be
registered as the owner of the shares but would in turn be subject to the
restrictions contained in the company's articles of association. The view
contended for by the executors would have resulted in property which could not
be sold in the open market escaping the tax net altogether. The Grossman case
was subsequently followed by the House of Lords in Lynali v IRC (1972) and has been adopted in a
series of cases concerning IHT. For instance, in Alexander v IRC (1991) a Barbican flat was purchased
under the 'right to buy' provisions of the Housing Act 1980. All or part of the
discount under that legislation had to be repaid in the event of the flat being
sold within five years of its purchase. The taxpayer, however, died in the
first year. The Court of Appeal-following Grossman-held that for valuation
purposes an open market value must be taken and the flat was to be valued on
the basis of what a purchaser would pay to stand in the deceased's shoes: ie
taking over the liability to repay the discount should he sell the property
within the prescribed period. It is inherent in this approach that the
valuation thereby obtained may result in a higher figure than would actually be
the case if the property were sold by the executors (and it appears that such a
sale, even if occurring within four years of death, will not result in
revaluation relief under IHTA 1984 s 190: see Chapter 30). [28.72]
Non-assignable
agricultural tenancies The vexed question of whether a non-assignable
agricultural tenancy had any value was decided in the affirmative by the Lands
Tribunal for Scotland on Grossman principles (see generally [31.72]). Once it
was accepted that Grossman applied, the issue is one of fixing the correct
value. In the Scottish case, Baird's Executors v IRC (1991), this matter was not
argued and the 'robust approach' of the District Valuer in taking 25% of the
open market value was accepted. The Court of Appeal decision in Walton v IRC (1996), confirmed that there can
be no hard and fast valuation rule in such cases. The tenancy will not
automatically be valued on the basis of a percentage of the freehold value on
the assumption that the landlord will always be a special purchaser: in Walton, for instance, the freeholder had
no interest in acquiring the tenancy. Evans U commented that 'the sale has to
take place "in the real world" and account must be taken of the
actual persons as well as of the actual property involved'. [28.73]
Life
assurance policies Life assurance policies normally involve the payment of
annual premiums in return for an eventual lump sum payable either on retirement
or on death. Special valuation rules, which do not apply on death (see Chapter
30), are provided by IHTA 1984 s 167 to prevent a tax saving when the benefit
of such a policy is assigned.
[28.74]-[28.100]
EXAMPLE
28.19
A gives
the benefit of a whole life policy effected on his own life to B when its open
market value is £10,000. A has paid five annual premiums of
£5,000, so that the cost of providing the policy is £25,000
to date. For IHT purposes the policy is valued at the higher of its market
value or the cost of providing the policy. As a result tax may be charged on
£25,000.
V
'ASSOCIATED OPERATIONS' (IHTA 1984 s 268)
The
legislation contains complex provisions to prevent a taxpayer from reducing the
value of a gift or the IHT chargeable by a series of associated operations.
'Associated
operations' are defined in IHTA 1984 s 268 as:
'(1) ...
any two or more operations of any kind, being--
(a)
operations which affect the same property, or one of which affects some
property and the other or others of which affect property which represents,
whether directly or indirectly, that property, or income arising from that
property, or any property representing accumulations of any such income; or
(b) any
two operations of which one is effected with reference to the other, or with a
view to enabling the other to be effected or facilitating its being effected,
and any further operation having a like relation to any of those two, and so
on; whether those operations are effected by the same person or different
persons, and whether or not they are simultaneous; and "operation"
includes an omission.
(2) The
granting of a lease for full consideration in money or money's worth shall not
be taken to be associated with any operation effected more than three years
after the grant, and no operation effected on or after 27 March 1974 shall be
taken to be associated with any operation effected before that date. [*668]
(3) Where
a transfer of value is made by associated operations carried out at different
times it shall be treated as made at the time of the last of them; but where
any one or more of the earlier operations also constitute a transfer of value made by the same transferor, the value
transferred by the earlier operations shall be treated as reducing the value
transferred by all the operations taken together, except to the extent that the
transfer constituted by the earlier operations but not that made by all the
operations taken together is exempt under s 18 (spouse exemption).' [28.101]
In a
series of cases the courts have imposed restrictions on this widely drafted
section.
1
Macpherson, Reynaud and 'relevant' associated operations
In IRC
v Macpherson
(1989) trustees entered into an agreement which reduced the value of the
settled property and subsequently appointed that property in favour of a
beneficiary. The House of Lords held that the two transactions were associated
operations, which formed part of an arrangement designed to confer a gratuitous
benefit, this benefit being conferred by the appointment (see further Chapter
31). Lord Jauncey (in a speech with which the other Law Lords concurred)
identified the boundaries of thˇ associated operations provisions as follows:
'If an
individual took steps which devalued his property on a Monday with a view to
making a gift thereof on Tuesday, he would fail to satisfy the requirements of
s 20(4) (now s 10(1)) because the act of devaluation and the gift would be
considered together ... The definition in s 44 (now s 268) is extremely wide
and is capable of covering a multitude of events affecting the same property
which might have little or no apparent connection between them. It might be
tempting to assume that any event which fell within this wide definition should
be taken into account in determining what constituted a transaction for the
purposes of s 268. However, counsel for the Crown accepted, rightly in my view,
that some limitation must be imposed. Counsel for the trustees informed your
Lordships that there was no authority on the meaning of the words
"associated operations" in the context of capital transfer tax
legislation but he referred to a decision of the Court of Appeal in Northern
Ireland, Herdman v IRC (1967) in which the tax avoidance provisions of ss 412 and 413 of the
Income Tax Act 1952 had been considered [now TA 1988 s 739: see [18.111]] Lord
MacDermott CJ upheld a submission by the taxpayer that the only associated
operations which were relevant to the subsection were those by means of which,
in conjunction with the transfer, a taxpayer could enjoy the income and did not
include associated operations taking place after the transfer had conferred
upon the taxpayer the power to enjoy income. If the extended meaning of
"transaction" is read into the opening words of s 20(4) the wording
becomes:
"A
disposition is not a transfer of value if it is shown that it was not intended,
and was not made in a transaction including a series of transactions and any
associated operations intended, to confer any gratuitous benefit ..."
So read
it is clear that the intention to confer gratuitous benefit qualifies both
transactions and associated operations. If an associated operation is not intended
to confer such a benefit it is not relevant for the purpose of the subsection.
That is not to say that it must necessarily per se confer a benefit but it must
form a part of and contribute to a scheme which does confer such a benefit.' [*669]
In Reynaud
v IRC (1999)
brothers transferred shares into trusts from which they were wholly excluded:
the following day the company bought back those shares from the trustees. The
Special Commissioners held that, although both operations were associated, no
disposition had been effected by associated operations since the value of the
brothers' estates had been diminished by the gift into settlement alone:
'the
purchase of own shares contributed nothing to the diminution which had already
occurred and was not therefore a relevant associated operation.' [28.102]
2 The
Hatton case
Hatton
v IRC (1992)
involved a tax avoidance scheme. Within the space of 24 hours two settlements
were created. In the first, the settlor (Mrs C) reserved a short-term life
interest; in the second, the reversionary interest in the first settlement was
itself settled (by Mrs H) on Mrs C for a further 24-hour period with the
property then being held absolutely for Mrs H. The creation of the original
settlement by Mrs C involved no loss to her estate (under the relevant
legislation she was treated as still owning the property by virtue of her
interest in possession: see Chapter 33). The creation of the second settlement
was likewise tax free since it involved the settlement by Mrs H of excluded
property (the reversionary interest: see now IHTA 1984 s 48 and Chapter 33).
Because the termination of Mrs C's first interest in possession was immediately
succeeded by an interest in possession in the second settlement it attracted no
tax charge (see now IHTA 1984 s 52(2)). Finally, the termination of that second
interest in possession was also tax free since the settled property thereupon
resulted to Mrs H, the settlor of that second settlement (see FA 1975 Sch 5
para 4(2): amended to prevent such schemes by FA 1981 s 104(1), now enacted as
IHTA 1984 s 53(5)(b): see Chapter 33).
So far as
the associated operations provisions were concerned, the judge concluded that
the first settlement was made with a view to enabling or facilitating the
making of the second (see IHTA 1984 s 268(1) (b)). Accordingly there was a
disposition by associated operations which was treated as a single disposition
of property from Mrs C into the second settlement of which she therefore became
a settior (see the definition of a settlement in IHTA 1984 s 43(2): Chapter
32).
It is not
unusual for there to be two or more settlors of a single settlement. For
instance, A and B could both transfer identified assets into a single trust.
Under the IHT legislation, when circumstances require, that property may be
treated as comprised in two separate settlements (see s 44(2)). For instance, A
might settle £100 and B £50 and the resulting settlement
fund could, when appropriate, be split into A's settlement (as to two-thirds) and
B's settlement (as to one-third). Chadwick J concluded, however, that there
could be circumstances where a division of the settlement property in this way
was impractical and so, given that more than one settlor existed, the
legislation must, in appropriate circumstances, treat each settlor as having
created a separate settlement comprising, in each case, the whole of the
settled property. This position can be illustrated in the Hatton case itself
where Mrs C was, by dint of the associated operation rules (and, according to
the Special Commissioners, because she was a person who had provided funds
directly or [*670] indirectly), a person who had settled
all the property in the second settlement. Mrs H was also a senIor; she was
named as the settior and had provided property in the shape of her reversionary
interest in the first settlement. Given the nature of the property settled by
these two settlors, Chadwickj was forced to conclude that each had created a
separate settlement of the entirety of the property in the second settlement.
Under the settlement created by Mrs C, the reverter to settlor rules did not
apply.
This
approach (treating each settlor as having established a separate settlement of
the entirety of the settled property) would, the judge suggested, also apply to
reciprocal settlements. In a simple case A would settle property on X for a
limited interest in possession and as a quid pro quo B would settle property on
Y for a similar interest. In both cases the reverter to senior provisions would,
at first sight, apply on the termination of X and V's respective interests.
Once it is accepted, however, that A is also a settlor of B's trust and vice
versa (see s 44(1)) that analysis does not hold good. Instead, because B is a
settlor of 'A's settlement' on the termination of X's limited interest an IHT
charge may arise. The judge viewed the situation as one in which A and B were
settlors of two separate settlements rather than accepting the view propounded
by the Revenue that B should be seen as 'a dominant settlor' of A's trust.
Presumably
the judge's approach would not be applied in cases where a full tax charge
would, in any event, arise. Take, for instance, the situation where A as part
of a reciprocal arrangement settles property on B's son for life with remainder
to B's daughter and B creates a similar trust in favour of A's son and
daughter. Although there are reciprocal settlements, on the death of (say) B's
son a full tax charge would then arise on the property in 'A's settlement' so that
even though the analysis may be that B is also a seuior of the whole of the
property in that trust there can surely be no question of imposing a further
tax charge on the ending of B's son's interest in possession.
Finally,
the analysis is not easy to apply in cases where property is settled on trusts lacking an interest in possession by two
settlors, one who has made chargeable
lifetime transfers and one who has not. Will HMRC be able to argue, in
appropriate cases, that the former is to be treated as the settior of the entirety so that in
arriving at the IHT charge on the settlement his previous chargeable transfers
will be taken into account? [28.103]
3 The
problem of multiple settlements
In Rysaffe
Trustee Co (CI) Ltd v JRC (2003) a taxpayer established five 'mirror' discretionary
settlements: ie in each case the beneficiaries and trustees were the same; each
comprised an initial sum of £10 and private company shares were
subsequently added to each trust. The settlements were dated on different days.
The Revenue sought to impose tax on the basis that the taxpayer had made only a
single settlement since the various transfers were associated and so amounted
to a single disposition (see further Chapter 34). Park J (and a unanimous Court
of Appeal) rejected the Revenue's arguments as follows:
(1) 'the
practical operation of the associated operations provisions is comparatively
limited. It is not some sort of catch-all anti-avoidance
provision
which can be invoked to nullify the effectiveness of any scheme or structure
which can be said to have involved more than one operation and which was
intended to avoid or reduce IHT ... section 268 is not an operative provision
which of itself imposes IHT liabilities. It is a definition of an expression (associated
operations) which is used elsewhere. The definition only comes into effect so
far as the expression "associated operations" is used elsewhere, and
then only if the expression in another provision is relevant to the way in
which that other provision applies to the facts of the particular case.'
(2)
although a 'disposition' in s 272 can include a disposition effected by
associated operations, associated operations are, however, only relevant if in
substance there is a single disposition which has been divided into a number of
separate 'operations'.
In
addition, Park j made two further points:
(1) the
transfers of the shares to the five trusts were not effected with reference to
each other (s 268(1)(b)):
'It is
true that each transfer was a part of one plan or scheme, but the transfer of
parcel 1 to settlement 1 made no reference to the transfer of parcel 2 to
settlement 2; and vice versa. Each transfer was effected in the knowledge that
the other was being effected as well, but that does not seem to me to be the
equivalent of saying that each transfer was effected "with reference
to the other".'
(2) the
five parcels of shares did not amount to the same property (see s
268(1)(a)). [28.104]
4 The
effects of s 268 applying
It
enables HMRC to tax as one transaction any number of separate transactions
(including omissions) which, when looked at together, reduce the value of the
taxpayer's estate. The transactions need not be carried out by the same person
nor need they be simultaneous. Apparently the lifetime act of making a will can
amount to an associated operation although the subsequent death will not! (Bambridge
v IRC (1955)).
Intestacy is covered by the reference to an omission.
Section
268(1) (a) is concerned with the channelling of gifts, in particular between
spouses (where the transfers are exempt). In such dispositions the transferor
is deemed to have made a transfer equivalent to the value of all the operations
at the time when the last of them is made. If one of the operations involved a
transfer of value by the same transferor, he is entitled to a credit for that
value against the aggregate value of the whole operation unless the transfer
was anyway exempt because it was made to a spouse (IHTA 1984 s 268(3)),
EXAMPLE
28.20
It is certain
that H will die shortly whereas his wife is in good health. Any transfer H
makes to his son (S), although a PET, will, therefore, be made chargeable by
his death. Accordingly, he transfers £20,000 to his wife (W). W then
passes the £20,000 to the son. Under IHTA 1984 s 268(1) (a) HMRC
could argue that the transfers (H to W and W to S) are 'associated'. H is
deemed to have made a transfer of value equivalent to the value transferred by
all the associated operations, ie £40,000, £20,000 (H to W)
and £20,000 (W to S). However, on his death, IHT is only [*672] chargeable on
£20,000 as his transfer of £20,000 to W is exempt as an
inter-spouse transfer. It is unclear whether under s 268(3) IHT could also be
charged on her gift of £20,000 to S. The preferable view is no since
the one charge on H should cover all the relevant transfers; but assume that H
also gives £3,000 to his son which is exempt by his annual exemption
(but see the Hutton case [28.103]). All three transfers (H to S, H to W and W
to S) are associated at the time of the last of them (W to S). Under IHTA 1984
s 268(3) on H's death IHT is not charged on the aggregate value of all three
transfers (ie £43,000) but on £20,000 only because he has a
credit for any previous (associated) transfers of value (the £3,000
transfer to S) and the inter-spouse transfer of £20,000.
Commenting
upon the associated operation provisions, Mr Joel Barnett (then Chief Secretary
to the Treasury) stated that they would only be used to attack inter-spouse
transfers in blatant tax avoidance cases:
where the
transfer by a husband to a wife was made on condition that the wife should at
once use the money to make gifts to others, a charge on a gift by the husband
might arise under [s 268].'
(Official
Report, Standing Committee A (13 February 1975) col 1596.)
Thus,
spouses may channel gifts in order to utilise the poorer spouse's exemptions,
eg the £3,000 annual exemption and the exemption for gifts on
marriage of up to £5,000, and to obtain income tax and CGT benefits
resulting from the independent taxation of spouses.
EXAMPLE
28.21
H is
wealthy, his wife, W, is poor. Both wish to use up their full IUT exemptions
and to provide for their son who is getting married. It would be sensible for
the following arrangement to be adopted:
Stage
1 H transfers
£11,000 to W which is exempt as an inter-spouse transfer. This will
enable W to utilise two years' annual exemption of £3,000 plus the
£5,000 marriage exemption.
Stage
2 Both spouses
then each give £11,000 to the son.
Section
268 will not be invoked provided that the gift to W is not made on condition
that she pass the property to S.
Section
268(1)(b) also enables HMRC to put two separate transactions together.
EXAMPLE
28.22
(1) A
owns two paintings which together are worth £60,000, but individually
are worth £20,000. A sells one picture for £20,000. This is
a commercial transaction (s 10(1)) and, therefore, not subject to IHT. A then
sells the second picture, also for £20,000, to the same purchaser.
As a
result of the two transactions, the purchaser has paid only £40,000
but received value of £60,000 and A's estate has fallen in value by
£20,000. The effect of s 268(1) (b) is that HMRC can put the two
transactions together and in appropriate cases tax the loss to his estate (ie
£20,000) provided there is a I gratuitous intent. Where the
transactions are with a connected person the presumption of gratuitous intent
will be hard to rebut. If both sales were to a commercial art gallery, however,
it is likely that, despite s 268, no tax would be chargeable.
Cun1rast
assume as above that A owns two paintings but wishes to give one to his son.
Accordingly, he settles that picture on trust for himself for life, remainder
to his son. Provided that the settlement commenced prior to 22 March 2006, no
IHT would have been charged on creation of that settlement since A would have
been treated as owning the picture (see Chapter 33). A then surrenders his life
interest and as a result tax appears to be chargeable on the value of the
picture in the settlement: ie on £20,000 only (IHTA 1984 s 52(1)).
Could it be argued by an application of s 268 that A has directly disposed of
the picture to his son so that £40,000 is subject to IHT?
(Alternatively, might the Rarnsay principle apply to produce that result?) Note
that for interest in possession trusts (apart from disabled trusts) created
during the settlor's lifetime on or after 22 March 2006, there is an immediate
IHT charge.
(2) A
owns freehold premises worth £200,000. A gives the property to his
nephew (N) in two stages. He grants a tenancy of the premises to N at a full
market rent thereby incurring no potential liability to IHT. Two years later,
he gives the freehold to N which being subject to a lease is worth only
£100,000. Hence, there is a potential liability for IHT on
£100,000 only, although A has given away property worth
£200,000. Under IHTA 1984 s 268(1)(b) HMRC can tax the overall loss
to his estate. IHTA 1984 s 268(2), however, provides an exemption where more
than three years have elapsed between the grant of the lease for full consideration
and the gift or sale of the reversion.
(3) A wants to give his annual exemption of
£3,000 to B each year. Although he has no spare cash, he owns a house
worth £30,000. Accordingly, A sells the house to B for
£30,000 which is left outstanding as a loan repayable on demand. Each
year A releases as much of the outstanding loan as is covered by his annual
exemption. After ten years the loan is written off. The house is then worth
£40,000 (the scheme is generally known as a 'sale and mortgage
back'). A loan which is repayable on demand is not chargeable to IHT (see
[28.131]) and the release of part of the loan each year, although a transfer of
value, is covered by A's annual exemption.
These may
be associated operations under IHTA 1984 s 268(1)(b). HMRC has intimated that
it might regard the overall transaction as a transfer of value by A of the
asset at its market value (E40,000) at the date when the loan is written off. A
would have a credit for his previous transfers of value, ie £30,000
(s 268(3)), and there would, therefore, be a potential charge to IHT on the
capital appreciation element only, ie £10,000.
For
HMRC's view in Example 28.22(3) to be upheld it would have to show that the
donor retained ownership of the house throughout the period of ten years. In
support, it could be argued that the transferor's estate must be valued
immediately after the disposition and that in the case of a disposition
effected by associated operations that means at the time of the last of those operations
(see IHTA 1984 ss 3(1), 268(3)). The counter-argument is that the value
transferred is the difference between the value of the house immediately before
the first stage in the operation (ie £30,000) and the value of the
debt after the last operation (nil) so that the loss to the transferor is
£30,000, all of which is covered by the annual exemptions. [28.105]-[28.120] [*674]
VI HOW IS
IHT CALCULATED?
I
Cumulation and rates of tax
1) Cumulation
Each
individual must keep a cumulative account of all the chargeable transfers made
by him because IHT is levied not at a flat rate but at progressively higher
rates according to that total. It is the cumulative amount that fixes the rate
of IHT for each subsequent chargeable transfer. From 18 March 1986 cumulation
has only been required over a seven-year period. This restricted period
contrasts with the original CTT legislation that had provided for unlimited
cumulation (a ten-year period was introduced in 1981). [28.121]
b) Rates
of tax
From 6
April 2006 IHT rates are as follows:
. Portion of value
Rate of tax
Lower
limit Upper limit Per cent
------------------------- -----------
. £
£
Nil*
.
0
285,000 40*
. 285,000 ---
*
Chargeable lifetime transfers (for instance into a discretionary trust) are
charged at half rates (ie at 0% or 20%).
[28.122]
EXAMPLE
28.23
(Ignoring
exemptions, reliefs and assuming that current IHT rates apply throughout.) A
makes the following chargeable transfers (ie none of the transfers is a PET):
(1) June
1995
£100,000
Applying
the half rates of IHT the £100,000 falls within the nil rate band.
(2) June
2001
£195,000
The
starting point in using the table is £100,000 which was the point
reached by the gift in 1995 and IHT is charged at rates applicable to transfers
from £100,000 to £295,000:
ie first
£285,000 at nil%
the final
£10,000 at 20%.
(3) July
2002 £55,000
The 1995
gift of £100,000 drops out of the account as it was made more than
seven years before. IHT is, therefore, charged at rates applicable to transfers
from £195,000 to £250,000 (ie at 0%).
e) Taxing
PETs
PETs are
presumed to be exempt unless and until the transferor dies within seven vers of
the transfer. 1f the donor does die within seven years the PET [*675] becomes a chargeable transfer (thereby necessitating the
payment of IHT). In cases where the deceased taxpayer had made a mixture of
chargeable transfers and PETs in the seven years before death, tax paid on the
chargeable transfers may have to be recalculated, first because the PETs are
converted into chargeable transfers from the date when they were made and, secondly,
because of the death within seven years of making the chargeable transfer.
EXAMPLE
28.24
T makes
the following transfers of value:
Year 1 PET of £75,000
Year 2 chargeable transfer of
£250,000
Year 4 T dies.
IHT
charged on the chargeable transfer in Year 2 will have been calculated ignoring
the PET made in Year 1. Accordingly it will have proceeded on the basis that T
had made no prior chargeable transfers. As a result of his death in Year 4,
however, the PET of £75,000 is chargeable in Year 1 so that IHT On
the Year 2 transfer must be recalculated on the basis that when it was made T
had made a prior chargeable transfer of £75,000. Hence it is
recalculated using the IHT rates applicable in Year 2 from £75,000 to
£325,000.
The
effect of death on chargeable lifetime transfers and PETs is considered more
fully in Chapter 30. [28.123]
2
Grossing-up
As
already stated IHT is charged on the fall in value in the transferor's estate.
Accordingly, tax is charged on the value of the gift and on the IHT on that
gift, when the tax is paid by the transferor. To understand this principle,
take the example of A, who has made no previous chargeable transfers and who
settles £298,000 on discretionary trusts. IHT payable by A can be
calculated as follows:
Step 1
Deduct from the transfer any part of it that is exempt. A has an available
annual exemption of £3,000 (see further [31.3]): there is, therefore,
a chargeable transfer of £295,000.
Step 2
Calculate the rate(s) of IHT applicable to the chargeable transfer. The first
£285,000 falls within the nil rate band and, therefore, IHT is
payable only on the balance of £10,000 at 20%.
Step 31f
A pays the IHT on the gift, his estate falls in value by £295,000
plus the IHT payable on the £10,000, ie A is charged on the cost of
the gift by treating the £295,000 as a gift net of tax.
Therefore,
the part of the gift on which IHT is payable (here £10,000) must be
'grossed up' to reflect the amount of tax payable on the gift by using the
formula:
.
100
.
--------
.
100-R
[*676] where R is the rate of IHT applicable
to the sum in question. In A's case the calculation is:
£10,000
x 1o% = £12,500 gross.
As a
result:
(1)
Position of A: Gift to trust (298,000) plus IHT liability (2,500) means a total cost of
£300,500;
(2)
Position of the trust: Receives from A £298,000.
Once the
taxpayer's cumulative total exceeds the nil rate band (currently
£285,000) tax is levied (because of the grossing-up computation) at
25% on the excess. For instance, if A gives £50,000 to his close
company (a chargeable lifetime transfer) at a time when his cumulative total
exceeds £285,000, tax on that transfer, if paid by A, will be 25% x
£50,000 = £12,500. [28.124]
3 Effect
of the tax being paid by a person other than the transferor
Grossing-up
establishes the cost to a donor of making a gift where the donor is paying the
IHT. There is no grossing-up, however, if the tax is paid by any other person.
Accordingly, as most lifetime transfers will be PETs, any IHT that is
eventually charged will be due after the transferor's death from the donee and
it will not, therefore, be necessary to gross up. In such cases the transferee
is charged on the gift that he receives (strictly, on the fall in value of the
transferor's estate) and the tax will be calculated according to the previous
chargeable transfers of the donor.
[28.125]
EXAMPLE
28.25
(1) A has
made no previous chargeable transfers but has used up his annual exemption. He
gives £295,000 to discretionary trustees who agree to pay the IHT due
on the chargeable transfer. A has made a chargeable transfer of
£295,000, on £10,000 of which IHT is payable at the rate of
20%. If the trustees pay, A's estate falls in value by only £295,000.
The trustees are charged to IHT at A's rates. The trustees, therefore, pay IHT
at 20% on £10,000 (ie £2,000) so that £500 less
tax is paid than if A had paid (he would have paid tax at a rate of 25% on
£10,000 = £2,500). However, the trust ends up with less
property than if A had paid the IHT: £293,000, instead of
£295,000. A further result of the trustees paying the tax is that A's
cumulative total of gross chargeable transfers is lower for the purposes of
future chargeable transfers, ie £295,000, rather than
£297,500.
Compare
(2) If
the trustees are to pay the IHT on A's gift to them and A wants them to retain
a net sum of £295,000 after paying the tax, A must give a larger sum
(297,500) to enable them to pay the tax of £2,500. The result is that
whether donor or donee pays the IHT, HMRC will receive £2,500 tax and
the total cost to A will be the same.
4
Transferring non-cash assets the cheapest way
When the
gift is of a non-cash asset such as land, IHT is calculated as before, but the
question of who pays the tax and how much has to be paid will be of critical
importance since neither party may have sufficient cash to pay the IHT without
selling the asset. If the donor pays the IHT, the value of the gift [*677] must be grossed up. In addition, the tax must he paid in one
lump sum. If, however, the donee (normally trustees on a chargeable lifetime
transfer) pays the tax, there is no grossing-up so that the transfer attracts
less IHT. Additionally, in the case of certain assets the tax can be paid by
the donee in ten yearly instalments (IHTA 1984 s 227). If the asset is income
producing, the donee may have income out of which to pay, or contribute
towards, the instalments. Alternatively, the donor can fund the instalments
paid by the donee by gifts utilising his annual exemption. The assets on which
IHT may be paid by instalments are:
(1) land,
whether freehold or leasehold;
(2) a
controlling shareholding of either quoted or unquoted shares;
(3) a
minority shareholding of unquoted shares in certain circumstances (see
[30.54]);
(4) a
business or part of a business, eg a share in a partnership.
However,
in the case of a transfer of land ((1) above), interest on the outstanding tax
is charged when payment is made by instalments. [28.126]
EXAMPLE
28.26
A wants
to settle his landed estate which is valued at £ 535,000 on
discretionary trusts. A has made no previous chargeable transfers. If A pays
the tax (ignoring exemptions and reliefs) the gift ( 535,000) must be grossed
up so that the total cost to A is £ 597,500 and the IHT payable is
£62,500; A must pay this in one lump sum. If the trust pays the tax,
the £ 535,000 is a gross gift on which the IHT at A's rates is
£50,000. Thus, there is a tax saving of £12,500. Further, the
trust can pay the tax in instalments out of income from the estate.
5 Problem
areas
a) Transfers
of value by instalments (IHTA 1984 s 262)
Where a
person buys property at a price greater than its market value, the excess paid
will be a transfer of value (assuming that donative intent is present). If the
price is payable by instalments, part of each is deemed to be a transfer of
value. That part is the proportion that the overall gift element bears to the
price paid. [28.127]
EXAMPLE
28.27
A transfers
property worth £40,000 to B for £80,000 payable by B in
eight equal yearly instalments of £10,000. Hence, after eight years
there will be a transfer of value of £40,000 divided between each
instalment as follows:
.
value of gift
£40,000
Annual
instalment x ------------- = £10,000 x ------- = 5,000.
.
price payable
£80,000
h) Transfers
made on the same day (1k/TA 1984 s 266)
If a
person makes more than one chargeable transfer on the same day and the order in
which the transfers are made affects the overall amount of IHT [*678] payable, they are treated as made in the order which results
in the least amount of IHT being payable (IHTA 1984 s 266(2)). This will be
relevant where the transfers taken together straddle different rate bands and
the donor does not pay the tax on all the transfers. Where this is the case the
overall IHT will be less if the grossed-up gift is made first. In other cases
an average rate of tax is calculated and applied to both transfers. When a PET
made on the same day as a chargeable transfer is rendered chargeable by the
donor's death within seven years these rules apply. [28.128]
c) Transfers
reported late (IHTA 1984 s 264)
When a
transfer is reported late (for the due date for reporting transfers, see
1128.172]) after IHT has been paid on a subsequent transfer, tax must be paid
on the earlier transfer and an adjustment may have to be made to the tax bill
on the later transfer. The tax payable on the earlier transfer is calculated as
at the date of that transfer and interest is payable on the outstanding tax as
from the date that it was due. If there is more than seven years between the
earlier and the later transfers, no adjustment need be made in respect of the
later transfer since the seven-year limit on cumulation means that the later
transfer is unaffected by the earlier transfer. When there is less than seven
years between the two transfers the extra tax charged on the later transfer is
levied on the earlier transfer in addition to the tax already due on that
transfer. The recalculation problems that arise when PETs become chargeable are
considered in Chapter 30. [28.129]
d) Order
of making lifetime transfers
If the taxpayer
wishes to make both a chargeable transfer (eg the creation of a discretionary
trust) and a PET (eg a gift to a child) the chargeable transfer should be made
before the PET so that if the latter becomes chargeable it will not necessitate
a recomputation of tax on the chargeable transfer (nor, in the case of a
discretionary trust, have an effect on the subsequent calculation of tax
charged on the settlement: see Chapter 34). [28.130]
e) Non-commercial
loans
There are
no special charging provisions for loans of property and accordingly (subject
only to IHTA 1984 s 29 which ensures that the usual exemptions and reliefs are
available) tax will be charged, if at all, under general principles (ie has the
loan resulted in a fall in value of the lender's estate?). In the case of money
loans it is necessary to distinguish between interest-free loans repayable
after a fixed term and loans repayable on demand. If A lends B
£20,000 repayable in five years' time at no interest, A's estate is
reduced in value because of the delay in repayment and (assuming gratuitous
intent) A makes a PET equal to the difference between £20,000 and the
value of the right to receive £20,000 in five years' time.
If,
instead, A lent B £20,000 repayable on demand with no interest
charged, A's estate either does not fall in value because it includes the
immediate right to £20,000 or, alternatively, any fall is likely to
be de mini mis. Accordingly, A has not made a transfer of value and there is no
question of [*679] any charge to IHT. Loans repayable on
demand may be employed so that the use of property, and any future increase in
its value, is transferred free from IHT to another.
If a
commercial rate of interest is charged on a loan, the transaction is not a
chargeable transfer since the estate of the lender will not have fallen in
value. Further, any interest may (normally) be waived without any charge to IHT by using the exemption
for regular payments out of income (see Chapter 31). [28.131]
EXAMPLE
28.28
Jasmine
benefits her children without attracting a potential liability to HTIT as
follows:
(1) She
lends her daughter £100,000 repayable on demand. The money is
invested in a small terraced house in Fulham which quickly trebles in value. That
increase in value belongs to the daughter who is merely obliged to repay the
original sum loaned if and when Jasmine demands it.
(2) She
allows her son to occupy her London flat rent free. The son enjoys the benefit
of living there during the winter and lets the property to wealthy summer
visitors. As there is no loss to Jasmine's estate the son's benefits are not
subject to IHT (but note in such cases the possibility of an income tax charge
under Settlement Provisions in Income Tax (Trading and Other Income) Act
(ITTOIA 2005)): see Chapter 16).
f) Relief
against a double charge to iHT
In a
number of situations there is the possibility of a double charge to IHT:
EXAMPLE
28.29
Gustavus
gives Adolphus his rare Swedish bible (a PET). Two years later the bible is
given back to Gustavus who dies shortly afterwards. As a result of his death
within seven years the original gift of the bible is chargeable and, in
addition, Gustavus' estate on death, which is subject to IHT, includes the
bible.
Regulations
made under FA 1986 s 104 provide a measure of relief and are discussed in
Chapter 36. [28.132]-[28.150]
VIII
SPECIAL RULES FOR CLOSE COMPANIES
Only
transfers of value made by individuals are chargeable to IHT (IHTA 1984 s
2(1)). An individual could, therefore, avoid IHT by forming a close company and
using that company to make a gift to the intended donee, or a controlling
shareholder in a close company could alter the capital structure [*680] of the company or the rights attached to his shares, so as
to reduce the value of his shareholding in favour of the intended donee.
EXAMPLE
28.30
(1) A
transfers assets worth £100,000 to A Ltd in return for shares worth
£100,000. A's estate does not fall in value so that there is no
liability to IHT. The company then gives one of the assets (worth
£50,000) to A's son B. The company and not A has made a transfer of
value. (2) A Ltd has an issued share capital of £100 all in ordinary
£1 shares owned by A. The company is worth £100,000. The
company resolves:
(i) to
convert A's shares into non-voting preference shares carrying only the right to a repayment of nominal
value on a winding up;
(ii) to
issue to B a further 100 £1 ordinary shares at par value.
The
result is that the value has passed out of A's shares without any disposition
by A.
IHTA 1984
Part W contains (inter alia) provisions designed to prevent an individual from
using a close company to obtain a tax advantage in either of these ways. For
these purposes 'close company' and 'participator' have their corporation tax
meaning (see Chapter 41) except that a close company includes a non-UK resident
company which would be close if it was resident in the UK and participator does
not include a loan creditor (IHTA 1984 s 102). [28.151]
1
Transfers of value by close companies (IHTA 1984 s 94)
When a
close company makes a transfer of value, it is apportioned amongst the
participators in proportion to their interests in the company, so that they are
treated as having made the transfer ('lifting the veil') (IHTA 1984 s 94(1)).
Thus, in Example 28.30(1) above, A is treated as having made a transfer of
value of £50,000. For s 94(1) to apply the company must have made a
transfer of value, ie its assets must fall in value by virtue of a
non-commercial transaction (IHTA 1984 s 10(1)). The value apportioned to each
participator is treated as a net amount which must be grossed up at the
participator's rate of IHT. Any participator whose estate has increased in
value as a result of that transfer can deduct the increase from the net amount
(ignoring the effect that the transfer may have had on his rights in the
company). The transfer in these circumstances is a deemed transfer of value and
cannot be a PET (see [28.461]). IHT is therefore chargeable.
EXAMPLE
28.31
A Ltd is
owned as to 75% of the shares by A and 25% by B. It transfers land worth
£100,000 to A. By IHTA 1984 s94, A and B are heated as having made
net transfers of value of £75,000 and £25,000 respectively.
B will be charged to IHT on £25,000 grossed up at his rate of IHT. A,
however, can deduct the increase in his estate (IJOO,000) from the net amount
of the apportionment (f75,000), so that he pays no IHT. If A's shares (and B's)
have diminished in value, that decrease is ignored.
Apportionment
is not always as obvious as it may seem. For instance, in calculating a
participator's interest in the company, the ownership of prefer-[*681]-ence
shares is usually disregarded (IHTA 1984 s 96). Further, where trustees are
participators and the interest in the company is held in an interest in
possession settlement (see Chapter 33) the apportioned amount is taxed as a
reduction in the value of the life tenant's estate (IHTA 1984 s 99(2)(a)). In
non-interest in possession trusts the apportioned amount is taxed as a payment
out of the settled property by the trustees (IHTA 1984 s 99(2) (b)). Finally,
where a close company is itself a participator in another close company any
apportionment is then sub-apportioned to its own participators (IHTA 198,1 s
95).
In two
cases no apportionment occurs. First, if the transfer is charged to income tax
or corporation tax in the donee's hands, there is no IHT liability (IHTA 1984 s
94(2) (a)). Secondly, where a participator is domiciled abroad, any
apportionment made to him as a result of a transfer by a close company of
property situated abroad is not charged to IHT (IHTA 1984 s 94(2) (b)).
EXAMPLE
28.32
(1) A Ltd
(whose shares are owned 50% by A and 50% by B) pays a dividend. The dividend is
not chargeable to IHT in A or B's hands because income tax is charged on that
sum under ITTOJA 2005 Part 4 Chapter 3 (tax on dividends and other
distributions).
(2) A Ltd
in (1) above provides A with free living accommodation and pays all the
outgoings on the property. 1f A is a director or employee of A Ltd, these items
are benefits in kind on which A pays income tax under ITEPA 2003 (earnings
income) (see Chapter 8). If A is merely a shareholder in the company these
payments are treated as a distribution by A Ltd and are charged to income tax
in A's hands under ITTOIA 2005 Part 4 Chapter 3 (tax on dividends and other
distributions). However, if A was not a member of A Ltd, there would be no
income tax liability, so that the participator, B, would be treated for IHT
purposes as having made a chargeable transfer of value under IHTA 1984 s 94(1).
(3) An
English company, A Ltd, in which B and C each own 50% of the shares, gives a
factory in France worth £100,000 to B, who is domiciled in the UK. C
is domiciled in France and, therefore, the amount apportioned to him (f50,000)
is not chargeable under IHTA l984 s 94(1).
Participators
can reduce their IHT liability on sums apportioned by the usual lifetime
exemptions with the exception of the small gifts exemption and the exemption
for gifts on marriage. Insofar as the transfer by the company is to a charity
or political party it is exempt. Participators are also entitled to 100%
business relief if the close company transfers part of its business or shares
in a trading subsidiary.
The
company is primarily liable for the tax. If it fails to pay, secondary liability rests concurrently with the
participators and beneficiaries of the transfer.
A participator's liability is limited to tax on the amount apportioned to him;
for a non-participator beneficiary it is limited to the increase in value of
his estate. [28.152]
2 Deemed
dispositions by participators (IHTA 1984 s 98)
When
value is drained out of shares in a close company by an alteration (including
extinguishment) of the share capital or by an alteration in the [*682] rights attached to shares, this is treated as a deemed
disposition by the participators although the section does not deem a transfer
of value to have been made. When such a transfer occurs, liability under IHTA
1984 s 98 rests solely on the participators and not on the company. There is no
deemed transfer of value under s 98, but such transfers are expressly prevented
from being PETs by IHTA 1984 s 98(3) (see Example 28.33(3), below). [28.153]-[28.170]
EXAMPLE
28.33
(1)
Taking the facts of Example 28.30(2) above there is no actual transfer of value
by A or A Ltd. However, under IHTA 1984 s 98 there is a deemed disposition by A
equivalent to the fall in value of his shareholding. From owning all the shares
and effectively all the assets he is left with a holding of 100 shares worth
(probably) only their face value.
(2) A
owns 60% and B 40% of the shares in A Ltd. Each share carries one vote.
The
articles of association of the company are altered so that A's shares continue
to carry one vote, but B's shares are to carry three votes each. There is a
deemed disposition by A to B equivalent to the drop in value in A's estate
resulting from his loss of control of A Ltd.
(3)
Zebadee, the sole shareholder in Zebadee Ltd, arranges for a bonus issue of
fully paid preference shares which carry the right to a fixed dividend. He
retains the shares but gives his valuable ordinary shares to his daughter. This
familiar tax planning rearrangement depends in part upon the gift of the
ordinary shares being a PET. Under s 98(1) the alteration in the share
structure is treated as a disposition by Zebadee but as the bonus shares are at
that stage issued to him, he does not then make any transfer of value.
Accordingly, the subsequent gift of the ordinary shares will be a PET. It is
thought that HMRC will not normally seek to argue that the bonus issue and
later gift are associated operations falling within s 98(1) as an extended reorganisation
(so that the gift of the shares is not prevented from being a PET by s 98(3)).
VIII
LIABILITY ACCOUNTABILITY AND BURDEN
1
Liability for IHT (IHTA 1984 Part VII)
The
person primarily liable for IHT on a chargeable lifetime transfer is the transferor
(IHTA 1984 s 199), although in certain cases, his spouse may be held liable as
a transferor to prevent him from divesting himself of property to that
spouse so
that he is then unable to meet an IHT bill (IHTA 1984 s 203).
EXAMPLE
28.34
H makes a
gross chargeable transfer to a discretionary trust of Elm and fails to pay IHT.
He later transfers property worth £50,000 to his wife W which is
exempt (inter-spouse). W can be held liable for H's IHT not exceeding
£50,000.
If HMRC
cannot collect the tax from the transferor (or his spouse) it can then claim
it, subject to specified limits, from one of the following:
(1) The
transferee, ie any person whose estate has increased in value as a result of
the transfer. Liability is restricted to tax (at the transferor's rates) on the
value of the gross transfer after deducting any unpaid tax. [*683]
EXAMPLE
28.35
A makes a
gross chargeable transfer to discretionary trustees of £40,000 on
which IHT at A's rate of 20% is £8,000. A emigrates without paying
the tax. HMRC can only claim £6,400 in tax from the trustees, ie:
Gross
chargeable transfer by A 40,000
Less:
unpaid tax 8,000
Revised
value transferred
£32,000
Trustees
are liable for IHT at 20%
£6,400
(2) Any
person in whom the property has become vested alter the transfer. This category
includes a person to whom the transferee has in turn transferred the property;
or, if the property has been settled, the trustees of the settlement and any
beneficiary with an interest in possession in it; or a purchaser of the
property unless he is a bona fide purchaser for money or money's worth and the
property is not subject to an HMRC charge. The liability of these persons is
limited to tax on the net transfer only and liability is further limited, in
the case of trustees and beneficiaries, to the value of the settled property
and, in the case of a purchaser, to the value of the property. Also included
within this category is any person who meddles with property so as to constitute
himself a trustee de son tort and any person who manages the property on behalf
of a person under a disability.
(3) A
beneficiary under a discretionary trust of the property to the extent that he
receives income or any benefit from the trust. Liability is limited to the
amount of his benefit after payment of any income tax.
The
liability to pay additional IHT on a gift because of the transferor's death
within seven years, and liability to tax on a PET which becomes a chargeable
transfer is considered in Chapter 30.
Quite
apart from those persons from whom they can claim tax, HMRC has a charge for
unpaid tax on the property transferred and on settled property where the
liability arose on the making of the settlement or on a chargeable transfer of
it (IHTA 1984 s 237). The charge takes effect in the same way as on death (see
Chapter 30) except that for lifetime transfers it extends to personal property
also. It will not bind a purchaser of land unless the charge is registered and
in the case of personal property unless the purchaser has notice of the facts
giving rise to the charge (IHTA 1984 s 238).
Once IHT
on a chargeable transfer has been paid and accepted by HMRC, liability for any
further tax ceases six years after the later of the date when the tax was paid
or the date when it became due (IHTA 1984 s 240(2)). However, 1f HMRC can prove
fraud, wilful default or neglect by a person liable for the tax (or by the
settlor which results in an underpayment of tax by discretionary trustees),
this six-year period only starts to run once HMRC knows of the fraud, wilful
default or neglect, as the case may be (IHTA 1984 s 240(3)). When HMRC is
satisfied that tax has been or will be paid, it may, at the request of a person
liable for the tax, issue a certificate discharging persons and/or property
from further liability (IHTA 1984 s 239)
[28.171] [*684]
2
Accountability and payment
a) Duty
to account
An
account should only be delivered in respect of a chargeable transfer which is
not a PET: in the case of PETs an account is only required if the transferor
dies within seven years (IHTA 1984 s 216). Thus, HMRC need not be notified of a
transfer of excluded property or of a transfer that is wholly exempt (eg within
the annual exemption or inter-spouse), with the exception of an exempt transfer
of settled property which must normally he notified.
In
addition, in two situations chargeable transfers are 'excepted' from the duty
to account (SI 2002/1731). First, where the gift is by an individual and,
together with other chargeable transfers in the same tax year, does not exceed
£10,000 so long as the gift and other chargeable transfers in the
previous seven years do not exceed £40,000 in total; and, secondly,
where the value transferred on the termination of an interest in possession in
settled property is extinguished by the beneficiary's annual or marriage gifts
exemption (see IHTA 1984 s 57 and Chapter 33). (There are also exempting
regulations for 'excepted settlements': see 51 2002/1732 and [34.21].)
As a
general rule, the person who is primarily liable for the IHT mut deliver the
account (ie the transferee in the case of a lifetime gift, but note that FA
1999 expressly extended the obligation to PRs in respect of gifts made within
seven years before death). This obligation to deliver an account under IHTA
1984 's 216 is removed where regulations made under IHTA 1984 s 256 provide
otherwise. Under the current regulations (SI 2002/1733), there is no need to
deliver an account where, broadly, the estate is simple and valued less than
£240,000. The aim of the FA 2004 changes is to apply the simpler
reporting procedures to estates which are non-taxpaying but which do not
currently qualify for the simpler procedures eg estates which are greater than
the current nil rate hand but where no IHT is payable because the bequests are
exempt such as to a spouse or to charity.
When the
transfer is by a close company, nobody is under a duty to account, but in
practice the company should dc) so in order to avoid a charge to interest on
unpaid tax.
The
account must be delivered within 12 months from the end of the month when the
transfer was made or within three months from the date when that person first
became liable to pay IHT (if later). In practice the account should be
delivered earlier, since the tax is due before this date. Form IHT 100 is used
for all lifetime transfers including transfers of settled property on life or
death with an interest in possession. Anyone who fails to deliver an account,
make a return, or provide information when required may be subject to penalties
and HMRC has a wide general power to obtain information from 'any' person (IHTA
1984 s 219 and ss 219A-B) by means of a notice. HMRC cannot use the s 219 power
to compel a solicitor or barrister to disclose privileged information
concerning a client, but can use it to obtain the name and address of a client.
The s 219A power (requiring information from persons obliged to submit
accounts), however, contains no exclusion for professionally privileged
information. [28.172]
b) Payment
of tax
For all
lifetime chargeable transfers of settled or unsettled property made
between 6
April and 30 September, the tax is due on 30 April following and for transfers
made between 1 October and 5 April it is due six months from the end of the
month when the transfer was made (IHTA 1984 s 226). The optimum date to make a
chargeable transfer is therefore 6 April which gives a 12-month delay before
tax is due. [28.173]
Payment
instalments Generally IHT must be paid in one lump sum. IHTA 1984 s 212
provides that any person liable for the tax (except the transferor and his
spouse) can sell, mortgage or charge the property even if it is not vested in
him, so that if, for instance, A gives property to B who settles it on C for
life, either B, the trustees, or C (if called upon to pay the tax) can sell,
mortgage or charge the property in order to do so.
As an
exception to the general rule, if the transferee pays the IHT he can elect in
the case of certain assets to pay the tax in ten yearly instalments; the first
becoming due when the tax is due (IHTA 1984 s 227); This lifetime instalment
option is available for the same assets as on death (see Chapter 30), except
for the transfer of a minority holding of unquoted shares or securities within
category (4) (relief when the IHT on instalment property amounts to 20% of the
total bill). Trustees or beneficiaries who are liable for the tax on transfers
of settled property can elect to pay in instalments provided that the property
falls within one of the specified classes. Despite this election, the
outstanding tax (and any interest due) may be paid at any time and if the
relevant property is sold or transterred by a chargeable transfer the tax must
be paid at once (IHTA 1984 s 227(4)).
[28.174]
Interest
Interest is charged on any tax which is not paid by the due date (IHTA 1984 s
233). Where the tax is to be paid by instalments, interest is charged on
overdue instalments only, except in the case of land where interest is charged
on all the outstanding tax.
[28.175]
Satisfaction
of tax HMRC has a discretion to accept certain property in satisfaction of tax
(see IHTA 1984 s 230 and Chapter 31).
[28.176]
Adjustments
to the tax bill Subject to a six-year limitation (see [28.202]) if HMRC proves
that too little tax was paid in respect of a chargeable transfer, tax underpaid
is payable together with interest. Conversely, if too much tax was paid, HMRC
must refund the excess together with interest, which is free of income tax in
the recipient's hands (IHTA 1984 s 235).
[28.177]
3 Burden
of tax
The
question of who, as between the transferor and the transferee, should bear the
tax on a lifetime transfer is a matter for the parties to decide as discussed
above. The decision may affect the amount of tax payable (see [28.125]). The
parties can agree at any time before the tax becomes due and HMRC will accept
their decision so long as the tax is paid. However, the [*686] agreement does not affect
the liability of the parties, so that if the tax remains unpaid, HMRC can
collect it from persons liable under Part VII of the legislation (see
[28.171]). [28.178]-[28.200]
IX
ADMINISTRATION AND APPEALS
1
Calculation of liability
IHT is
not assessed by reference to the tax year. Instead, when HMRC is informed of a
chargeable transfer of value it raises an assessment called a determination
(IHTA 1984 s 221). If it is not satisfied with an account or if none is
delivered when it suspects that a chargeable transfer has occurred, it can
raise a 'best of judgment' or estimated determination of the tax due. A
determination of IHT liability is conclusive against the transferor and for all
subsequent transfers, failing a written agreement with HMRC to the contrary or
an appeal.
If the taxpayer
disputes the determination he can appeal to the Special Commissioners within 30
days of it (IHTA 1984 s 222). The appeal procedure is basically the same as
under TMA 1970 for income tax, corporation tax and CGT, except that an appeal
can be made direct to the High Court, thereby bypassing the commissioners,
either by agreement with HMRC or on application to the High Court (as, for
instance, occurred in Bennett v IRC (1995): see Chapter 31). In this case, the appeal is not
limited to points of law. Appeal then lies in the usual way to the Court of
Appeal and, with leave, to the House of Lords (or by the 'leap frog' procedure
direct to the House of Lords). The disputed tax is not payable at the first
stage of the appeal (IHTA 1984 s 242). However, if there is a further appeal,
the tax becomes payable; if this appeal is then successful, the tax must be
repaid with interest. [28.201]
2
Penalties
FA 1999
tightened up the IHT penalty provisions by introducing new sections, ss 245 and
245A, into IHTA 1984 and by amending s 247. If a person is fraudulent
(including wilful default) in producing accounts and other information, the
penalty is £3,000 plus the difference between the liability
calculated on the true and false bases. For negligence, the penalty is
£1,500 plus that difference (IHTA 1984 s 247 as amended: for a
consideration of this provision in the context of estimated valuations, see Robertson
v IRC (2002)
discussed in [30.43]). Solicitors and other agents who fraudulently produce
incorrect information are liable to a maximum penalty of £3,000
reduced to £1,500 in cases of neglect (IHTA 1984 s 247(3) (4) as
amended).
FA 2004 s
295 contains provisions that are aimed at bringing the current IHT penalty
procedure more into line with the procedures applicable to income tax and
capital gains tax. For instance, there is no longer a penalty charge where no
additional IHT becomes payable as a result of fraudulent or negligent
information/material submitted to HMRC. Further, the reasonable excuse
provisions will apply to all failures to provide information and to deliver
accounts. Further still, a penalty of £3000 is introduced for
continuing failure to deliver an account or notify tax payable.
Proceedings
for these penalties may be taken before the Special Commissioners or the High
Court within three years of the determination of the correct tax due (IHTA 1984
ss 249-250).
Assessments
to recover IHT lost through fraud, wilful default and neglect of a person
liable for the tax (which for these purposes includes the settlor in the case
of discretionary trusts) may be made up to six years from the discovery of the
fraud, etc (IHTA 1984 s 240).
[28.202]-[28.220]
[*688] [*689]
29
IHT-reservation of benefit
Updated
by Natalie Lee, Barrister, Senior Lecturer in Law, University of Southampton
and Aparna Nathan, LLB Hons, LLM, Barrister Gray's Inn Tax Chambers
I Legislative history [29.1]
II IHT consequences if property is subject
to a reservation [29.21]
III When do the reservation rules apply?
[29.41]
IV Exceptions-when the rules do not apply
[29.71]
V Identifying property subject to a
reservation [29.101]
VI
Reserving benefits after FA 1986 [29.121]
I
LEGISLATIVE HISTORY
It was
possible, under the CTT regime, for taxpayers to give away property but at the
same time retain the benefit and control of it. Typical arrangements included:
EXAMPLE
29.1
(1) Joe
creates a discretionary trust and includes himself amongst the beneficiaries.
(2) Arty
owns a fine Constable landscape. He transfers legal ownership to his daughter
by deed of gift but the picture remains firmly hanging up in his house until
his death.
(3) Sam
gives his Norfolk farm to his son and continues to live in the farmhouse.
These
arrangements were ideal for the moderately wealthy since, although the original
transfer might attract tax (to the extent that it was not covered by the annual
exemption and the nil rate band) future increases in value of the gifted
property occurred outside the transferor's estate whilst, should the need arise
(and especially if the property was settled as in Example 29.1(1)), the
property could be recovered by the transferor. The widespread use of such
arrangements made it likely that they would be attacked by legislation and the
switch from CTT to IHT, which included the introduction of PETs, made this
inevitable. Accordingly, provisions were introduced to deal with property
subject to a reservation (see FA 1986 s 102 and Sch 20) which apply to lifetime
gifts made on or after 18 March 1986. The legislation is closely based on
earlier estate duty provisions and the H estate duty authorities remain
relevant in construing the legislation (as was confirmed in the Ingram case
which is considered below).[29.1]-[29.20]
[*690]
II IHT
CONSEQUENCES IF PROPERTY IS SUBJECT TO A RESERVATION
A gift of
property subject to a reservation is treated, so far as the donor is concerned,
as a partial nullity for IHT purposes. This is because he is deemed to remain
beneficially entitled to the gifted property immediately before his death. It
is clear from the wording of s 102(3) that the property only returns into the
estate of the donor at this moment although, if the benefit reserved ceases
during the lifetime of the donor, he is treated as making a PET of the property
at that time (a deemed PET). No advantage therefore flows from releasing any
reserved benefit just before death. Possible double charges to IHT in this area
are dealt with in the regulations discussed in Chapter 36. It should be
remembered that the reservation of benefit rules only apply to the donor for
the purposes of IHT; accordingly, although the property may be taxed as part of
the death estate of the donor, there is no question of such property benefiting
from the CGT uplift on death. Further, the property is also comprised in the
estate of the donee so that IHT charges can arise on his death.
The
legislation is widely drafted to catch a benefit reserved in the gifted
property itself and a 'collateral advantage' (defined in s 102(1) (b) as 'any
benefit to [the donor] by contract or otherwise').
EXAMPLE
29.2
(1) In
1998 A gives his daughter his country cottage (then worth £50,000) in
return for an annuity of £500 pa payable for the next four years. The
annuity ends in 2002 and A dies in 2003. By stipulating for the payment of an
annuity A reserved a benefit.
(i) The
original transfer: In 1998 was a PET. The value transferred was reduced because of A's
annuity entitlement.
(ii) On
the ending of the annuity in 2002: A made a PET equal to the then value of the
cottage. (Note that because this was a 'deemed' PET the value transferred is
not reduced by A's annual exemption.)
(iii)
With his death in 2003 both the earlier transfers became chargeable.
(2) Had A
died in 2000 the reservation would have been operative at his death
so that,
in addition to the 1998 PET being chargeable, the value of the cottage in 2000
would have formed part of his death estate.
For
relief against a double lUT charge, see Chapter 36.
(3) Zac
gives his house to Jim and they live in it together. The gift is caught by the
reservation of benefit rules so that:
(a) on
Zac's death the house will be taxed as part of his estate. There will be no CGT
death uplift;
(b) on
Jim's death, because he owns the house, it will be taxed
as part
of his estate with the usual CGT uplift.
As a
result of including the property in the deceased's estate immediately before
death, it is necessary to value it at that time (and not at the time of the
gift). Hence, where a transferor makes a gift with reservation there is no
'asset freezing' advantage. It also follows, of course, that as the value of
the property swells the size of the estate, it may increase the estate rate of
IHT (see [30.28] for 'estate rate') that is charged on the rest of the estate.
Primary liability to pay the IHT attributable to reservation property lies with
the donee (who should submit an account within 12 months of the end of the [*691] month of death) although the donor's PRs are liable if tax
remains unpaid at the end of 12 months from the death. PRs who have made a
final distribution of the assets in the estate may therefore be faced with a
wholly unexpected claim for more IHT and this matter is considered in detail at
[30.49]. As already noted, although the gifted property is included in the
estate for Il-IT purposes it does not form part of the estate otherwise and
hence does not benefit from the CGT uplift on death with the result that the
donee may be faced with a substantial CGT liability on selling the property.
[29.21]-[29.40]
III WHEN
DO THE RESERVATION RULES APPLY?
I There
must be disposal of property by way of gift
To base
liability on the making of a gift does not fit in with the general scheme of
the IHT legislation which bases the tax charge upon chargeable transfers of
value (see [28.2]). The resultant difficulties perfectly illustrate the
problems of attempting to weld legislation from estate duty onto the CTT
structure. Obviously, the gift must have been completed (and it should be remembered
that the courts have no general power to perfect an uncompleted gift: see Milroy
v Lord (1862))
but it may be assumed that the reservation provisions apply not just to pure
gifts but also to the situation where, although partial consideration is furnished,
there is still an element of bounty (see A-G vJohnson (1903)). A bad bargain,
on the other hand, lacks any element of gift. The distinction between a gift
(the basis of the reservation rules) and a transfer of value (the basis for IHT
liability) is illustrated in the following example: [29.41]
EXAMPLE
29.3
(1) Adam
owns a pair of Constable watercolours and sells one to his daughter, Jemima. He
retains possession of the picture. Each picture is worth £10,000: as
a pair they are worth £35,000. Jemima pays Adam £10,000 for
the picture.
(i) There
is a transfer of value of £15,000 (drop in value of Adam's estate).
This transfer is a PET (see [28.43]).
(ii) Is
there a fl of property so that the reservation rules apply? As Jemima has paid
full value for the picture that she has acquired there is no element of gift,
so the rules are inapplicable.
(2) Sam
settles property on trust retaining the right to income until he is aged 50
with the remainder being settled on discretionary trusts for his family
(including Sam). Assume that the trustees have the power to terminate Sam's
life interest which they exercise six months after the creation of the trust
(i) There
is no transfer of value when Sam creates the settlement since he is the life
tenant (IHTA 1984 s 49(1)).
(ii) Does
Sam, however, make a gift at the time when he sets up the trust? Arguably, on
general principles, he does: after all he has given property to trustees
reserving only a life interest. If this is correct then once that life interest
ends he will be caught by the reservation rules given that he is one of the
discretionary beneficiaries.
(iii)
When his life interest terminates Sam makes a chargeable transfer of value but
does not make a gift (contrast the position if he had [*692]
voluntarily surrendered his interest). With the cessation of the life
interest the fund is now held on discretionary trusts and (see (ii) above) may
be property subject to a reservation (FA 1986 Sch 20 para 5(1)).
2
Possession and enjoyment of the property by the donee
The
reservation rules apply if full possession and enjoyment of the gifted property
is not enjoyed by the donee either at or before the beginning of the relevant
period. For this purpose the relevant period is the period ending with the
donor's death and beginning either seven years before that date or (if later)
on the date of the gift. [29.42]
EXAMPLE
29.4
(1) By
deed of gift A gives B the family silver but he retains it locked in a cupboard
till his death; or
(2) A
gives full possession and enjoyment of the family silver to B and dies two
years
later; or
(3)
Assume in (1) above that the deed of gift was made in 1990 but that A only hands over the silver in 1993 and
dies in 2003; or
(4) A
gives the family silver to B in 1988 but borrows it back just before his death
in 2003.
In (1)
possession of the silver is never enjoyed by B so that there is a gift with
reservation and the silver forms part of A's estate on death.
In (2)
full possession and enjoyment is obtained at the beginning of the relevant
period. (Hence no reservation although there is, of course, a failed PET.)
In (3)
full possession and enjoyment is obtained more than seven years before death.
(No reservation.)
In (4)
although full possession and enjoyment was given to B, the return of the silver
to A is fatal because of the next requirement.
3
Exclusion of donor from benefit
The
reservation rules apply if the donor has not been excluded from benefit at any
time during the relevant period. In Example 29.4(4) the return of the silver
shortly before the donor's death results in the property being subject to a
reservation at A's death and, accordingly, it is subject to IHT. [29.43]
EXAMPLE
29.5
In 1924
the taxpayer created a settlement for the benefit of his infant daughter
contingent upon her attaining 30. He was wholly excluded from benefit. In 1938
(just before she became 30) he arranged with her to borrow the income from the
trust fund in order to reduce his overdraft. Until 1943 he borrowed virtually
all the income: he finally died in 1946 (see Stamp Duties Comr of New South
Wales v Permanent Trustee Co (1956)). On these facts the Privy Council held that a
benefit had been reserved for estate duty purposes and the same would be true
for IHT. Notice that the settlor had no enforceable right to the income: he
merely made an arrangement with his daughter that she could have revoked at any
time.
4 The two
limbs
The
requirement that the donor must be excluded from all benefit during the
relevant period is comprised in two alternative limbs. Limb I requires his [*693] exclusion from the gifted property, whilst Limb II
stipulates that he should not have received any benefit 'by contract or
otherwise.
So far as
Limb I is concerned, in order to determine whether the donor has been entirely
excluded from the gifted property, it is necessary to decide what that property
comprises. There is a distinction of some subtlety between keeping back rights
in the property (ie making only a partial gift) and giving the entire property
but receiving a subsequent benefit therein from the donee (but note the
limitations on this principle in the case of lahd resulting from FA 1999: see
129.130]). Once the gift is correctly identified, the donor must be entirely
excluded both in law and in fact (see Example 29.5).
EXAMPLE
29.6
A father
owned two properties on which an informal farming partnership was carried on
with his son. Profits were split two-thirds to the father, one-third to the
son. The father gave one of the properties to his son, free of all conditions,
so that the son could have farmed it independently. In fact both continued to
farm the property sharing the profits equally. It was held that the father had
not been entirely excluded from the gifted property (Stamp Duties Comr of
New South Wales v Owens (1953)).
Limb II,
that the donor must be excluded from any benefit by contract or otherwise, is
sufficiently widely drafted to catch collateral benefits that do not take
effect out of the gifted property.
EXAMPLE 29.7
(1)
Charlie gives land in Sussex to his son Jasper who covenants, at the same time,
to pay Charlie an annuity of £500 pa for the rest of his life. The
land is property subject to a reservation (eg A-G v Worrall (1895): '... it is not necessary that
the benefit to the donor should be by way of reservation' per Lopes LJ).
(2) Adam
sells his farm to Bertram for £100,000 when its true value is
£500,000.
As a sale
at undervalue there is an element of gift. However, it is not easy to see how
there can be a benefit reserved. The estate duty cases do not go this far and
even if it is accepted that there is a reserved benefit, it presumably ceases
at the moment when the £100,000 is paid to Adam with the result that
there may be a deemed PET on that date. Accordingly, the somewhat absurd result
is that on the same day there would be a PET of £400,000 (value of
farm less consideration received) and a further PET of £500,000
(value of property in which the reservation has ceased). It is understood that
HMRC will not argue that on these facts there is a benefit reserved.
(3)
Claude wishes to give his farm to his son Dada subject to Dada taking over the
existing mortgage thereon. If the arrangement is structured in this manner, the
provision for the discharge of his mortgage would appear to result in Claude
reserving a benefit. However, the Revenue has commented, with reference to this
example, that 'the gift would be the farm subject to the mortgage and it would
be an outright gift'. Were he to sell the farm for the amount of the
outstanding mortgage that sale for partial consideration is not thought to involve a
reservation (see (2) above); Dada could raise a mortgage on the security of the
land; Claude would pay off his existing mortgage and any capital gain resulting
from the consideration received (the gift element is subject to the hold-over
election under TCGA 1992 s 165) might be covered by taper relief. Note also the
stamp duty land tax [*694] implications: see FA 2003 Sch 4 para 8.
Although
the benefit need not come from the gifted property itself, it must be reserved
as part of a linked transaction: a purely accidental benefit in no way
connected with an earlier gift is ignored. In determining whether there is such
a connection, account must be taken of any associated operations (see FA 1986
Sch 20 para 6(1) (e) incorporating for these purposes IHTA 1984 s 268: see
[28.101]).
Limb II
is concerned with benefits reserved 'by contract or otherwise'. According to
estate duty authority these words should be construed eiusdenz generis with
contract and, therefore, as requiring a legally enforceable obligation (see the
unsatisfactory case of A-G v Seccombe (1911)). It seems most unlikely that courts today--in the
era of Ramsay--would
permit obligations binding in honour only to slip through this net, however,
and the statutory associated operations rule (discussed above) is couched in
terms of conduct (ie what actually happened) not of legal obligation. Not
surprisingly, the Revenue has confirmed that 'for IHT purposes [the words 'or
otherwise'] should be given a wider meaning than they had for estate duty'.
[29.44]-[29.70]
IV
EXCEPTIONS--WHEN THE RULES DO NOT APPLY
1 De
minimis
Certain
benefits to the donor are specifically ignored. FA 1986 s 102(1) requires the
entire exclusion or virtually the entire exclusion of the donor from the gifted
property. 'Virtually the entire exclusion' had no predecessor in the estate
duty legislation and is apparently designed to cover, for instance, occasional
visits by the donor to a house which he had earlier given away (including short
holidays! For the Revenue's views on this matter see Tax Bulletin, November
1993). [29.71]
2 Full
consideration
A second
exclusion is available where the donor furnishes full consideration for the
benefit enjoyed (FA 1986 Sch 20 para 6(1)(a) and ss 102A(3), 102B(3)(b). The
consideration must be 'full' throughout the donor's period of use-hence rent
review clauses should be included in any letting agreement. The gifted
property, however, must be an interest in land or a chattel and to come within
the exclusion actual occupation, enjoyment or possession of that property must
have been resumed by the donor (see Example 29.8). [29.72]
EXAMPLE
29.8
(1) Gift
of land but donor is subsequently given shooting/fishing rights or rights to
take timber. So long as full (not partial) consideration is furnished there is no
reservation of
benefit.
(2) Gift
of Ming vase-returned to donor in return for the payment of full rent. No
reservation. [*695]
(3) As in
(1) save that donor sub-lets his rights. Outside Sc/i 20 para 6(l) (a) since
actual enjoyment is not resumed and therefore there is a reservation of
benefit.
(4) Gift
of shares: donor continues to enjoy dividends and pays full value for that
right. Outside Sch 20 para 6(l) (a) since the property in question is neither
land nor chattels. Hence a benefit is reserved.
3
Hardship
Additionally,
a benefit may be ignored on hardship grounds but this provision is restrictive
and is concerned solely with the occupation of gifted land by a donor whose
circumstances have changed since the original gift and who has become unable to
maintain himself for reasons of old age or infirmity. Further, the donee must
be related to the donor (or his spouse) and the provision of occupation must
represent reasonable provision for the care and maintenance of the donor (FA
1986 Sch 20 para 6(1)(b) and see s 102C(3)). [29.73]-[29-100]
V
IDENTIFYING PROPERTY SUBJECT TO A RESERVATION
FA 1986
Sch 20 paras 1-5 contains complex rules for identifying property subject to a
reservation and makes provision, in particular, for what happens if the donee
ceases to have possession and enjoyment of the property whether by sale or
gift; for the effect of changes in the structure of bodies corporate when the
original gift was of shares or securities; for the position if the donee
predeceases the donor; and finally for the effect of changes in the nature of
the property when the original gift was settled. The rules distinguish between
settled and unsettled gifts and in the latter case there appears to be a defect
in the legislation in relation to cash.
When
property subject to the reservation qualified for agricultural or business
relief at the date of the gift that relief may also be available if IHT would
otherwise be charged because of the retained benefit (see [31.60]).
The
recent case of Sillars v IRC [2004] SSCD 180 concerned a deposit account held in the
joint names of the deceased and her two daughters. The daughters each regarded
one third of the balance in the account as theirs. When the deceased died, the
deceased's share in the account was returned as a one-third share. The Revenue
contended that the whole balance of the account fell within the deceased's
estate because the account was property where the deceased had a general power
or authority enabling her to appoint or dispose of the property as she thought
fit (IHTA 1984 s 5(2)). Alternatively, that the deceased had reserved a benefit
in the account because the daughters did not have possession and enjoyment of
the account and because the deceased was excluded from benefit. The Special
Commissioner held that deceased did have a general power to dispose of the
balance of the account as she thought fit. The property was therefore within
her estate for I}ITA 1094 s 5(2) purposes. Alternatively, the deceased had
reserved a benefit in the account because the deceased was not excluded from
benefiting from the account and the daughters had not assumed possession
or [*696] enjoyment of the account. The
Deceased's gift was a gift of a chose in action of the whole account and not
just of two-thirds of the initial balance. This case was followed in Perry v
IRC [2005] SSCD
474 (joint bank account) [29.101]-[29.120]
VI
RESERVING BENEFITS AFTER FA 1986
1 General
matters
The
avowed purpose behind the provisions of FA 1986 was to prevent 'cake and eat
it' arrangements that had flourished in the CTT era. To what extent do the new
rules achieve their purpose? When it is necessary to identify the property
given away, it may be that there is a defect in the rules FA 1986 Sch 20 with
regard to gifts of cash. Such gifts are expressly exclude from the rules and it
is arguable that once the money is spent by the donee there is no property in
which a benefit can be reserved (a similar principle applies if property
originally given was turned into cash by the donee and that cash was either
dissipated or used to purchase a replacement asset). A further loophole related
to inter-spouse gifts (apparently closed in the wake of the Eversden case: see [29.138]) whilst the
rules do not prevent the retention of control over the property given (see
[29.134]). [29.121]
2
Drafting: reservation or partial gift ('shearing')
'[By retaining]
something which he has never given, a donor does not himself within the
mischief of [the statutory provisions] ... In the simplest analysis if A gives
to B all his estates in Wiltshire except Blackacre, he does not Blackacre out
of what he has given; he just does not give Blackacre' (Lord Simmonds in St
Aubyn v A-G
(1952)).
EXAMPLE
29.9
(1) A
owned freehold land. In 1909, a sheep farming business was carried on in
partnership with his six children on it.
1913: he
gave the land to his children. The partnership continued.
1922 A
died.
What
had he given away in 1913? Only his interest in the land subject to the rights of the
partnership. Accordingly there was no property subject to a reservation of
benefit (see Munro v Stamp Duties Comr (1934)). It is though that the FA 1999 changes
would now result in a reserved benefit (see [29.130]).
(2) In
1934 a father made an absolute gift of grazing land to his son. In 1935 that
land was bought into a partnership with, inter alia, the father. On the death of the
father in 1952 it was held that he had reserved a benefit in the land because
of his interest in the partnership. (See Chick v Stamp Duties Comr (1958): contrast (1) above in
that interest of the father arose after the absolute gift.)
(3) T
owns Whiteacre. He grants a lease to a nominee, assigns the freehold reversion
to his daughter, and continues to occupy the property. Has T made a partial
gift (of the reversion) so that the reservation of benefit rules do not apply? [*697]
It should
be noted that in Munro (Example 29.9(1), above) not only was there a substantial time gap
between the grant of the lease and the gift of the freehold but, at the time
when the lease was granted, the donor had no intention of making a gift of the
freehold: ie it was both prior and demonstrably independent.
Doubts
about shearing operations that involved the use of a nominee were caused by Kildrummy
(Jersey) Ltd v IRC
(1990), a case decided in the Scottish Court of Session and concerning a stamp
duty avoidance scheme. Attempting to avoid duty, the taxpayers formed ajersey
company to which they granted a lease over property that they owned outright:
the Kildrummy estate. That jersey company executed a declaration that the lease
was held 'in trust and as nominee for' the taxpayers. Just over one month later
the freehold was disposed of to a second Jersey company. The Court of Session
decided, unanimously, that the grant of the lease to the nominee company was
null and void. Lord Sutherland commented as follows:
'There is
no doubt that it is perfectly competent for a person to enter into a contract
with his nominee but such a contract would normally be of an administrative
nature to regulate the relationship between the parties and to describe the
matters which the nominees are empowered to do by their principal. A contract
of lease, however, is in my opinion of an entirely different nature. It
involves the creation of mutual rights and obligations which can only be given
any meaning if the contract is between two independent parties.'
The whole
question of 'shearing operations' of this type was considered by the courts in
the Ingram litigation. [29.122]
3 Ingram
v IRC
a) The
facts
In Ingram
v IRC (1999),
Lady Jane Ingram transferred landed property to a nominee in 1987; the
following day (on her directions) he granted her a 20-year rent-free lease in
the property and on the next day transferred the property (subject to the
lease) to trustees who immediately executed declarations of trust whereby the
property settled was held for the benefit of certain individuals, excluding
Lady Jane. The arrangements, all part of a pre-planned scheme, amounted to a
classic carve-out or shearing operation. Lady Jane died in 1989 and the Revenue
issued a determination that, because of the reservation of benefit rules, the
gifted property still formed part of her estate at her death. [29.123]
b) The
Revenue's claim
The
Revenue argued that the grant of a lease by a nominee in favour of his
principal was a nullity with the result that, although it was accepted that the
trustees took the property subject to the interest of Lady Jane (as per the abortive lease), that
interest took effect by way of a leaseback. Hence Lady Jane's interest could
only arise contemporaneously with the gift made to the trustees, thereby
resulting in a reservation of benefit. Alternatively, and even if the nominee
lease was effective, the same result would follow as a result of applying the Ramsay principle. [29.124] [*698]
c) The
approach of the House of Lords
Lord
Hoffmann referred to the long history of the legislation in this area and noted
that the decided cases showed that although its provisions prevent a donor from
'having his cake and eating it', there is nothing to stop him from 'carefully
dividing up the cake, eating part and having the rest'. He decided the appeal
on the assumption that the lease granted by the nominee was a nullity, ie on
the basis that the leasehold interest came into existence only at the time when
the freehold was acquired by the trustees. The consequences of such a
'contemporaneous carve-out' involved a consideration of the estate duty case of
Nichols v IRC
(1975) which had concerned a gift by Sir Philip Nichols of his country house
and estate to his son, Francis, subject to Francis granting him an immediate
leaseback. Goff J, giving the judgment of the Court of Appeal, concluded that
such an arrangement involved a reservation of benefit by Sir Philip:
'... we
think that a grant of the fee simple, subject to and with the benefit of a
lease-back, where such a grant is made by a person who owns the whole of the
freehold free from any lease, is a grant of the whole fee simple with something
reserved out of it, and not a gift of a partial interest leaving something in
the hands of the grantor which he has not given. It is not like a reservation
or remainder, expectant on a prior interest. It gives an immediate right to the
rent, together with a right to distrain for it, and, if there be a proviso for
re-entry, a right to forfeit the lease. Of course, where, as in Munro v
Commissioner of
Stamp Duties (NSI4") (1934) the lease, or, as it then may have been, a
licence coupled with an interest, arises under a prior independent transaction,
no question can arise because the donor then gives all that he has, but where
it is a condition of the gift that a lease-back shall be created, we think that
must, on a true analysis, be a reservation of benefit out of the gift and not
something not given at all.'
In the
event the Nichols
case fell to be decided on the basis of the covenants given by the son in the
lease in which he assumed the burden of repairs and the payment of tithe
redemption duty, which covenants themselves amounted to a reservation. The
wider statement of Goff J quoted above to the effect that a leaseback must by
itself involve a reservation constituted the main authority relied upon by the
Revenue (and the comment that the Munro case involved a 'prior independent
transaction' had subsequently been widely debated). Lord Hoffmann unequivocally
rejected this approach:
'It is a
curious feature of the debate in this case that both sides claim that their
views reflect the reality, not the mere form of the transaction, but the
Revenue's version of reality seems entirely dependent upon the scintilla
temparis which must elapse between the conveyance of the freehold to the donee
and the creation of the leasehold in favour of the donor. For my parti do not
think that a theory based on the notion of a scintilla temporis can have a very
powerful grasp on reality ... If one looks at the real nature of the
transaction, there seems to me no doubt that Ferris J was right in saying that
the trustees and beneficiaries never at any time acquired the land free of Lady
Ingram's leasehold interest.'
[29.125]
d) The
nominee lease
Given
that no reservation was involved even if the nominee lease was a nullity, it
was not strictly necessary for their Lordships to express any view on the [*699] validity of such an arrangement. Lord Hoffmann, however,
indicated that he was of the opinion that such a lease was valid as a matter of
English law for reasons given by Millet U in the Court of Appeal. (Nominee
leases are in fact widely used in practice.) It should, however, be appreciated
that nothing in the speeches affects the proposition that a man cannot grant a
lease to himself (see Rye v Rye (1962)) nor the position under Scots law (see Kildrummy
(Jersey) Ltd v IRC (1990)). [29.1261]
e) Ramsay
Given the
conclusion that a leaseback did not involve any reservation of benefit, the
question of the Ramsay principle being used to nullify the nominee lease did not arise, and
neither Lord Hoffmann nor Lord Hutton expressed any views on this matter. [29.127]
f) The
meaning of 'property' in FA 1986 s 102
Lord
Hoffmann pointed out that s 102 is concerned with a gift of 'property' and that
term does not necessarily refer to something that has a physical existence such
as a house, but is used in a technical sense and requires a careful analysis of
the nature of what has been gifted. A landowner may, for instance, gift an
unencumbered freehold interest in his house in which case were he to continue
to occupy that property (in the absence of a payment of full consideration and
assuming that such occupation was more than on a de minimts level) then he
would reserve a benefit. By contrast, he might retain a leasehold interest and
only give away the encumbered freehold interest, in which case no benefit would
be reserved in the property gifted (which would be the encumbered freehold). Of
course, if the donor in the latter situation continued to occupy the house
after the expiry of the retained lease, then that would (subject to what is
said above about full consideration and de minimis) amount to a benefit
retained in the freehold interest gifted. As Lord Hoffmann concluded, section
102 'requires people to define precisely the interest which they are giving
away and the interest, if any, which they are retaining'. [29.128]
g) The
use of shearing arrangements
The
speeches demolished the argument that the creation of the lease and the gift of
the encumbered freehold had to be independent transactions.
The lease
could be carved out contemporaneously with the gift. Accordingly a prior
nominee arrangement is not necessary; the arrangement could be structured as a
gift and leaseback. However, it was essential that all the relevant terms of
the lease were agreed before the freehold gift was made so that it is clear
that the proprietary interest retained was defined with the necessary precision. [29.129]
4 FA 1999
s 104 (inserting new ss 102A-C into FA 1986)
Unsurprisingly
the Ingram decision was reversed in respect of gifts of interests in land made
after 8 March 1999, but the reversing legislation is narrowly [*700] targeted and, it would seem, does not otherwise change the
reservation of benefit rules. 1f the following conditions are met the donor is
treated as reserving a benefit in the gifted property with the normal
consequences:
(1) There
must be a gift of an interest in land (other assets are not included). Note
that as with the original legislation the trigger is a gift.
(2) The
donor must retain 'a significant right or interest ... in relation to the land'
(in certain circumstances it will be sufficient if this is retained by his
spouse) or be party to a significant arrangement in relation to the and. A
right or interest is not 'significant' if the donor pays full consideration for
it nor if the interest was obtained at least seven years before the gift (hence
it is possible to grant a lease; wait seven years and then gift the freehold
interest without falling foul of these rules).
It is not
thought that these rules apply where a property is divided (eg lodge/main
house) and one is gifted, one retained.
[29.130]
EXAMPLE
29.10
(1) In
2003 A carves out a lease (using a nominee arrangement) and gifts the en
cumbered freehold interest to his daughter Because A has given away ai)
interest in land and retained an interest in the same land, the gifted interest
is caught by the reservation rules: hence it will form part of A's estate on
his death (s lO2A(2));
(2) As
above except that having carved out the lease A waits seven years before giving
away the freehold.
The
reservation rules do not apply to the gifted freehold interest (s 102A(5)).
(3) A is
the life tenant of a seulement cmeoted his grandfather and which owns his main
residence. The trustees exercise overriding powers to appoint an encumbered
freehold interest on continuing trusts Pr A 's children leaving a leasehold interest
in the life interest fund.
Although
A makes a transfer of value (to the extent of the freehold interest ceasing to
be subject to his life interest) he does not make a gift and so the reservation
rules will not apply.
5
Reversionary leases
EXAMPLE
29.11
Tom owns
the Red House. He grants a 350-year lease to his son at a peppercorn rent to
begin in 21 years' time. Meanwhile he continues to occupy the property.
Analysis:
This is an alternative 'shearing' arrangement: the gift is of the leasehold interest
whilst Tom's continued occupation is attributable to his retained freehold
interest. In the light of the speeches in Ingram it would seem likely that such
arrangements are outside the original reservation rules and they do not seem to
be affected by the 1999 legislation provided that the freehold interest was
acquired at least seven years before the deferred lease was granted. (It is
understood that HMRC does not accept this on the basis that there is a
'significant arrangement' 4 that is not protected by the seven-year provision
in s 102A(5).) Alternatively, the rules may not apply if the freehold was
acquired for full consideration. [29.131]
[*701]
6
Settlements
a) Retaining
an interest
If the
settlor reserves an interest for himself under his settlement, whether he does
so expressly or whether his interest arises by operation of law, there is no
reservation of benefit and he is treated as making a partial gift (see Re
Cochrane (1906)
which involved a reversionary interest). . [29.132]
b) The
object of a discretionary trust
The
position with regard to discretionary trusts is more problematic. If the
settlor is one of the beneficiaries he is not entirely excluded from the
property with the result that the entire fund will be included as part of his
estate. In view of the limited nature of a discretionary beneficiary's rights
(see Gartside v IRC (1968)), he cannot be treated as making a partial gift (see IRC v
Eversden (2003)).
1f the donor could be added as a beneficiary under a power to add contained in
the settlement it is thought that again the property is subject to a
reservation. [29.133]
e) The
settior as paid trustee
A danger
arises if the settior is one of the trustees and is entitled to remuneration as
trustee. According to the estate duty case of Oakes v Stamp Duties Comr (1954) he has reserved a benefit
(although at present HMRC does not follow this case). In any event there is no
problem if the settlor/ trustee is not entitled to remuneration and so it is
possible for a donor to retain control over the settled property without
infringing the reservation of benefit rules. [29.134]
d) The
termination of an interest in possession
Where an
individual either became entitled to an interest in possession before 22 March
2006 or, if after that time, the interest was an immediate post-death interest,
a transitional serial interest or a disabled person's interest (for
definitions, see Chapter 32), and is accordingly treated as owning the property
itself (see Chapter 33), a termination of the interest in the individual's
lifetime on or after 22 March 2006, where the property continues to be settled
after that termination, will be treated as a gift for the purposes of the gift
with reservation rules. Thus, if such an individual retains the use of the
settled property after their interest in it ends, it will remain chargeable in
their hands. [29.135]
EXAMPLE
29.12
In
November 2000, Cliff settled his country house on trust for Richie for life or
until he should re-marry, thereafter to Richie's ex-wife Maddie for life, with
remainder to his niece, Saphron. Richie re-married in September 2006 and, since
Maddie had settled in France, the trustees permitted Richie to remain living in
the house. Should Richie die in, say, December 2008, the value of the house
will form part of his estate for IHT purposes in the same way as if he had
formerly owned it outright.
[*702]
7
Benefits that are permitted
a)
Statutory 'get outs'
It is
only necessary for the property to be enjoyed virtually to the entire exclusion
of the donor, thereby permitting the occasional visit or holiday (see [29.71]).
More important is the exception where the donor provides full consideration for
the benefit retained. [29.136]
EXAMPLE
29.13
Dad gives
his farm to Phil but continues to reside in the farmhouse under a lease which
requires him to pay a full rent. Dad's continued use of a part of the gifted
property does not bring the reservation rules into play.
b) Co-ownership
The
following situation was considered by ministers at the time when the rules were
introduced in 1986.
'Elderly
parents make unconditional gifts of a share in their house to their children
(so that the children become tenants in common with the parents). Assuming that
they all reside in the house and each bears his share of the running costs, it
appears that the parents' continued occupation or enjoyment of that part of the
house which they have given away is in return for similar enjoyment by the
children of the other part of the property. Accordingly, the parents'
occupation is for full consideration' (Standing Committee G: Hansard, 10 June
1986, col 425).
The
restrictive nature of this statement is all too obvious: it is assumed, for
instance, that the children are occupying the house with their parents. If they
lived elsewhere would their right to occupy be sufficient to lead to the same
result? (Furthermore, if they never lived in the house after the making of the
gift can they be said to have assumed 'full possession and enjoyment' of the
gifted property?) It appears implicit in the statement that ownership of the
house is divided equally between the various tenants in common (or that less
than 50% is given away) since otherwise the full consideration argument would
seem inapplicable.
Perhaps
the major difficulty with the views expressed in the statement is that they
proceed upon the premise that the house is divided into 'parts' so that the
parents use the children's 'part' in return for letting the children use their
'part'. In reality, of course, the interest of a tenant in common is in the
whole property: he is the owner of an undivided share. Accordingly, the right
of such a tenant to occupy the entire property is derived from the interest
retained. As it does not amount to a reservation in the gifted share the full
consideration argument becomes irrelevant. If this view is correct, it would
follow that the precise interest of a tenant in common (eg does he have a 50%
share or only 1%?) becomes irrelevant since whatever the size of the interest
it confers a right to occupy the entirety.
FA 1986 s
102B (inserted by FA 1999) was introduced to deal with gifts of a share in land
and is couched in significantly wider terms than the 1986 Ministerial
Statement. Accordingly, that Statement should, in relation to [*703] events occurring after 8 March 1999, be regarded as wholly
superseded. Under the legislation, there will be no reservation of benefit if:
(1) there
is a gift of a share in land;
(2) both
donor and donee occupy the land;
(3) the
donee does not receive any benefit other than a negligible one which is
provided by the donee for some reason connected with the gift.
The
abandonment of any reference to 'full consideration' should be noted which indicates that the gift
may be of (say) a 90% interest in the property. Note also that the donor can, if he wishes,
continue to pay all the running costs of the property. [29.137]
EXAMPLE
29.14
Sally
owns a five-bedroom property at the seaside and is regularly visited by her
daughter and two children (who live in Tooting). She gives a 50% beneficial
interest in the house to the daughter who comes and goes as she pleases and
leaves possessions in the rooms of the house (eg her bedroom). Although it is
not the daughter's main residence and is not her 'family home' it is
nevertheless felt that s 102B(4) applies so that Sally has not reserved any
benefit in the gifted share. The daughter is 'in occupation' in much the same
way as owners of a country cottage would be in occupation. Take care in
relation to the division of expenses: Sally must not receive any benefit from
the daughter in any way connected with the gift. She should, for instance,
continue to bear her own day-to-day living expenses and
her
proportionate share (she could pay all!) of the property expenses.
8
Reservation and spouses: the Eversden case
a) General
principles
The
reservation of benefit rules do not apply in the case of an inter-spouse gift
(see FA 1986 s 102(5)). [29.138]
EXAMPLE
29.15
(1) S
creates a discretionary trust. He is the unpaid trustee, his wife is one of the
beneficiaries. S has not reserved any benefit although it appears that fhis
wife benefits under the trust and zfhe shares that benefit HMRC will argue that
he has not been excluded from enjoyment or benefit in the gifted property.
(2) H
settles a bond on his wife, W, for life but subject to an overriding power of
appointment in favour of a class of beneficiaries including H. Her life
interest is terminated after (say) six months by the trustees whereupon the
bond is held in an interest in possession trust for H's daughter (but still
subject to the power of appointment which could be exercised in favour of H).
Because the original gift made by H was spouse exempt the Court of Appeal
decided in Eversden that the reservation of benefit rules could not apply to
the subsequent trusts affecting the property.
b) The
Eversden case
Slightly
simplifying the facts, in 1988 the settior conveyed her house to a trust under
which she reserved a 5% absolute beneficial share with the remaining [*704] reservation of benefit
95% being
held for her husband for life and subject thereto on discretionary trusts for a
class of beneficiaries including the settlor. The husband and settlor occupied
the property: on the husband's death in 1992 IHT was payable on the termination
of his life interest and the wife continued to occupy the property until her
death in 1998. The Court of Appeal decided:
(1) that
the original settlement involved a gift by the settlor which was covered by the spouse exemption;
(2)
accordingly there was no room for the application of the reservation of benefit rules.
The
Revenue argued that although the gift of the life interest was spouse exempt,
the gift on discretionary trusts was not and because the settlor was a
beneficiary of those trusts she had reserved a benefit.
Concluding
that the spouse exemption in s 102(5) (a) was wide enough to cover gifts of
even a determinable life interest to a spouse, Carnwath LJ in the Court of
Appeal commented as follows:
'However
the problem if it exists derives from s 49, which treats the acquisition of an
interest in possession as equivalent to the acquisition of the property itself.
That has the result that, in the present case, the estate of the settlor's
husband is taxed on the property, but that of the settlor is not. There is
nothing in s 102 to modify that aspect of the scheme of the 1984 Act. 1f that
is of concern to the Revenue, they must look for correction to Parliament, not
to the courts.' [29.139]
c)
Amending legislation (FA 2003 s 185)
The
so-called 'Eversden loophole' was closed by legislation effective in relation
to disposals made on or after 20 June 2003. The effect of this can be
illustrated as follows:
(i)
Assume that on 1 August 2003 Adam settles property on a revocable life interest trust for his wife Eve.
That
disposal will be spouse exempt and even if Adam continues to benefit from the
property there will be no reservation of benefit;
(ii) On 1
April 2004 the trustees exercise their overriding powers to end Eve's life
interest whereupon the property is held on discretionary trusts under which
Adam is capable of benefiting.
The
termination of Eve's life interest will be a chargeable transfer by her. So far
as Adam is concerned, the new s 102(SB) provides that it is as if Adam's
original disposal by way of gift 'had been made immediately after (Eve's) ...
interest in possession came to an end'. The reservation rules therefore apply
at that point to catch Adam's gift.
As can be
seen the effect of the change (a) is not to effect the treatment of outright
spouse gifts-nor indeed of life interest gifts which are enlarged into absolute
ownership-but (b) in other cases limits the spouse exemption to the period
during which the spouse retains an interest in possession in the property. [29.140]
9
Post-death variations
Instruments
of variation and disclaimer provide an ideal way of transferring wealth without
resulting in any IHT or CGT liability and permit the disponor to reserve a
benefit in the property (see generally [30.153]) [29.141] [*705]
EXAMPLE
29.16
(1)
Father dies leaving his country cottage to his daughter. She continues to use
it for regular holidays and at all bank holidays but transfers it to her son by
instrument of variation made within two years of father's death and read back
into his will.
The
crucial point is that the variation is treated as made by father for all IHT
purposes so that his daughter has not made a gift of property capable of
falling within the reservation of benefit provisions.
(2) On
H's death property (including the second home) is left to his wife on a
terminable life interest, remainder to the son. The trustees terminate the
spouse's life interest in the country cottage but the son permits her to
continue to use it on a regular basis. The reservation of benefit rules do not
apply because the termination of the interest in possession, although a
transfer of value (a PET) by the spouse, is not a gift (see [29.41].
10
Pre-owned assets
FA 2004 s
84 and Sch 15 introduce an income tax charge where disponors enjoy benefits
from pre-owned assets. The rules will apply from 2005/06. As the name suggests,
'pre-owned assets' are assets previously owned by the disponor and disposed of
by him since March 1986. the disposition maybe of a part or the whole of the
pre-owned asset.
In
relation to land, an charge to income tax under these provisions will arise in
respect of a 'chargeable amount' where an individual ('the chargeable person')
occupies any land ('the relevant land'), whether alone or together with or her
persons and either the disposal condition or the contribution condition is met
as respects the land.
The
disposal condition is met where at any time after 17 March 1986, the chargeable
person owned an interest in the relevant land or other property the proceeds on
the disposal of which were applied (directly or indirectly) by another person
in acquiring the relevant land and the chargeable person has disposed of all or
part of his interest in the relevant land otherwise than by an excluded
transaction. Excluded transactions are set out at FA 2004 Sch 15 para 10(1) and
include transfers to the spouse of the chargeable person, arms' length
transactions, gifts by virtue of which the relevant property became settled
property in which the spouse or former spouse has an interest in possession,
and transfers falling within the exemptions set out at IHTA 1984ss 11, 19 and
20.
The
contribution condition is, broadly, satisfied where the chargeable person has
funded some other person, otherwise than by an excluded transaction, to acquire
an interest in the relevant property. Excluded transactions for these purposes
are set out at FA 2004 Sch 15 para 10(2) and include acquisitions by the spouse
of the chargeable person, or where the spouse becomes entitled to an interest
in possession in the relevant property on its acquisition, where the
consideration provided by the chargeable person was by way of outright gift and
was made at least seven years before the chargeable person occupied the relevant
land, the consideration provided by the chargeable person falls within IHTA
1984 ss 11, 19 or 20.
The
chargeable amount for any taxable period is the appropriate rental value less
the amount of any payments which, in pursuance of any legal [*706] obligation, are made by the chargeable person during period
to the owner of the relevant landing respect of the occupation by the
chargeable person of the relevant land.
There are
equivalent provisions for chattels. These are found at FA 2004 Sch 15 paras
6-7. There are similar provisions in relation to intangible assets.
Exemptions
from charge under FA 2004 Sch 15 are set out at para 11. These include
situations where the chargeable person's estate includes the relevant property
or other property that derives its value from the relevant property and its
value is not substantially less than the value of the relevant property.
FA 2004
Sch 15 does not apply in any year where the former owner is not UK resident. If
the chargeable person is UK-resident but non-domiciled, then the charge only
applies in relation to UK situs property. The charge does not apply to
disposals of property by persons who were non-domiciled at the time of the
disposal but who have since acquired UK domicile.
There is
a de minimis amount set of £2,500. Benefits falling below this figure
will not be changeable under FA 2004 Sch 15.
Where
post-death variations have been effected, the persons who owned the property
which is the subject of the variation are not treated for the purposes of FA
2004 Sch 15 as having previously owned the property (FA 2004 Sch 15 para
16). [29.142] [*707]
30
IHT--death
Updated
by Natalie Lee, Barrister Senior Lecturer in Law, University of Southampton and
Aparna Nathan, LLB Hong, LLM, Barrister, Gray's Inn Tax Chambers
I General [30.1]
II How to calculate the IHT bill on death
[30.21]
III Payment of IHT-incidence and burden
[30.41]
IV Problems created by the partially
exempt transfer 130.91]
V Abatement [30.121]
VI Specific problems on death [30.141]
I GENERAL
IHTA 1984
s 4(1) provides that:
'on the
death of any person tax shall be charged as if immediately before his death he
had made a transfer of value and the value transferred by it had been equal to
the value of his estate immediately before his death
Accordingly,
there is a deemed transfer of value that occurs immediately before the death
and which must be cumulated with chargeable transfers made by the deceased in the preceding seven years. In addition
to causing a charge on his estate
at death, death also has the effect of making chargeable potentially exempt
transfers made in the seven years before death and it may lead to a
supplementary IHT charge on chargeable transfers made in that same period. It
should be noted that, following the changes made by FA 2006 Sch 20 to the
inheritance taxation of trusts, whereby inter vivos interest in possession
trusts (apart from disabled trusts) created on or after 22 March 2006 will
incur an immediate charge to tax rather than qualify as PETs (see [28.42]),
there are likely to be fewer PETs and more chargeable transfers. The complex
tax computations that may result in either case are considered in [30.21]
ff. [30.1]
1 Meaning
of 'estate'
The
definition of 'estate' has already been considered in connection with lifetime
transfers (IHTA 1984 s 5(1); see [28.61]. For a recent decision confirming that
rights under an intestacy are 'property' for IHT purposes and hence form part
of a taxpayer's estate, see Daffodil v IRC (2002). On [*708]
death, the estate does not include excluded property (see [35.20] for
the meaning of excluded property) although it does include property, given away
by the deceased, in which he had reserved a benefit at the time of his death
(see Chapter 29). Property owned by the deceased in a fiduciary capacity, for
instance as 'treasurer' for his family, does not form part of his estate (Anand
v IRC (1997)).
The person opening a joint bank account may be found, on the facts, to be the
beneficial owner of the moneys in that account at the date of his death (O'Neill
v IRC (1998)). As
the transfer is deemed to occur immediately before the death, the estate
includes the share of the deceased in jointly owned property that passes by
operation of law (jus accrescendi) at the moment of death.
EXAMPLE
30.1
Bill and
his sister Bertha own their home as beneficial joint tenants so that on the
death of either that share will pass automatically to the survivor and will not
be transferred by will. For IHT purposes the half share in the house will be
included in their respective death estates and will be subject to charge (for
the valuation of the half share, see [28.64]).
The
estate at death also includes a gift made before death in anticipation' of
death and conditional upon it occurring (a donatio mortis causa). Hence,
although dominion over the property will have been handed over, it is still
taxed as part of the deceased's estate at death. [30.2]
2
Valuation
a) A
hypothetical sale
(See also
[28.621 ff.)
In
general, assets must be valued at 'the price which the property might
reasonably be expected to fetch if sold in the open market at that time'. No
reduction is allowed for the fact that all the property is put on the market at
the same time (IHTA 1984 s 160). This hypothetical sale occurs immediately
before the death and if the value is ascertained for IHT purposes it becomes
the value at death for CGT purposes and, hence, the legatee's base cost (TCGA
1992 s 274: see [21.21]). Reliefs that reduce the IHT value (notably business
property relief) are ignored for CGT purposes. For IHT, low values ensure the
least tax payable but will give the legatee a low base cost and so a higher
capital gain when he disposes of the asset. [30.3]
b) Lotting
and the Fox decision
In valuing
an estate at death, 'lotting' requires a valuation on the basis that 'the
vendor must be supposed to have' taken the course which would get the largest
price for the combined holding 'subject to the caveat ... that it does not
entail undue expenditure of time and effort'. For instance, if a taxpayer dies
possessed of a valuable collection of lead toy soldiers they will not be valued
individually but rather as a collection (see Duke of Buccleuch v IRC (1967)). [*709]
In IRC
v Gray (1994) the
deceased (Lady Fox) had farmed the Croxton Park Estate in partnership with two
others and the land was subject to tenancies that Lady Fox, as freeholder, had
granted to the partnership. The Revenue sought to aggregate (or lot) the
freehold in the land with her partnership share as a single unit of property so
that the value of Lady Fox's freehold reversion was an appropriate proportion
of the aggregate value of that reversion and her partnership interest treated
as a single item of property (in effect therefore the reversion was being
valued on a vacant possession basis with an allowance for the partnership
interests of the other partners). It may be noted that under the partnership
deed she was entitled to 921/2% of profits (and bore virtually all the losses).
The Court of Appeal reversed the Lands Tribunal, holding that lotting was
appropriate since that was the course that a prudent hypothetical vendor would
take to obtain the best price. The fact that the two interests could not be
described as forming a 'natural unit of property' was irrelevant. Hoffmann U
commented that:
'The
principle is that the hypothetical vendor must be supposed to have "taken
the course which would get the largest price" provided that this does
not-entail "undue expenditure of time and effort". In some cases this
may involve the sale of an aggregate which could not reasonably be described as
a "natural unit" ... The share in the farming partnership with or
without other property, was plainly not a "natural" item of commerce.
Few people would want to buy the right to farm in partnership with strangers.
Nevertheless [s 160] requires one to suppose that it was sold. The question for
the Tribunal was whether, on this assumption, it would have been more
advantageous to sell it with the land.'
In many
ways this was not a typical case involving the fragmentation of farm land
within a family and therefore it should not be assumed that this judgment will
apply in all such cases: see Private Client Business (1994) p 210.
[30.4]
e) Funeral
expenses
Although
the general rule is that assets must be valued immediately before death, IHTA
1984 Part VI permits values to be amended in certain circumstances, eg
reasonable funeral expenses can be deducted including a reasonable sum for
mourning for family and servants and the cost of a tombstone or gravestone: see
SP 7/87. The Revenue have indicated that 'what is reasonable in one estate may
not be reasonable in another and regard has to be had to the deceased's
position in life and to the size of the estate. Each case has to be treated on
its own merits'. [30.5]
d) Changes
in value resulting from the death
In
certain cases, a change in the value of assets caused by the death is taken
into account. [30.6]
EXAMPLE
30.2
(1) A
took out a whole life insurance policy for £100,000 on his own life.
Its value immediately before death would be equal to the surrender figure. As
a [*710] result of A's death £100,000
will accrue to A's estate and hence the value of the policy for IHT purposes is
treated as that figure (IHTA 1984 s 167(2)).
(2) A and
B were joint tenants in equity of a freehold house worth £100,000.
Immediately
before A's death his joint interest would be worth in the region of
£50,000. As a result of death that asset passes to B by survivorship
(je its value is nil to A's estate). In this case it is not possible to alter
the pre-death valuation (IHTA 1984 s 171(2)).
e) Post-death
sales
In three
cases the pre-death valuation can be altered if the asset is sold within a
short period of death for less than that valuation. Relief is not given merely
because the asset falls in value after death; only if it is sold by bargain at
arm
length is
the relief available. Normally the sale proceeds will be substituted as the
death valuation figure if an election is made by the person liable for the IHT
on that asset (in practice this will be the PRs who should elect if IHT would
thereby be reduced). Where such revaluations occur, not only must the IFIT bill
(and estate rate) on death be recalculated but also, for CGT purposes, the
death valuation is correspondingly reduced so as to prevent any claim for loss
relief. The three cases when this relief is available are: [30.7]
Related
propert'i sold within three years of death (IHTA 1984 s 176) The meaning of
related property has already been discussed (see [28.67]). So long as a
'qualifying sale' (as defined) occurs, the property on death can be revalued
ignoring the related property rules (ie as an asset on its own). Although the
sale proceeds need not be the same as the death value, if the sale occurs
within a short time of death the proceeds received will offer some evidence of
that value. [30.8]
EXAMPLE
30.3
Sebastian's
estate on death includes one of a pair of Constable watercolours of Suffolk
sunsets. He leaves it to his son; the other is owned by his widow, Jemima. As a
pair, the pictures are worth £200,000. Applying the related property
provisions the watercolour is valued at £100,000 on Sebastian's
death. If it were to be sold at Sotheby's some eight months after his death for
£65,000, the death value could, if a claim were made, be recalculated
ignoring the related property rules. It would be necessary to arrive at the
value of the picture immediately before the death.
Quoted
shares and securities sold within 12 months of death (IHTA 1984 ss 1 78f]) I!
sold for less than the death valuation the sale proceeds can be substituted for
that figure. It should be noted that if this relief is claimed it will affect
allsuch investments sold within the 12-month period; hence, the aggregate of
the consideration received on such sales is substituted for the death values.
Special rules operate if investments of the same description are repurchased.
The shares or securities must be listed on the Stock Exchange so that the
provisions do not apply to private company shares. Relief is also available in
cases where the investments are either cancelled without replacement within 12
months of death or suspended within 12 months of death and remain suspended on
that anniversary. In the former case, there is deemed sale for a nominal
consideration of 1 at the time of cancellation; in the latter a deemed sale of
the suspended investments immediately before the anniversary at [*711] their then value. With recent falls in the Stock Market this
is a valuable relief and PRs may be criticised if they fail to take advantage
of it to reduce the IHT bill.
[30.9]
Land sold
within four years of death (IHTA 1984 ss l9OfJ) The relief extends to all interests
in land and is similar to that available for quoted securities although it
enables a higher as well as a lower figure to be substituted. Hence, all sales
within the four-year period are included in any election. Note, however, that
in the fourth year the election is not available if the sale value would exceed
the probate value (IHTA 1984 s 197A). Exchange of contracts is not a 'sale':
see Jones (Balls' Administrators) v IRC (1997).
[30.10]
The
'appropriate person' In the case of both quoted shares and land, the election
to substitute the sale proceeds must be made by the appropriate person who is
defined in the legislation as 'the person liable for inheritance tax
attributable to (the property)'. This will be the PRs. Obviously the election
in such cases will commonly be made if the property is sold for less than its
probate value, but the section dealing with land is not so limited and
therefore the election may appear attractive in the sort of case illustrated in
Example 30.4 where substituting a higher probate value would wipe out a CGT
liability. [30.11]
EXAMPLE
30.4
MacLeod
left his entire estate to his wife Tammy on his death in 2000; it included land
valued at death at £10,000. As a result of new regional development
plans, the land now has hope value and is worth in the region of
£100,000. Accordingly, it is now to be sold. An election to
substitute the sale proceeds for the probate value would be beneficial in CGT
terms. However, because there is no appropriate person (since IHT is not
payable on MacLeod's death), that election cannot be made. Had the land been
left to MacLeod's son, Ronnie, and fallen within MacLeod's unused nil rate band
an election would then be possible (and desirable if the increased value would
still attract IHT at 0%!) (and see Stonor v IRC (2001)).
f) Provisional
valuations
The
valuation of certain assets (notably private company shares) may take some time
and the PRs may wish to obtain a grant immediately. In such cases it is
possible to submit a provisional estimate for the value of the property that
must then be corrected as soon as the formal valuation has been obtained (see
LHTA 1984 s 216(3A) and the Robertson case, considered at [30.43]). [30.12]
3
Liabilities
a) General
rule
Liabilities
only reduce the value of an estate if incurred for consideration in money or
money's worth, eg an outstanding mortgage and the deceased's unpaid tax
liability (IHTA 1984 s 5(5)).
[30.13] [*712]
b) Artificial
debts
FA 1986 s
103 introduced further restrictions on the deductibility from an estate at
death of debts and incumbrances created by the deceased. These provisions
supplement s 5(5) in relation to debts or incumbrances created after 17 March
1986. Broadly, their aim is to prevent the deduction of 'artificial' debts, ie
those where the creditor had received gifts from the deceased as in the
following example:
EXAMPLE
30.5
Berta
gives a picture to her daughter Bertina in 1998. In 2000 she buys it back,
leaving the purchase price outstanding until the date of her death.
(1) The
gift is a PET and escapes IHT if Berta survives seven years.
(2) The
debt owed to Bertina is incurred for full consideration and hence satisfies the
requirements of IHTA 1984 s 5(5). Deduction is, however, prevented by FA 1986 s
103.
Section
103(1) provides that debts must be abated in whole or in part if any portion of
the consideration for the debt was either derived from the deceased or was
given by any person to whose resources the deceased ha4 contributed. In the
latter case contributions of the deceased are ignored, however, if it is shown
(ie by the taxpayer) that the contribution was not made with reference to or to
enable or facilitate the giving of that consideration.
Accordingly,
unless property derived from the deceased furnished the consideration for the
debt, a causal link is necessary between the property of the deceased and the
subsequent debt transaction.
EXAMPLE
30.6
(1) In
Example 30.5 the consideration for the debt is property derived from the
deceased and therefore the debt may not be deducted in arriving at the value of
her estate. (NB: it does not matter that the gift of the deceased occurred
before 17 March 1986 so long as the debt was incurred after that date.)
(2) In
1974 Jake gave a diamond brooch to his daughter (Liz). In 1984 she in turn gave
the brooch to her sister Sam. In 1996 Sam lends £50,000 tojake who
subsequently dies leaving that debt still outstanding. The consideration for
the debt was not derived from property of the deceased and Sam would
(presumably) be able to show that, although she received property from a person
whose resources had been increased by the gift of deceased, the disposition of
that property by the deceased was not linked to the subsequent transaction. Had
Jake bought the brooch back from Liz in 1996 (leaving the price outstanding as
a debt) the consideration for the debt would then be property derived from him
so that the debt would not be deductible.
When a
debt, which would otherwise not be deductible on death because of s 103(1), is
repaid inter vivos the repayment is treated as a PET (a deemed PET). This
provision is essential since otherwise such debts could be repaid immediately
before death without any IHT penalty. However, the application of this rule
when a taxpayer repurchases property that he had earlier given [*713] away is a matter of some uncertainty. Take, for instance,
the not uncommon case where A, having made a gift of a valuable chattel,
subsequently decides that he cannot live without it. Accordingly, he
repurchases that chattel paying full market value to the donee. Has A made a
notional PET under s 103(5) at the time when he pays over the purchase price
or, if the money is paid as part and parcel of the repurchase agreement, did A
never incur any debt or incumbrance falling within the section? It is thought
that the latter view is correct since if the purchase price is paid at once a
debt will never arise.
An
element of multiple charging could arise from the artificial debt rule (in
Example 30.5, for instance, the PET is made chargeable if Berta dies before
2005; the debt is non-deductible and the picture forms part of Berta's estate).
However, the regulations discussed in Chapter 36 prevent the multiple
imposition of IHT in such cases.
Finally, although
a debt may not be deducted in order to arrive at the value of the deceased's
estate for IUT purposes, it must still be paid by the PRs and it is, therefore,
treated as a specific gift by the deceased (see further [30.56]).
[30.14]-[30.20]
EXAMPLE
30.7
(1) S
settled property on discretionary trusts in 1980. In 1990 the trustees lend him
£6,000. This debt is non-deductible. NB: it does not matter when the
trust was created.
(2)
Terry-Testator borrows £50,000 from the Midshire hank which he gives
to his son. The debt that he owes to the bank is deductible on his death: in no
sense is this an 'artificial debt'.
(3)
Terry-Testator lends £50,000 to his daughter (interest free;
repayable on demand). She buys a house with the money that increases in value.
There is no transfer of value by Terry; the debt provisions are irrelevant, and
Terry has not reserved any benefit in the property purchased with the loan.
II HOW TO
CALCULATE THE IHT BILL ON DEATH
Tax is
calculated according to the rates set out in the following table:
Gross
cumulative transfer (£)
Rate (%) Death Rate
(%)--Life
0-285,000
0
0
Above
285,000
40
40
These
rates (which came into force on 6 April 2005) are applied to the estate at
death and, in addition, when that death occurs within seven years of a
chargeable lifetime transfer or PET made by the deceased the following results
occur:
(1) In
the case of a chargeable transfer, IHT must be recalculated either in
accordance with the rates of tax in force at the donor's death if these are
less than the rates at the time of the transfer or, alternatively, by using
full rates at the time of the transfer. Subject to taper relief, extra tax may
then be payable (IHTA 1984 s 7(4), Sch 2 para 2).
(2) In
the case of a PET, the transfer is treated as a chargeable transfer so that
first, 1HT must be calculated (subject to taper relief) at the rates [*714] current at the donor's death (again provided that these
rates are less than those in force at the time when the transfer occurred:
otherwise the latter apply: see Sch 2 para lA), and secondly, the PET must now
be included in the total transfers of the taxpayer for cumulation purposes
which may necessitate a recalculation of the tax charged on other chargeable
transfers made by the donor and, where a discretionary trust is involved, the
recalculation of any exit charge. These problems will be considered in order,
looking first at the effect of death upon the chargeable lifetime transfers of
the deceased and then at the taxation of the death estate. The consequences for
discretionary trusts are considered at [34.22]. [30.21]
1
Chargeable transfers of the deceased made within seven years of his death
As
already explained (see [28.122]) IHT will have been charged, at half the then
death rate, at the time when the transfer was made. In computing that tax,
chargeable transfers in the seven preceding years will have been included in
the cumulative total of the transferor. As a result of his death within the
following seven years IHT must be recalculated on the original value
transferred at the full rate of IHT in force at the date of death. After
deducting the tax originally paid, extra tax may be payable. [30.22]
a) Taper
relief (IHTA 1984 s 7(4))
1f death
occurs more than three years after the gift, taper relief ensures that only a
percentage of the death rate is charged. The tapering percentages are as
follows:
(1) where
the transfer is made more than three but not more than four years before the death, 80%;
(2) where
the transfer is made more than four but not more than five years
before
the death, 60%;
(3) where
the transfer is made more than five but not more than six years
before
the death, 40%; and
(4) where
the transfer is made more than six but not more than seven years before the
death, 20%.
EXAMPLE
30.8
Danaos
settles £335,000 on discretionary trusts in July 2003 (IHT is paid by
the trustees). He dies:
(1) on 1
January 2005
or (2) on 1 January 2009
or (3) on i January 2011.
The
original transfer in 2003 was subject to IHT at one half of rates in force for
2003-04 (see Table at [30.21]).
In (1) he
dies within three years of the gift: accordingly, a charge at the full tax
rates for 2004-05 must be calculated, tax paid in 2003 deducted, and any
balance is then payable.
In (2) he
dies more than five but less than six years after the gift: therefore only 40%
of the full amount of tax on death is to be calculated, the tax paid in 2003
deducted, and the balance (if any) is then payable. [*715]
In (3)
death occurs more than seven years after the transfer and therefore no
supplementary tax is payable.
If it is
assumed that the current rates of IHT apply throughout this period, the actual
tax computations are as follows (assuming that the 2003 transfer was the first
chargeable transfer of Danaos):
(a) IHT
on the 2003 chargeable transfer is as follows:
first
£ 285,000 - nil
Remaining
£ 50,000 at 20% - £10,000
total IHT
payable by the trustees is therefore £10,000.
(b) If
death occurs within three years: tax on a transfer of £ 335,000 at
the then death rates is:
first
£285,000 - nil
remaining
£50,000 at 40% - £20,000
Total IHT
is therefore £20,000 which after deducting the sum paid in 2003
(10,000), leaves a further £10,000 to be paid.
(c) If
death occurs in 2009 the calculation is as follows: (j) full IHT at death rates
£20,000 (as in (b) above) (ii) take 40% (taper relief) of that tax:
£20,000 x 40% = £8,000
(iii) as
that sum is less than the tax actually paid in 2003 there is no extra IHT to
pay.
It should
be noted in Example 30.8 that even though the result of taper relief may be to
ensure that extra IHT is not payable because of the death, it does not lead to any refund of the original IHT
paid when the chargeable transfer was made: in such cases the taper relief is
inapplicable, see IHTA 1984 s 7(5).
(The assumption in Example 30.8 that rates of tax remain unchanged is, of
course, unrealistic since the IHT rate bands are linked to rises in the RPI.) Taper relief is
moreover of no benefit if the gift fell within the
donor's nil rate band since, although using up all or part of that band, no tax
is actually paid and taper relief operates by reducing the tax payable
(contrast taper relief for CGT purposes: see Chapter 20). [30.23]
b) Fall
in value of gifted property
If the
property given falls in value by the date of death, the extra IHT is calculated
on that reduced value (IHTA 1984 s 131). This relief is not available in the
case of tangible movables that are wasting assets and there are special rules
for leases with less than 50 years unexpired.
EXAMPLE
30.9
In Year 1
Dougal gave a Matisse figure drawing worth £335,000 to his
discretionary trustees (who paid the IHT). He died in Year 3 when the Matisse
was worth only £292,000.
(1)
Assuming it was Dougal's first chargeable transfer, IHT paid on the Year 1 gift
was £10,000 (335,000 - £285,000) x 20%.
(2) IHT
on death (assume rates unchanged) is calculated on £292,000 =
£2,800.
Hence
extra IHT payable is nil.
Had the
property been sold by the trustees before Dougal's death for £43,000
less than its value when given away by Dougal the extra (death) IHT would be
charged on the sale proceeds with the same result as above. If, however,
the [*716] property had been given away by the
trustees before Dougal's death, even though its value might at that time have
fallen by £43,000 since Dougal's original gift, no relief is given,
with the result that the extra charge caused by Dougal's death will be levied
on the full £335,000.
The value
of a chargeable lifetime transfer for cumulation purposes is not reduced in the seven-year period since s
131 merely reduces the value that is taxed (not the value cumulated) whilst
taper relief is given in terms of the rate of IHT to be charged on that
transfer. Hence the full value of the life transfer remains in the cumulative
total of the transferor and there is no reduction in the tax charged on his
death estate. [30.24]
2 PETs
made within seven years of death
The PET
becomes a chargeable transfer and is subject to IHT in accordance with the
taxpayer's cumulative total at the date when it was made (ie taking into
account chargeable transfers in the preceding seven years). The value
transferred is frozen at the date of transfer unless the property has fallen in
value by the date of death in which case the lower value is charged (the rules
concerning the fall in value of assets are the same as those considered at
[30.24]).
Despite
these provisions, which look back to the actual date of the transfer of value,
the IHT is calculated by reference to the rates in force at the date of death
unless those rates have increased in which case the rates at the time of the
transfer are taken (subject to taper relief, as above). [30.25]
EXAMPLE
30.10
In
October 2002 Zanda gave a valuable doll (then worth £310,000) to her
granddaughter Cressida. She died in July 2006 when the value of the doll was
£287,000. Assuming that Zanda had made no other transfers of value
during her life, ignoring exemptions and reliefs, the IHT consequences are:
(1) The
2002 transfer was potentially exempt. However, as Zanda dies within seven years it is made chargeable.
(2) As
the asset has fallen in value by the date of death IHT is charged on the reduced value, ie on £287,000.
(3) IHT
at the rates current when Zanda died is: first
£285,000 = nil next
£2,000 at 40% = £800 Total
IHT = £800.
(4) Taper
relief is, however, available since Zanda died more than three years after the
gift. Therefore:
£800
x 80% (taper relief) = £640.
Note: Although IHT is calculated by
reference to the reduced value of the asset, for cumulation purposes (and for
CGT purposes) the original value transferred (f310,000) is retained.
3
Position where a combination of PETs and chargeable transfers have been made
within seven years of death
PETs are
treated as exempt transfers unless the transferor dies within the following
seven-year period. Accordingly, they are not cumulated in calculating IHT on
subsequent chargeable transfers. Consider the following illustration:
How to
calculate the IHT bill on death 717
EXAMPLE
30.11
In July
1999 Planer gives shares worth £287,000 to his son.
In April
2003 he settles land worth £295,000 on discretionary trusts and pays
the IHT himself (so that grossing-up applies: see [28.124]).
He dies
in February 2004. (Assume no other transfers of value were made by Planer;
ignore exemptions and reliefs; current IHT rates apply throughout.)
(1) The
transfer in 1999 was a PET.
(2) In
calculating the IHT on the chargeable transfer in 2003 the PET is ignored and
IHT is £2,000 ([£295,000-£285,000] x 20%).
The
chargeable transfer in 2003 is therefore £297,000 (£295,000
+ £2,000).
(3) As a
result of his death within seven years the PET is made chargeable and the IHT
calculation is as follows:
(a) On
the 1999 transfer lHT at the rates when Planer died is subject to 60% taper
relief (gifts more than four, less than five years before death). Hence IHT at
death rates is:
first
£285,000 - nil
next,
£2,000 (£287,000 - £285,000) at 40% =
£800 Taper relief at 60%:
£800
x 60% = £480 (tax due on 1999 transfer)
Note: Primary liability for this tax
falls upon the donee (see [30.27]). Grossing-up does not apply when IHT is
charged, or additional tax is payable, because of death.
(b) On
the 2003 transfer IHT must be recalculated on this transfer since the
transferor has died within seven years, and the former PET must be included in
the cumulative total of Planer at the time when this transfer was made. Hence:
(i)
cumulative transfers of Planer in 2003 = £287,000
(ii)
value transferred in 2003 = £297,000
(iii) IHT
at death rates on transfers between £287,000 and £584,000
is £297,000 x 40% = £118,800
Taper
relief is not available on this transfer since Planer dies within three years.
Therefore:
deduct
IHT paid in 2003:
£118,800-2,0O0
= £116,800
Additional
IHT payable on the 2003 transfer is £116,800
Note: The cumulative total of
transfers made by Planer at his death (which will affect the IHT payable on his
death estate) is £584,000.
The
following diagram illustrates how seven-year cumulation operates for PETs and
chargeable transfers (CTs) made within seven years of a death occurring on 1
June 2003:
When a
PET is made after an earlier chargeable transfer and the transferor dies in the
following seven years, tax on that PET will be calculated by including the
earlier transfer in his cumulative total. In this sense the making of the PET
means that there is no reduction in his cumulative total for a further seven
years and the result is that IHT could eventually turn out to be higher than if
the PET had never been made ('the PET trap'!). [30.26]
EXAMPLE
30.12
Yvonne
made a chargeable transfer of £285,000 on 1 May 1995 and on 1 May
2001 made a gift of £330,000 to take advantage of the PET regime.
Unfortunately, she dies after I May 2002 (when the 1995 transfer drops out of
cumulation) but before 1 May 2004 (when taper relief begins to operate on the
PET). [*718]
.
Limit of
Death
.
7 years <-> 7-year
death <-> 1.6.03
.
1.6.96 aggregation
.
|
Aggregate
.
PETs made |
chargeable
.
on or before
| transfers
.
this date |
over previous
.
treated | 7
years
.
|
. Chargeable
|
. transfer
Failed
. 3.6.93
PET
Limit
<------------------------->1.11.99
1.11.92
(1) IHT
on the former PET (at current rates) is £134,000 since the 1995
transfer forms part of \zonne's cumulative total at the time when the PET was
made in 2001. Tax on the death estate will then be calculated by including the
2001 transfer (the former PET) in Wonne's cumulative total.
(2) Had
Yvonne not made the 2001 PET so that £330,000 formed part of her
death estate, tax thereon (ignoring the 1995 transfer that has dropped out of
cumulation) is £18,000.
Extra IHT
resulting from the making of the PET is therefore £134,000 -
£18,000 = £116,000.
4
Accountability and liability for IHT on lifetime transfers made within seven
years of death
The donee
of a PET which becomes chargeable by virtue of the subsequent death of the
transferor must deliver an account to HMRC within 12 months of the end of the
month of death (IHTA 1984 s 216(1)(bb): PRs of the deceased must also report
such transfers, see s 216(3)(b)). Tax itself is payable six months after the
end of the month of death and interest on unpaid IHT runs from that date. There
is no question of interest being charged from the date of the PET. Primary
liability for the tax is placed upon the transferee although HMRC may also
claim the IHT from any person in whom the property is vested, whether beneficially
or not, excluding, however, a purchaser of that property (unless it was subject
to an HMRC charge for the tax owing: see generally [28.171]).
To the
extent that the above persons are not liable for the IHT or to the extent that
any tax remains unpaid for 12 months after the death, the deceased's PRs may be
held liable (IHTA 1984 s 199(2)). An application for a certificate of discharge
in respect of IHT that may be payable on a PET may not be made before the
expiration of two years from the death of the transferor (except where the
Board exercises its discretion to receive an earlier application). If the
property transferred qualified for the instalment [*719] option
(see [28.174]) the tax resulting from death within seven years may be paid in
instalments if the douce so elects and provided that he still owns qualifying
property at the date of death (IHTA 1984 s 227(1A)).
So far as
additional tax on chargeable lifetime transfers is concerned the same liability
rules apply. Primary liability rests upon the donee.although the deceased's PRs
can be forced to pay the tax in the circumstances discussed above.
The
problems posed for PRs by this contingent liability for IHT on PETs and inter
vivos chargeable
transfers are considered at [30.49].
[30.27]
5
Calculating IHT on the death estate
Having
considered the treatment of PETs and the additional IHT on lifetime transfers
that may result from the death of the transferor, it is now necessary to
consider the taxation of the death estate (which includes property subject to a
reservation and settled property in which the deceased was the life tenant). To
calculate the IHT the following procedure should be adopted:
Step 1 Calculate total chargeable death
estate; ignore, therefore, exempt transfers (eg to a spouse) and apply any
available reliefs (eg reduce the value of relevant business property by the
appropriate percentage).
Step
2Join the IHT table at the point reached by the deceased as a result of
chargeable transfers made in the seven years before death. This cumulative
total must include both transfers that were charged ab initio and PETs brought
into charge as a result of the death.
Step 3
Calculate death
IHT bill.
Step 4 Convert the tax to an average or
estate rate--ie divide IHT (Step 3) by total chargeable estate (arrived at in Step
1) and multiply
by 100 to obtain a percentage rate. It is then possible to say how much IHT
each asset bears. This is necessary in cases where the IHT is not a
testamentary expense but is borne by the legatee or by trustees of a settlement
or by the donee of property subject to a reservation (see [30.47]). If the
deceased had exhausted his nil rate band as a result of lifetime transfers made
in the seven years before death, his death estate will be subject to tax at a
rate of 40% which will be the estate rate.
EXAMPLE
30.13
Dougal
has just died leaving an estate valued after payment of all debts etc at
£285,000. A picture worth £10,000 is left to his daughter
Diana (the will states that it is to bear its own IHT) and the rest of the
estate is left to his son Dalgleish. Dougal made chargeable transfers in the
seven years preceding his death of £100,000. To calculate the IHT on
death: (1) Join the death table at £100,000 (lifetime cumulative total).
(2) Calculate IHT on an estate of £285,000:
. £
£100,000
x 0%
0
£100,000
x 40%
40,000
.
------
.
£40,000
[*720]
(3)
Calculate the estate rate:
£40,000
(IHT)
-----------------
x 100=14.04
£285,000
(Estate)
(4) Apply
estate rate to picture (je 14.04% x £10,000) = £1,404. This
sum is payable by Diana.
(5)
Residue (275,000) is taxed at 14.04% = £38,610. The balance is paid
to Daigleish.
Property
subject to a reservation and settled property in which the deceased had enjoyed
an interest in possession at the date of death is included in the estate in
order to calculate the estate rate of tax. The appropriate tax is, however,
primarily the responsibility of the donee and the trustees. The IHT position on
death can be represented as follows:
[30.28]-[30.40]
|
(up to 40%) Death estate
|
(including
|
property
|
subject to
|
reservation
|
-------------------
|
Total of chargeable
| cumulate
|
transfers (including
| in 7 years
|
0% former PETS)
| before death
III
PAYMENT OF IHT-INCIDENCE AND BURDEN
If the
deceased was domiciled in the UK at the time of his death, IHT is chargeable on
all the property comprised in his estate whether situated in the UK or abroad.
If he was domiciled elsewhere, IHT is only chargeable on his property situated
in the UK. (For the meaning of domicile in this context, see 35.4].) [30.41]
1 Who
pays the IHT on death?
a) Duty
to account
The
deceased's PRs are under a duty to deliver to HMRC within 12 months of the end
of the month of the death an account specifying all the property that formed
part of the deceased's estate immediately before his death and including
property:
(1) in
which the deceased had a beneficial interest in possession (eg where the
deceased was the life tenant under a settlement); and
(2)
property over which he had a general power of appointment (this property is
included since such a power enabled the deceased to appoint himself the owner
so that in effect the property is indistinguishable from property owned by him
absolutely). [*721]
In
practice, the PRs will deliver their account as soon as possible because they
cannot obtain probate and, therefore, administer the estate until an account
has been delivered and the IHT paid; further, they must pay interest on any IHT
payable on death and which is unpaid by the end of the sixth month after the
end of the month in which the deceased died (for instance, a death in January
would mean that IHT is due before 1 August and, thereafter, interest is
payable). [30.42]
b) Estimated
values and penalties: the Robertson case
The
practice of sending in provisional valuations in order to obtain a grant of
representation has been noted at [30.12]. IHTA 1984 s 216(3A) is in the
following terms:
'If the
personal representatives, after making the fullest enquiries that are
reasonably practicable in the circumstances, are unable to ascertain the exact
value of any particular property, their account shall in the first instance be
sufficient as regards that property if it contains--
(a) a statement
to that effect;
(b) a
provisional estimate of the value of the property; and
(c) an
undertaking to deliver a further account of it as soon as its value is ascertained.'
In Robertson
V IRC (2002) the
executor wished to obtain an early grant of representation in order to sell the
deceased's house in Scotland. In his JilT calculation he estimated a value for
the deceased's personal chattels at £5,000 (subsequently valued at
£24,845) and for a property in England at £50,000 (subsequently
valued at £315,000). The Revenue considered that the return had been
prepared negligently and that a penalty of £9,000 was due (see IHTA
1984 s 247). Corrective valuations were submitted within six months of the
deceased's death so this was not a case where there had been any loss of tax
and nor was any interest payable. A Special Commissioner decided that no
penalty was payable and the following matters may be noted:
(1) The
executor had acted in accordance with standard practice and with common sense.
(2) The
values were clearly marked as estimates and corrective accounts submitted.
(3) There
was a need to obtain the grant as a matter of urgency.
(4) A
penalty is only payable if an incorrect account has been negligently produced
and the exeuctor had not been negligent.
(5) In
the subsequent decision, Robertson v IRC (No 2) (2002), the costs of the Commissioners'
hearing were awarded against the Revenue on the basis that it had acted 'wholly
unreasonably' in connection with the hearing.
In cases
where a grant is required urgently and the PRs are in difficulties in
completing the IHT account, a helpline is available and HMRC may then confirm
its acceptance of estimated values.
[30.43]
e) 'Excepted
estates' (SI 2002/1733 amended by SI 2003/1658)
No
account need be delivered in the case of an 'excepted estate'. [*722]
The
taxpayer must die domiciled in the UK; must have made no chargeable lifetime
transfers other than 'specified transfers' where the value did not exceed
£75,000; must not have been a life tenant under a settlement; his
death estate must not include property subject to a reservation and he must not
have owned at death foreign property amounting to more than £50,000.
Subject thereto the estate will be excepted if the gross value at death does
not exceed £240,000. This figure takes account of all property
passing under the will or intestacy; of nominated property; and, in cases where
the deceased had been a joint tenant of property, the value of the deceased's
share in that property.
HMRC
reserves the right to call for an account (on Form 204) within 35 days of the issue of a grant of probate, but if
it does not do so, the PRs are then automatically discharged from further
liability. [130.44]
d) IHT
form
In cases
other than c) above, to obtain a grant the PRs must submit an HMRC account (an
IHT Form).
From 2
May 2000 a new HMRC account for estates was introduced
comprising
a basic eight-page form together with supplementary pages that, will only need
to be completed if they are relevant to that estate. The new form replaced old
Forms 200, 201 and 202. [30.45]
e) Liability
for IHT (IHTA 1984 Part VII)
Personal
representatives PRs must pay the IHT on assets owned beneficially by the
deceased at the time of death and on land comprised in a settlement which vests
in them as PRs. Their liability is personal, but limited to assets which they
received as PRs or might have received but for their own neglect or default
(IHTA 1984 s 204 and see IRC v Stannard (1984) which establishes that overseas PRs or
trustees may find that their personal UK assets are seized to meet that
liability). [30.46]
Other
Persons If tile PRs fail to pay the IHT other persons are concurrently liable,
namely:
(1)
Executors de son tort, ie persons who interfere with the deceased's property so
as to constitute themselves executors. Their liability is limited to the assets
in their hands (see IRC v Stype Investments (Jersey) Ltd (1982)).
(2)
Beneficiaries entitled under the will or on intestacy in whom the property
becomes vested after death. Their liability is limited to the property that
they receive.
(3) A
purchaser of real property if an HMRC charge is registered against that
property. His liability is limited to the value of the charge.
(4) Any
beneficiary entitled to an interest in possession in the property after the
death. Liability is generally limited to the value of that property.
[30.47]
Trustees
Where the deceased had an interest in possession in settled property at the
date of his death, it is the trustees of the settlement who are liable for [*723] any IHT on the settled property to the extent that they
received or could have received assets as trustees. Should the trustees not pay
the tax, the persons set out in (3) and (4) above are concurrently liable.
[30.48]
Contingent
liability of PRs In three cases PRs may incur liability to IHT if the persons
primarily liable (the douces of the property) have reached the limits of their
liability to pay or if the tax remains unpaid for 12 months after the death.
These occasions are, first, when a lifetime chargeable transfer is subject to
additional IHT because of the death; secondly, if a PET is brought into charge
because of the death; and thirdly if the estate includes property subject to a
reservation. The following example illustrates the type of problem that may
arise:
EXAMPLE
30.14
Mort dies
leaving an estate (fully taxed) of £635,000. The PRs are unaware of
any lifetime gifts and, therefore, pay IHT of £140,000 and distribute
the remainder of the estate. Consider the following alternatives:
(1) After
some years a lifetime gift by Mort of £275,000, which had been made
six years before his death and was potentially exempt when made, is discovered.
Although no IHT is chargeable on that gift the PRs are accountable for extra
IHT on the death estate of £110,000; or
(2) A
gift of £1,000,000 made one year before Mort's death is discovered.
In this case not only will the PRs be accountable for extra IHT of
£110,000 as above but in addition if the donee fails to pay IHT on
the £1,000,000 gift the PRs will be liable to pay that IHT (limited
to the net assets in the estate which have passed through their hands).
Contingent
liabilities present major problems for PRs and the following matters should be
noted:
(1) Their
liability may arise long after the estate has been fully administered and
distributed (eg a PET may be discovered which is not only itself taxable but
also affects the charge on subsequent lifetime chargeable transfers and on the
death estate). It may therefore be desirable for PRs to obtain suitable
indemnities from the residuary beneficiary before distributing the estate
although such personal indemnities are of course always vulnerable (eg in the
event of the bankruptcy of that beneficiary).
(2) The
liability of PRs is limited to the value of the estate (as discussed above).
However, even if IHT has been paid on the estate and a certificate of discharge
obtained they are still liable to pay the further tax that may arise in these
situations.
(3) If
PRs pay IHT no right of recovery is given in IHTA 1984 against donees who were
primarily liable except in the case of reservation of benefit property (in this
situation s 211(3) affords a right of recovery), although such a right may
exist as a matter of general law (see Private Client Business (1998) p 58).
There is, of course, nothing to stop a donor taking an indemnity from his douce
to pay any future IHT as a condition of making the PET. Such an arrangement
would be expressed as an indemnity in favour of his estate and does not involve
any reservation of benefit in the gifted property. As noted above, [*724] personal indemnities are, of course, vulnerable in the event
of the bankruptcy or emigration of the donee.
(4) It
will not be satisfactory for PRs to retain estate assets to cover the danger of
a future tax liability. Apart from being unpopular with beneficiaries there is
no guarantee that PRs will retain an adequate sum to cover tax liability on a
PET which they did not know had been made: only by retaining all the assets in
the estate will they be wholly protected!
(5)
Insurance would seem to be the obvious answer to these problems. PRs should
give full information on matters within their knowledge and then seek cover (up
to the limit of their liability) in respect of an unforeseen Il-IT liability
arising. It would seem reasonable for testators to give expressly a power to
insure against these risks. It is understood that cover can be arranged on an
individual basis in such cases.
Limited
comfort to PRs is afforded by a letter from the Inland Revenue to the Law
Society dated 11 February 1991 which states:
'The
Capital Taxes Office will not usually pursue for inheritance tax personal
representatives who
- after
making the fullest enquiries that are reasonably practicable in the
circumstances to discover lifetime transfers, and so
- having
done all in their power to make full disclosure of them to the Board of Inland Revenue
- have
obtained, a certificate of discharge and distributed the estate before a
chargeable lifetime transfer comes to light.
This
statement ... is made without prejudice to the application in an appropriate
case of s 199(2) Inheritance Tax Act 1984.' [30.49]
Land In
addition to persons who are liable for IHT on death, real property (including a
share in land under a trust for sale) is automatically subject to an HMRC
charge from the date of death until the date when the IHT is paid (IHTA 1984 s 237(1)(a)
and see Howarth's Executors v IRC (1997)).
[30.50]
f) Payment
of tax: the instalment option (IHTA 1984 ss 227, 8)
To obtain
a grant of representation, PRs must pay all the IHT for which they are liable
when they deliver their account to HMRC.
However,
in the case of certain property the tax may, at the option of the PRs, be paid
in ten-yearly instalments with the first instalment falling due six months
after the end of the month of death. The object of this facility is to prevent
the particular assets from having to be sold by the PRs in order to raise the
necessary IHT.
The
instalment option is available on the following assets:
(1) land,
freehold or leasehold, wherever situate;
(2)
shares or securities in a company which gave the deceased control of that
company ('control' is defined as voting control on all questions affecting the
company as a whole);
(3) a
non-controlling holding of shares or securities in an unquoted company (ie a
company which is not quoted on a recognised Stock Exchange) where HMRC is
satisfied that payment of the tax in one lump sum would cause 'undue
hardship'; [*725]
(4) a
non-controlling holding as in (3) above where the tax on the shares or
securities and on other property carrying the instalment option comprises at
least 20% of the tax due from that particular person (in the same capacity);
(5) other
non-controlling shareholdings in unquoted companies, where the value of the
shares exceeds £20,000 and either their nominal value is at least 10%
of the nominal value of all the issued shares in the company, or the shares are
ordinary shares whose nominal value is at least 10% of the nominal value of all
ordinary shares in the company; and
(6) a
business or a share in a business, eg a partnership share.
An added
attraction of paying by instalments is that, generally, no interest is charged
so long as each instalment is paid on the due date. In the event of late
payment the interest charge is merely on the outstanding instalment.
Interest
is, however, charged on the total outstanding IHT liability (even if the
instalments are paid on time) in the case of land that is not a business asset and shares in investment companies.
If the asset subject to the instalment option is sold, the outstanding
instalments of IHT become payable at once. Note that the definition of
'qualifying property' for these purposes is not subject to the same limitations
as business property relief with regard to investment businesses and excepted
assets: see [31.58]. [30.51]
Exercising
the option: cash/low benefit If the instalment option is exercised the first
instalment is, as already mentioned, payable six months after the month of
death. Hence, PRs will normally exercise the option in order to pay as little
IHT as possible before obtaining the grant. Once the grant has been obtained
they may then discharge the IHT on the instalment property in one lump sum. PRs
should, however, bear in mind that some IHT will usually be payable before the
grant. The necessary cash may be obtained from the deceased's account at either
a bank or a building society (building societies, in particular, will commonly
issue cheques to cover the initial inheritance tax payable); from the sale of
property for which a grant is not necessary; or by means of a personal loan
from a beneficiary. If a loan has to be raised commercially, the interest
thereon will qualify for income tax relief for 12 months from the making of the
loan so long as it is on a loan account (not by way of overdraft) and is used
to pay the tax attributable to personal property (including leaseholds and land
held on trust for sale: TA 1988 s 364).
Alter the
grant has been obtained, if the remaining tax is not paid off at once, PRs may
vest the asset in the relevant beneficiary on the understanding that he will
discharge the unpaid instalments of tax. Adequate security should, however, be
taken in such cases because if the beneficiary defaults, the PRs remain liable
for the outstanding IHT (see Howarth s Executors v IRC (1997)). In the case of a
specific gift which bears its own IHT and that qualifies for the instalment
option, the decision whether to discharge the entire IHT bill once probate has
been obtained should be left to the legatee. PRs should not make a unilateral
decision (see further [30.56]). [30.52]
Certificates
of discharge Once PRs have paid all the outstanding IHT they are entitled to a
certificate of discharge under IHTA 1984 s 239(2). [30.53] [*726]
Instalments
on chargeable lifetime transfers As already
discussed, the instalment option may also be available when a chargeable inter
vivos transfer is made (see [28.174]) and when LHT becomes payable on a PET or
additional IHT on a chargeable transfer. In these situations, however, further
requirements must be satisfied before the option can be claimed. The donee must
have retained the original property or, if it has been sold, have used the
proceeds to purchase qualifying replacement property (for a discussion of these
requirements in the context of business relief see [31.59]). Further, when the
property consisted of unquoted shares or securities those assets must remain
unquoted from the date of transfer to the date of death (IHTA 1984 s
227(1A)). [30.54]
2
Allocating the burden of IHT
a) The
general rule
HMRC is
satisfied once the IHT due on the estate has been paid. As far as the PRs and
beneficiaries under the will are concerned, the further question arises as to
how the tax should be borne as between the beneficiaries: eg should the tax
attributable to a specific legacy be paid out of the residue as a testamentary
expense or is it charged on the property (the specific legacy)? The answer is
particularly important when specific legacies are combined with exempt or
partially exempt residue, since, if the IHT is to be paid out of that residue,
the grossing-up calculation under IHTA 1984 s 38 (see [30.96]) will be
necessary and will result in more IHT being payable. [30.55]
b) Impact
on will drafting
As a
general rule, a testator can, and should, stipulate expressly in his will where
the IHT on a specific bequest is to fall. If the will makes no provision for
the burden of tax, the general principle is that IHT on UK unsettled property
is a testamentary expense payable from residue. Under the estate duty regime
land had, in such cases, borne its own duty, but the Scottish case of Re
Dougal (1981)
decided that the IHT legislation drew no distinction between realty and
personalty and the matter was put beyond doubt by IHTA 1984 s 211.
EXAMPLE
30.15
In
Lyslie's will his landed estate is left to his son and his stocks and shares to
his daughter. The residue is left to his surviving spouse. In addition he owned
a country cottage jointly with his brother, Ernie.
(1) IHT
on the specific gifts of the land and securities is borne by the residue in the
absence of any provision to the contrary in Lyslie's will. Note that the spouse
exemption therefore only applies to exempt from charge what is left after the
payment of IHT on the specific gifts.
(2) IHT
on the joint property is paid by the PRs who are given the right to recover
that tax from the other joint tenant(s): IHTA 1984 s 211(3).
In
drafting wills and administering estates the following matters should be borne in mind: [*727]
(1) When
drafting a new will, expressly state whether bequests are tax-bearing or are
free of tax.
(2) Old
wills which have been drawn up but are not yet in force should be checked to
ensure that provision has been made for the payment of IHT on gifts of realty.
The will may have been drafted on the assumption that such gifts bear their own
tax in which case amendments will be necessary.
(3) IHT
on foreign property and joint property will always be. borne by the beneficiary
unless the will provides to the contrary. If the will provides for a legacy to
be 'tax free' these words are likely to be limited to UK tax: accordingly if it
is intended that the estate should also pay any foreign taxes an express
statement to that effect needs to be included (see re Norbury (1939)).
Assuming
that the will contains a specific tax-bearing legacy, how will the IHT, in
practice, be paid on it? As the PRs are primarily liable to HMRC for the IHT,
they will pay that tax in order to obtain probate and either deduct it from the
legacy (eg if it is a pecuniary legacy) or recover it from the legatee. For
specific legacies of other property (eg land or chattels), the. PRs have the
power to sell, mortgage or charge the property in order to recover the tax. If
they instead (usually at the legatee's request) propose to transfer the asset
to him, they should ensure that they are given sufficient guarantees that the
tax will be refunded to them. Where the PRs pay IHT that is not a testamentary
expense (ie on all tax-bearing gifts; joint property and foreign property),
they have a right to recover that sum from the person in whom the property is
vested (IHTA 1984 s 211(3)).
[30.56]
c) IHTA
1984 s 41; Re Benham 's Will Trusts and Re Ratcliffe
IHTA 1984
s 41 As a qualification to the general rules stated above, a chargeable share of
residue must always bear its own tax so that the burden of tax cannot be placed
on an exempt slice of residue and any provision to the contrary in a will is
void (IHTA 1984 s 41). [30.57]
The
Benham case The implications of IHTA 1984 s 41 in the context of a will
containing both chargeable and exempt gifts of residue were considered in Re
Benham's Will Trusts, Lockhart v Harke Read and the Royal National Lifeboat
Institution
(1995) in which residue was left as follows:
(1) upon
trust to pay debts, funeral and testamentary expenses;
(2)
subject thereto 'to pay the same to those beneficiaries as are living at my
death and who are listed in List A and List B hereunder written in such
proportions as will bring about the result that the aforesaid beneficiaries
named in List A shall receive 3.2 times as much as the aforesaid beneficiaries
named in List B and in each case for their own absolute and beneficial use and
disposal'.
List A
contained one charity and a number of non-charitable beneficiaries; and List B
contained a number of charities and non-charitable beneficiaries.
By an
originating summons, the executor asked whether, in view of IHTA 1984 s 41 and
the terms of the will, the non-charitable beneficiaries should receive their
shares subject to IHT, or whether their shares should be grossed up.
On this
question, there were three theoretical possibilities: [*728]
(1) the
non-charitable beneficiaries received their respective shares subject to IHT,
which would mean that they would receive less than the charities; or
(2) the
non-charitable beneficiaries should have their respective shares grossed up, so
that they received the same net sum as the charities; or
(3) the
IHT was paid as part of the testamentary expenses under
clause
3(A), so that the balance was distributed equally between the non-charitable
beneficiaries and the charities.
The court
agreed that the third possibility was precluded by s 41. However, it did not
agree that the charities should receive more than the non-charitable beneficiaries.
The plain intention of the testatrix was that each beneficiary, whether
charitable or non-charitable, should receive the same as the other
beneficiaries on the relevant list. The court therefore concluded that the
non-charitable beneficiaries' shares should be grossed up. [30.58]
The
available options In analysing the effect of this case, consider an estate of
£100,000 to be divided between wife and daughter (although remember
that the problem arises whenever residue is divided between exempt and
chargeable beneficiaries: for instance, between relatives on the one hand and a
charity on the other).
EXAMPLE
30.16
Net
residue of £100,000 to be divided equally between surviving spouse
and daughter. Estate rate 40%.
(1)
Option 1: deduct tax on £50,000 and divide balance (fSO,000) equally;
prohibited by s 41.
(2)
Option 2: divide equally so that spouse gets £50,000 and daughter's
£50,000 then bears tax so that she ends up with £30,000.
(3)
Option 3: gross up daughter's share so that both end up with the same:
ie x +
(100/60) x = £100,000
x =
£37,500
Both
receive £37,500; gross value of daughter's share is
£62,500.
.
Spouse (£)
Daughter (£) Tax
man (£)
Option
1 40,000
40,000 20,000
Option
2 50,000
30,000 20,000
Option
3 37,500
37,500 25,000
The
difficulty posed by Benham lies in the court's assertion that:
'the
plain intention of the testatrix is that at the end of the day each
beneficiary, whether charitable or non-charitable, should receive the same as
the other beneficiaries On one view the case therefore depends upon its own
facts and, in particular, on the wishes of the testatrix. However, the ready
inclusion (as a matter of construction) of a grossing-up clause in all cases
where:
(1) the
residue is left to exempt and non-exempt beneficiaries;
(2) the
will provides for them to take in equal shares and there is no evidence that
the testator did not intend Benham to apply; and
(3) the
value of the estate is such that IHT is payable on the chargeable portion of
residue; would have gone against the existing practice which had been to apply
s 41 (Option 2, in Example 30.16 above) in such cases. [30.59]
Will
drafting after Benham It is important that the whole matter is explained to the
testator (with a suitable example to illustrate the fiscal and other
consequences of the grossing-up route) and that the will is then drafted either
to provide for a division of residue into shares before imposing the tax
liability or to incorporate a grossing-up clause. The drafting should make it
clear whether Option 2 or Option 3 is being adopted. [30.60]
The Ratcliffe case Re Ratcliffe (1999) was
brought as a test case to resolve the problems which had resulted from the Benham decision. The testatrix left some
£2.2m to be divided in accordance with the following residue clause:
'4 I give
devise and bequeath all my real and personal estate whatsoever and wheresoever
not hereby otherwise disposed of unto my Trustees upon trust to sell and
couvert the same into money with power at their absolute discretion to postpone
any such sale and conversion for so long as they shall think fit without being
answerable for any loss and after payment thereout of my debts and funeral and
testamentary expenses to stand possessed of the residue as to one-half part
thereof for John Hugh McMullan and Edward Browniow McMullan (the sons of my
cousin Helen McMullan) in equal shares absolutely ... and as to the remainder
of my estate upon trust for the following Charities in equal shares ...'
If Option
2 in Example 30.16 above were followed the charities would receive
£1.12m; the chargeable beneficiaries £720,000 and tax
payable would be £400,000; if Option 3, the charities and chargeable
beneficiaries would each share £870,000 and the IHT would rise to
£500,000.
Blackburne
J indicated that the matter turned on a true construction of the will that, in
this case, pointed to the intention to divide equally the residuary estate
including the tax attributable to the chargeable beneficiaries' share (ie the
Option 2 approach). He accepted that a will could result in grossing-up the
chargeable beneficiaries' share (ie Option 3) but 'much clearer wording would
be needed than the common form wording actually used'. He dismissed the
decision (and comments of the judge) in Benham as follows:
'If I had
thought that Re Benham's Will Trusts laid down some principle, then, unless
convinced that it was wrong, I would have felt that I should follow it. I am
not able to find that it does and, accordingly, I do not feel bound to follow
it'. Although the case was set down for appeal, a compromise was agreed. [30.61]
Administering
estates after Rcztcl([fe In cases where the will does not put the matter beyond
doubt practitioners are now faced with two conflicting decisions, Ben ham and
Ratc4ffe. Of the two, the latter is to be preferred given that the judge
carefully reviewed all the authorities including Benham: that case had
involved, of course, a most obscurely drafted will and the wide dicta on
grossing-up were not relevant to the case itself. [30.62] [*730]
3 Cases
where IHT has to be recalculated
In a
limited number of instances IHT paid on a deceased's estate will need to be
recalculated. [30.63]
Cases
where sale proceeds are substituted for the death valuation (see [30.71.)
[30.64]
As the
result of a variation or disclaimer Such instruments, if made within two years
of the death, may be read back into the original will which may necessitate a
recalculation of the tax payable (see [30.153]). [30.65]
Discretionary
will trusts If the conditions of IHTA 1984 s 144 are satisfied, tax is
calculated as if the testator had provided in his will for the dispositions of
the trustees (see [30.145]).
[30.66]
Orders
under the Inheritance (Provision for Family and Dependants) Act 1975 When the
court exercises its powers under s 2 of the 1975 Act to order financial
provision out of the deceased's estate for his family and dependants, the order
is treated as made by the deceased and may result in there having been an
under- or overpayment of IHT on death. Any application under this Act should
normally he made within six months of the testator's death, so that the PRs
will have some warning that adjustments to the IHT bill may have to be made.
Further adjustments to the tax bill may be required if the court makes an order
under s 10 of the Act reclaiming property given away by the deceased in the six
years prior to his death with the intention of defeating a claim for financial
provision under the Act. In this case, the deceased's cumulative total of
chargeable lifetime transfers is reduced by the gift reclaimed. This, of
itself, may affect the rate at which tax is charged on the deceased's estate on
death. Also the value of the reclaimed property and any tax repaid on it falls
into the deceased's estate thus necessitating a recalculation of the IHT
payable on death.
These
rules are bolstered up by a somewhat obscure anti-avoidance provision in IHTA
1984 s 29A. It is relevant when there is an exempt transfer on death (eg to the
surviving spouse) and that beneficiary then, in satisfaction of a claim against
the estate of the deceased, disposes of property 'not derived from the death
transfer'. [30.67]-[30.90]
EXAMPLE
30.17
A dies
leaving everything to Mrs A. Dependant B has a claim against A's estate but is
'bought off' by Mrs A making a payment (out of her own resources) of
£150,000.
(1) In the
absence of specific legislation: the arrangement would probably be a PET by Mrs
A to B and so free from IHT provided that Mrs A survived by seven years.
Alternatively it could be argued that there was no transfer of value since the
compromise was a commercial arrangement under IHTA 1984 s 10. No IHT was, of
course, charged on A's death.
(2) Position under s 29A: A's will is deemed
amended to include a specific gift of £150,000 to B with the
remainder (only) passing to Mrs A. Accordingly a recalculation will be
necessary and an immediate IHT charge will arise.
IV
PROBLEMS CREATED BY THE PARTIALLY EXEMPT TRANSFER
1 When do
ss 36-42 apply?
In many
cases the calculation of the IHT bill on death will be straightforward.
Difficulties may, however, arise when a particular combination of dispositions
is made in a will. IHTA 1984 ss 36-42 provide machinery for resolving these
problems with a method of calculating the gross value of the gifts involved
and, accordingly, the IHT payable. Consider, first, a number of instances where
the calculation of the IHT on death poses no special difficulties: [30.91]
Where all
the gifts are taxable A leaves all his property to be divided equally amongst
his four children. In this case the whole of A's estate is charged to IHT. [30.92]
Where all
the gifts are exempt eg A leaves all his property to a spouse and/or a charity.
In this case the estate is untaxed.
[30.93]
Where
specific gifts are exempt and the residue is chargeable eg A leaves
£100,000 to his spouse and the residue of £500,000 to his
children. Here the gift to the spouse is exempt, but IHT is charged on the
residue of £500,000 so that only the balance will be paid to the
children. [30.94]
Where
specific gifts are chargeable and bear their own tax under the terms of the
will and the residue is exempt: eg A leaves a specific tax-bearing gift of
£300,000 to his niece and the residue to his spouse. The spouse
receives the residue after deduction of the £300,000 gift; IHT is
calculated on the £300,000 and is borne by the niece. [30.95]
Where
there are no specific gifts and part of the residue is exempt, part chargeable
eg A leaves his estate to be divided equally between his son and his spouse. As
already discussed the chargeable portion of residue must always bear its own
tax; any provision in the will to the contrary is void (LIITA 1984 s 41: see
[30.57]).
There are
bequests where the calculation of the IHT is not so obvious and it becomes
necessary to apply the rules in ss 36-42. Taking the simplest illustration,
consider a will containing a specific gift which is chargeable but does not
bear its own IHT and residue which is exempt, eg A's estate on death is valued
at £630,000 and he leaves £345,000 to his daughter with
remainder to his surviving spouse. As previously explained, the specific gift
of £345,000 will be tax-free unless the will provides to the
contrary. The problem that arises is to decide how much IHT should be charged
on the specific gift and this involves grossing-up that gift. With the
simplified IHT rate structure, grossing-up has become relatively
straightforward and, in the tax year 2006-07, the IHT payable will be
two-thirds of the amount by which the chargeable legacies exceed the available
nil rate band. Hence, assuming that A has an unused nil rate band of
£285,000, tax payable on the daughter's legacy will he two-thirds of
£345,000 - £285,000: ie £40,000. As a result: [*732]
(1) The
gross value of the legacy becomes £385,000 and the daughter receives
the correct net sum of £345,000 after deducting IHT at 40% on the
amount by which the gross legacy exceeds the available nil rate band.
(2) The
£40,000 tax is paid out of the residue leaving the surviving spouse
with £245,000. [30.96]
Business
and agricultural property When business property is specifically given to a
beneficiary that person will benefit from the appropriate relief but in other
cases the benefit of the relief is apportioned between the exempt and
chargeable parts of the estate (IHTA 1984 s 39A). [30.97]
EXAMPLE
30.18
Deceased's
estate is valued at £lm and includes business property (qualifying
for 50% relie!) worth £600,000. He left a £600,000 legacy
to his widow and the residue
to his
daughter.
.
£
Estate
1,000,000
Less: 50% relief on business
property 500,000
Value
transferred
700,000
(1)
Legacy of £600,000 to widow is multiplied by
R (value
transferred) £700,000
U (estate
before relief)
£1,000,000 = £420,000
(2)
Accordingly the value attributed to the residue (given to the daughter) is:
400,000 x
R (£700,000)
= £280,000
. ---
------------
.
U (£1,000,000)
(3) IHT
is therefore charged on £280,000.
Notes:
(1) Had
relief at 100% been available the taxable sum would have been
£160,000.
(2) The
lowest tax bill results if the agricultural or business property is
specifically given to a non-exempt beneficiary. 'Specific gift' is inadequately
defined in IHTA 1984 s 42(1) and the following points may be noted:
(i) an
appropriation of business property in satisfaction of a pecuniary legacy does
not count as a specific gift;
(ii) a
direction to pay a pecuniary legacy 'out of' business property is likewise not
a specific gift of business property (IHTA 1984 s 39A(6));
(iii) it
is possible to employ a formula to leave business property equal in value to
the testator's nil rate band after relief at 50%;
(iv) a
defectively drafted will may be cured by an instrument of variation whereby a
specific gift of business property is 'read hack' into the will.
(3)
Difficulties can be caused if a nil rate band clause is used in a will and the
estate includes business or agricultural property as illustrated in the
following example. [*733]
EXAMPLE
30.19
(1) Jill
leaves an estate valued at £lm that includes a shareholding in a
private company (qualifying for 100% business property relief (BPR)) valued at
£570,000.
If she
leaves the shares to her son Paul by way of specific, gift and residue to her
hissband Jack, no tax is payable.
If she
leaves a cash gift of £570,000 to son Paul (this gift to bear its own
tax) and residue to husband, the son's gift will attract relief at 50% (being
the appropriate part of the business property relief) so its value will reduce
to £285,000. After deduction of the nil rate band the taxable value
is nil.
(2) Jill
instead leaves a will which provides that her son will take 'a cash sum which
is the largest amount that can be given without any Inheritance Tax being
payable on the transfer of value of my estate which I am deemed to make
immediately before my death'. She had anticipated that her son would take
£285,000 (being the amount of the nil rate band legacy) although she
was aware that if she made chargeable lifetime gifts within seven years of her
death, the amount her son would take under the will on her death would be
reduced.
With 100%
BPR, however, the amount which her son will take, assuming her nil rate band is
unused on death, is £570,000 (which will he reduced by its share of
BPR to £285,000, the amount of the nil rate band). The consequence
will be that Jill's husbandJack will receive far less than his wife had
anticipated when the will was drafted. The effect would be even more dramatic
if business property in the estate was worth, say, £800,000. In this
case, the cash gift that Paul could take without payment of tax would leave
Jack with nothing!
(3) This
unintentional result would have been avoided if the will had stated that her son should take:
'a cash
sum which is the lesser of:
(i) the
largest amount that can be given without any Inheritance Tax being payable on
the transfer of value of my estate which I am deemed to make immediately before
my death, and
(ii) the
upper limit of the nil rate band in the table of rates of tax applicable on my
death in Schedule I to the Inheritance Tax Act 1984.'
2 Effect
of previous chargeable transfers on the ss 36-42 calculation
In
considering the application of ss 36-42, it has so far been assumed that the
deceased had made no previous chargeable lifetime transfers in the seven years
before his death. If he has, any specific gift on death must be grossed up
taking account of those cumulative lifetime transfers because they may affect
the rate at which tax is charged on the estate on death. [30.98]
EXAMPLE
30.20
A's
estate on death is valued at £250,000 and he leaves £90,000
tax-free to his son and the residue to a charity. A had made gross lifetime
transfers in the previous seven years of £285,000.
The
lifetime gifts have wiped out A's nil rate band and therefore IHT on the
specific legacy of £90,000 is two-thirds of £90,000 =
£60,000. Accordingly, the gross legacy is £150,000 so that
the charity is left with £100,000. [*734]
3 Double
grossing-up
IHTA 1984
ss 36-42 also deal with the more complex problems that arise if specific
tax-free gifts are combined with chargeable gifts bearing their own tax, and an
exempt residue. [30.99]
a) The
problem
Assume
that B makes a specific bequest of £300,000 tax free to his son, and
leaves a gift of £90,000 bearing its own tax to his daughter with
residue of £400,000 (before deducting any IHT chargeable to residue)
going to his spouse. To gross up the specific tax-free gift of
£300,000 as if it were the only chargeable estate would produce
insufficient IHT bearing in mind that there is an additional chargeable legacy
of £90,000. On the other hand, if the £300,000 were grossed
up at the estate rate applicable to £415,000 (ie the two gifts of
£300,000 and £90,000) the resulting tax would be too high
because the £90,000 gift should not be grossed up. Further, to gross
up £300,000 at the estate rate applicable to the whole estate including
the exempt residue would produce too much tax because this assumes, wrongly,
that the residue is taxable.
[30.100]
b) The
solution
The
solution provided in ss 36-42 is to gross up the specific tax-free gift at the
estate rate applicable to a hypothetical chargeable estate consisting of the
grossed-up specific tax-free gift and the gifts bearing their own tax. The
procedure, known as double grossing-up, is as follows:
Step 1 Gross up the specific tax-free
gift of £300,000 by multiplying excess over nil rate band by /3:
£15,000 x = £25,000
£25,000
+ £300,000 = £325,000
Step 2 Add to this figure the
tax-bearing gift of £90,000 making a hypothetical chargeable estate
of £415,000.
Step 3 Calculate IHT on
£415,000 using the death table = £52,000. Then convert to
an estate rate: namely
. 52,000
.
------- x 100 = 12.53%
.
415,000
Step 4 Gross up the specific tax-free
gift a second time at this rate of 12.53%:
. 100
.
£300,000 x ---------- = £342 974.73
.
100-12.53
Step 5 The chargeable part of the estate
now consists of the grossed-up specific gift (£342,974.73) and the
gift bearing its own tax (£90,000) = £432,974.73.
Step 6 On the figure of
£432,974.73, IHT is recalculated at £59,189.89
. 59,189.89
.
---------- x 100=13.67%
.
432,974.73
Step 7 The grossed-up specific tax-free
gift (342,974.73) is then charged at this rate (13.67%) = tax of
£46,886.39.
It should
be noted that the IHT on specific tax-free gifts must always be paid from the
residue and it is only the balance that is exempt so that the surviving spouse
will receive £400,000-46,886.39 = £353,113.61. The
tax-bearing gift of £90,000 will of course be taxed at 13.67%, but
the tax (ie £12,303) will be borne by the daughter. [30.101]
c) Conclusion
Sections
36-42 are relevant whenever a tax-free specific gift is mixed with an exempt
residue, and, if tax-bearing gifts are also included in the will, then a double
grossing-up calculation is required. Logically, to gross up only twice is
indefensible since the estate rate established at Step 6 should then be used to
gross up further the £300,000 (ie repeat Step 4) and so on and so on!
Thankfully, the statute only requires the grossing-up calculation to be done
twice with the consequence that a small saving in IHT results! [30.102]
4
Problems where part of residue is exempt, part chargeable
So far we
have been concerned with a wholly exempt residue. What, however, happens if
part of the residue is chargeable? For example, A, whose estate is worth
£500,000, leaves a specific tax-free gift of £300,000 to
his son; a tax-bearing gift of £90,000 to his daughter; and the
residue equally to his widow and his nephew.
The
method of calculating the IHT is basically the same as in the double
grossing-up example above in that the chargeable portion of the residue (half
to nephew) must be added to the hypothetical chargeable estate in Step 2 to
calculate the assumed estate rate. The difficulty is caused because, although
IHT on grossed-up gifts is payable before the division of residue into
chargeable and non-chargeable portions, the IHT on the nephew's portion of the
residue must be deducted from his share of residue after it has been divided
(IHTA 1984 s 41). To take account of this, the method for calculating the IHT
payable in such cases is amended as follows:
Step 1 Gross up the specific tax-free
gift of £300,000 to £325,000.
Step 2 Calculate the hypothetical
chargeable estate by adding to the grossed-up gift of £325,000: (1)
the tax-bearing gift of £90,000 and (2) the chargeable residue:
.
£
£
Estate
500,000
Less:
grossed-up gift
325,000
tax-bearing
gift
90,000 415,000
.
------- -------
.
85,000
The
nephew's share (the chargeable residue) is half of £85,000 =
£42,500.
This
results in a hypothetical chargeable estate of:
£325,000
+ £42,500 + £90,000 = £457,500
Step 3 Calculate the 'assumed estate
rate' on £457,500:
IHT on
£457,500 = £68,800
[*736]
Estate
rate is
.
68,800
.
------- x 100 = 15.04%
.
457,500
Step 4 Gross up the specific tax-free
gift at this rate of 15.04%:
. 100
.
£300,000
--------- = £353,107.32
.
100-15.04
Step 5 The chargeable part of the estate
now consists of:
.
Estate
500,000
Less: grossed-up gift 353,107.32
tax-bearing
gift
90,000.00
443,107.32
.
----------
.
56,892.68
.
===========
Nephew's
share is 1/2 x £56,892.68 = £28,446.34
Therefore,
chargeable estate is £28,446.34 + £90,000 +
£353,107.32 = £471,553.66
Step 6 Calculate the estate rate on the
chargeable estate of £471,553,66:
IHT on
£471,553.66 = £74,621.46
Estate
rate is
.
74,621.46
.
----------- x 100=15.82%
.
471,553.66
Step 7 The grossed-up specific tax-free
gift of £353,107.32 is taxed at the rate of 15.82% = £55,877.79.
Step 8 The tax-bearing gift of
£90,000 is taxed at 15.82% = £14,238. This tax is paid by
the daughter.
Step 9 The residue remaining is
£500,000 - (300,000 + £55,877.79 + £90,000) =
£54,122.21. This is then divided:
Half
residue to spouse = £27,061.11
Half
residue to nephew = £27,061.11 less IHT calculated at a rate of
15.82% on £28,446.34 (ie the nephew's share of the residue at Step
5, above).
Therefore, the tax on the nephew's share is £4,500.21 so that the
nephew receives £22,561.
[30.103]-[30.120]
V
ABATEMENT
Although
ss 36-42 are mainly concerned with calculating the chargeable estate in cases
where there is an exempt residue, they also deal with certain related matters:
Allocating
relief where gifts exceed an exempt limit A transfer may be partly exempt only
because it includes gifts which together exceed an exempt limit, a transfer to
a non-UK domiciled spouse which exceeds £55,000. To deal with such
cases IHTA 1984 s 38(2) provides for the exemption to be allocated between the
various gifts as follows:
(1)
Specific tax-bearing gifts take precedence over other gifts.
(2)
Specific tax-free gifts receive relief in the proportion that their values bear
to each other.
(3) All
specific gifts take precedence over gifts of residue. [30.121]
Abatement
of gifts 1f a transferor makes gifts in his will which exceed the value of his
estate, those gifts must be abated in accordance with IHTA 1984 s 37. There are
two cases to consider:
(1) Where
the gifts exceed the transferor's estate without regard to any tax payable, the
gifts abate according to the rules contained in the Administration of Estates
Act 1925 and tax is charged on the abated gifts.
EXAMPLE
30.21
A testator's
net estate is worth £300,000. He left his house worth
£100,000 to his nephew, the gift to hear its own tax, and a general
tax-free legacy of £300,000 to a charity. Under IHTA 1984 s 37(1) the
legacy must abate to £200,000 to be paid to the charity free of tax.
The house will bear its own tax.
(2) Where
the transferor's estate is only insufficient to meet the gifts as grossed up
under the rules in ss 36-42, abatement is governed by IHTA 1984 s 37(2). The
order in which the gifts are abated depends on the general law. [30.122]-[30.140]
VI
SPECIFIC PROBLEMS ON DEATH
1
Commorientes
a) The
problem
Where A
and B leave their property to each other and are both killed in a common
catastrophe or otherwise die in circumstances such that it is not clear in what
order they died, LPA 1925 s 184 stipulates that the younger is deemed to have
survived the elder. Hence, if A was the elder, he is presumed to have died
first so that his property passes to B and IHT will be chargeable. B's will leaving
everything to A will not take effect because of the prior death of A so that
his assets (including his inheritance from A) will pass on intestacy. IHT would
prima face be
chargeable. The result is that property bequeathed by the elder would (subject
to quick succession relief) be charged to IHT twice. [30.141]
b) The
IHT solution
To
prevent this double charge, IHTA 1984 s 4(2) provides that AandB 'shall be
assumed to have died at the same instant'. Hence, A's estate is charged only
once--on his death; it is not taxed a second time on B's death since the gift
is treated as lapsing. LPA 1925 s 184 is, therefore, ousted in order to avoid a
double charge to IHT, but it still governs the actual destination of the
property bequeathed by A and the question of whether the transfer on A's death
is chargeable. This may produce bizarre results [30.142]
[*738]
EXAMPLE
30.22
(1) Fred
(age 60) and his wife Wilma (aged 55) are both killed in a car crash. Fred had
left all his property to Wilma, Wilma had left all her property to their son
Barnie. According to LPA 1925 s 184, the order of deaths is Fred then Wilma and
Fred's property, therefore, passes to Wilma and thence to Barnie. However, the
effect of IHTA 1984 s 4(2) is to impose IHT on Fred's death only; ie on the
transfer to Wilma which is exempt from IHT, so that Barnie acquires Fred's
property free from IHT.
Compare:
(2)
Assume that Fred and Barnie are killed in the same crash and that Fred had left
his property to Barnie who in turn had left his estate to charity. Although the
property passes on Fred's death through Barnie's estate to the charity (which
is exempt from IHT), there is a chargeable transfer on Fred's death to Barnie.
2
Survivorship clauses
To
inherit property on a death it is necessary only to survive the testator so
that if the beneficiary dies immediately after inheriting the property, the two
deaths could mean two IHT charges, Some relief is provided by quick succession
relief (see [30.144], but the prudent testator may provide in his will for the
property to pass to the desired beneficiary only if that person survives him
for a stated period. Such provisions are referred to as survivorship clauses
and IHTA 1984 s 92 states that provided the clause does not exceed six months
there will be (at most) only a single IHT charge.
EXAMPLE
30.23
T leaves
£100,000 to A 'if he survives me by six months. If he does not the
money is to go to B'.
The
effect of IHTA 1984 s 92 is to leave matters in suspense for up to six months
and then to read the will in the light of what has happened. Hence, if A
survives for six months it is as if the will had provided '£100,000
to A'; if he dies before the end of that period, it is as if the will had
provided for £100,000 to go to B. Accordingly, two charges to IHT are
avoided; there will merely be the one chargeable occasion when the testator
dies.
In
principle, it is good will drafting to include survivorship clauses. The danger
of choosing a period in excess of six months is that IHTA 1984 s 92 will not
apply so that the bequest will be settled property to which ordinary charging
principles will apply. If a longer period is essential, insert a two-year
discretionary trust into the will (see [30.145]). [30.143]
3 Quick
succession relief (IHTA 1984 s 141)
Quick
succession relief offers a measure of relief against two charges to IHT when
two chargeable events occur within five years of each other.
For
unsettled property quick succession relief is only given on a death where the
value of the deceased's estate had been increased by a chargeable transfer
(inter vi vos or on death) to the deceased made within the previous five years.
It is not necessary for the property then transferred to be part of the
deceased's estate when he dies.
In the
case of settled property the relief is only available (and necessary) for
interest in possession trusts. It is given whenever an interest in possession
terminates and hence can be deliberately activated by the life tenant assigning
or surrendering his interest. The earlier transfer in the case of settled
property will be either the creation of the settlement or the termination of a
prior life interest.
EXAMPLE
30.24
S, who
had settled property by will on A for life, B for life, C absolutely, died in
2004. In 2005 A dies and in 2006 B surrenders his life interest.
2004 IHT
will be chargeable.
2005
Quick succession relief is available on A's death. The chargeable transfer in
the previous five years was the creation of the settlement in 2002.
2006
Quick succession relief is available on the surrender of B's life interest. The
chargeable transfer in the previous five years was the termination of A's life
interest.
The
relief reduces the IHT on the second chargeable occasion. IHT is calculated in
the usual way and then reduced by a sum dependent upon two factors. First, how
long has elapsed since the first chargeable transfer was made. The percentage
of relief is available as follows:
100% if
previous transfer one year or less before death 80% if previous transfer
one-two years before death 60% if previous transfer two-three years before
death 40% if previous transfer three-four years before death 20% if previous
transfer four-five years before death.
The
second factor is the amount of IHT paid on the first transfer. IHTA 1984 s
141(3) states that the relief is 'a percentage determined as above of the tax
charged on so much of the value transferred by the first transfer as is
attributable to the increase in the estate of the second transferor'. Hence, if
A had left £275,000 to B who died within one year of that gift, the
appropriate percentage will be 100% of the tax charged on the transfer from A
to B and if the transfer by A had been his only chargeable transfer and had
fallen into his nil rate band the relief is 100% x 0! [30.144]
EXAMPLE
30.25 (ASSUMING CURRENT RATES OF IHT THROUGHOUT)
(1)
Tax-free legacy/death: A, who has made no previous chargeable transfers, dies
leaving an estate of £570,000 out of which he leaves a tax-free
legacy of £285,000 to B. B dies 18 months later leaving an estate of
£410,000.
(a) IHT
on A's estate = £114,000
Proportion
paid in respect of tax-free legacy (50%) = £57,000
(b) Quick
succession relief 80% x £57,000 = £45,600
.
£
(c) IHT
on B's estate ((£410,000 - £285,000) x 40%) 50,000
Less:
Quick succession relief
45,600
IHT
payable
4,400
(2) Diego
gives £25,000 to Madonna in October 1999 (a PET). Madonna dies in
July 2001 and Diego in January 2002. As a result of Diego's death, the PET is
chargeable and IHT of (say) £5.000 is paid by Madonna's estate. [*740]
(a) Quick
SUCCCS51Ofl relief (QSR) at 80% is available-on the tax attributable to the
increase in the donee's estate.
(b) The
increase in Madonna's estate is £25,000 - £5,000 =
£20,000. IHT attributable to that increase is:
. 20, 000
. ------- x
£5,000 = £4,000
. 25,000
(c) QSR
available on Madonna's death is 80% x £4,000 = £3,200.
4
flexible will drafting (IHTA 1984 s 144)
1f a
testator, who dies before 22 March 2006, created, by his will, a trust without
an interest in possession, so long as an event occurs on which tax is
chargeable (ie a conventional 'exit' charge, see [34.23]) within two years of
his death, the IHT that would normally arise under the discretionary trust
charging rules 'shall not be charged but the Act shall have effect as if the
will had provided that on the testator's death the property should be held as
it is held after the event' (s 144(2)). In other words the dispositions of the
trustees are 'read back' into the will. Where the testator dies on or after 22
March 2006, the provisions will apply equally to will trusts with an interest
in possession, except where that interest is an immediate post-death interest
or a disabled person's interest (IHTA 1984 s 144(1A) inserted by FA 2006 Sch 20
para 27). Such a trust enables wills to be drafted with some flexibility and is
advantageous where, for example, the testator is dying and desires his estate
to be divided between his four children, but is not sure of the proportions. By
inserting the two-year trust a decision about the final distribution of the
estate can be postponed for a further two years. [30.145]
a) IHT
consequences
IHT will
be charged at the estate rate on the property settled at death but if the
ultimate distributions made by the trustees are 'read back' into the will that
IHT may need to be recalculated. In Example 30.26(1), for instance, a
discretionary trust is ended in favour of the testator's surviving spouse and
the reading back provisions result in a repayment of any IHT charged on the
death estate. Example 30.26(2) reveals an important restriction in the relief
afforded by s 144 that only applies if the transfer out of the discretionary
trust would otherwise attract a tax charge. However, by virtue of FA 2006 Sch
20, both pre- and post-22 March 2006 appointments of immediate post-death
interests, trusts for bereaved minors or age l8-to-25 trusts (which would not
otherwise be the occasion of a charge -- for definitions, see Chapter 32), may
be made without an lUT charge and back-dated to the death. [30.146]
EXAMPLE
30.26
A creates
a flexible trust in his will and the trustees:
(1) Six
months after death appoint the property to A's widow. This appointment is read
back to A's death: ie it takes effect as an exempt spouse gift so that there is
a resulting IHT repayment.
(2) As in
(1) but the appointment is made two months after death. Now there is no
question of reading back since there is no charge imposed on events occurring
within three months of the creation of a discretionary trust (IHTA 1984 s
64(4), see [34.25]). As a result, the original will remains intact, IHT is
charged on the entire estate and the spouse exemption is unused. Although, this
result was probably never intended the position has been confirmed by the Court
of Appeal in Frankland v IRC (1996).
(3) Six months after A's death on 1 February
2006 appoint the property to a trust for a bereaved minor (see Chapter 32).
Although n™ charge is imposed when property is put into this kind of trust
(IHTA 1984 s 71A, inserted by FA 2006 Sch 20), the appointment may nevertheless
be read back into the will (IHTA 1984 s 144(5) inserted by FA 2006 Sch 20 para
27).
b) Theoretical
problems and practical uses of s 144
Because
at the date of death property is left on a discretionary trust or, for deaths
on or after 22 March 2006, an interest in possession trust that is not an
immediate post-death interest or a disabled person's interest, that property is
subject to IHT and, in normal circumstances, tax will need to be paid before
the PRs can obtain a grant of probate. In cases where the trust is ended (as in
Example 30.26(1)) by appointment to a surviving spouse there will then be a
refund of the tax paid, but nonetheless the estate may have been put at a
cashflow disadvantage. In Fitzwilliam v IRC (1993) the testator's residuary
estate was settled on trusts that gave the trustees power in the 23 months
following the death to appoint amongst a discretionary class of beneficiaries.
After the expiration of that period the trustees were to pay the income to the
testator's widow for the remainder of her life. The executors indicated that
they intended to appoint the property to the surviving spouse and the
Winchester District Probate Registry therefore accepted that the estate was spouse
exempt. This conduct was criticised by the Revenue but Vinelott J did not join
in that criticism and pointed out that because the estate was largely composed
of agricultural land and chattels it would have been very difficult for the
executors to have paid such a bill. This matter was not raised in the higher
courts. [30.147]
c) Vesting
of property issue
The
operation of s 144 was for a time bedevilled by traps. In particular, the
Revenue took the view that an appointment could only be made out of a trust
that had been properly constituted with the vesting of property in trustees.
That by itself was unexceptionable but the Revenue originally considered that
this involved either the completion of the administration of the estate or,
alternatively, an express assent of property by the PRs to the trustees before
any appointment could be made. Helpfully, the Revenue has now abandoned this
position and accepts that such trusts are immediately constituted at the date
of the testator's death: see further Capital Taxes News, July 1990, p 98. [30.148]
d) CGT
tie-in
There is
one remaining disadvantage: namely that if an appointment is made out of such a
trust which is duly read back under s 144 there can be no [*742]
question of CGT hold-over relief being available unless the property in
the trust qualifies as business assets. There is no equivalent relief to s 144
permitting reading back in CGT legislation. 1f the estate is not fully
administered at the relevant time HMRC does, however, accept that the beneficiaries
take qua legatees at probate value (see [21.103]). [30.149]
e) Uses
This
trust can be used as an alternative to a survivorship clause. Say, for
instance, that the testator wants Eric to get the property if he survives him
by 18 months failing which Ernie is to receive it. This cannot be achieved by a
conventional IHT survivorship clause (which must be limited to six months; see
[30.143]). If Eric and Ernie are made beneficiaries of a discretionary trust,
however, and the trustees know the testator's wishes concerning the
distribution of the fund, there is no risk of a double IHT charge in carrying
out his wishes.
Such a
trust is also attractive as compared with variations and disclaimers. If there
is any doubt about who should be given the deceased's estate, it is better to
use a trust than to rely upon an appointed legatee voluntarily renouncing a
benefit under the will. All the most convincing fiscal arguments will often
fail to persuade people to give up property and they cannot be compelled to
vary or to disclaim!
Finally,
if the estate includes business property which may attract IHT relief at 100%,
consider leaving that property on discretionary trusts for beneficial class
including surviving spouse and issue. 1f it turns out that relief is not
available the trustees can appoint the business to the spouse with reading back
under s 144. Hence any IHT charge has been avoided. [30.150]
f) Precatory
trusts
Instead
of imposing a trust, the deceased may be content to leave property subject to a
non-binding memorandum of wishes. Such 'precatory trusts' are dealt with by
IHTA 1984 s 143 (which provides that if the legatee carries out the wishes
within two years of the testator's death there is reading back) and should not
be confused with the s 144 'two-year' trust (see Harding (Lovedays
Executors) v IRC
(1997)). [30.151]
5
Channelling through a surviving spouse
In cases
where the testator is survived by his spouse, prior to the substantial changes
introduced by FA 2006, there was another attractive way of drafting a will in
flexible form. Consider the following illustration.
Lord and
Lady Y were both possessed of 'serious money'. Lord Y left his property by will
as follows:
(1) as to
any unused proportion of his nil rate band on A&M trusts for his collection
of grandchildren;
(2) as to
the residue of his estate on a life interest trust for Lady Y with the trustees
having the power to terminate that interest (in whole or in part) at any time
once (say) six months have elapsed from the date of Lord V's death. Although
there is a power to advance capital it is understood between Lord and Lady Y
that the trustees will in practice exercise their power of termination
(probably at different times) and when that happens the property passes into
the A&M trust.
Lord V's
will was in standard form: first, he exhausted his nil rate band and then left
all his assets to his surviving spouse. On his death, therefore, no IHT would
be charged. The intention, however, was that the trustees would revoke the
interest in possession of Lady Y either in whole or in part. Restricting the
power of revocation until, say, six months had elapsed from death was commonly
done in order to avoid any suggestion that Lady V's interest lacked
'materiality' and so could be ignored. In Fitzwilliam, the House of Lords
refused to excise an interest in possession lasting one month (compare Hatton
v IRC (1992) at
[28.103]). To some extent therefore the six-month period was an arbitrary
choice: some draftsmen preferred a 12-month period whilst others were content
with a lesser period.
When Lady
V's interest was terminated, she was treated as making a PET (see [28.45]).
Provided that she survived for seven years IHT would be wholly avoided. Of
course, if she had died within that time an IHT charge would then have resulted
but it should be stressed that this would not have worsened the position of the
couple. Such a tax charge levied at the full rate of 40% would in any event
have arisen if Lord Y had directly left the property to his grandchildren.
Accordingly, there was no downside to this arrangement and, moreover, the
reservation of benefit rules would have no application if, after her life
interest was terminated, Lady Y continued to benefit from the property.
The
attractions as compared with the s 144 trust are obvious. Had this property
been left on a discretionary trust with the beneficiaries including Lady Y and
the grandchildren and appointed out to the grandchildren within two years,
reading back would have resulted in a tax charge to Lord V's rates.
The
changes introduced by FA 2006 will not only ring the death knell for such
arrangements in the future, but will also have an impact on existing
arrangements:
(1) Where
Lord Y died prior to 22 March 2006, and the A&M trust remains in existence,
relief from the relevant property regime (see Chapter 34) will continue to be
given on or after 6 April 2008 provided only from that date the grandchildren
will become absolutely entitled to the settled property (not just an interest
in it) by the age of 18 (IHTA 1984 s 71(1)(a) as amended by FA 2006 Sch 20,
para 3 (1) and (2))
(2) Were
Lord Y to die on or after 22 March 2006, then the arrangement would no longer
be attractive for two reasons. First, the occasion of the termination of Lady
V's interest in possession would no longer qualify as a PET (the circumstances
in which the termination of an interest in possession will continue to be a PET
are limited to where the successor interest is absolute, a transitional serial
interest, a disabled person's interest or a trust for a bereaved minor. These
terms are discussed in Chapter 32). This in itself would not be a disaster (see
above). Secondly, A&M trusts created on or after 22 March 2006 no longer
enjoy relief from the relevant property regime (unless they are classed as
trusts for disabled minors (see Chapter 32 for a definition), and this depends
upon the trust being established under the will of a parent). Moreover, [*744] where, on or aller 22
March 2006, a beneficiary whose life interest is terminated continues to enjoy
the property, the reservation of benefit rules will apply (see [29.135]).
Accordingly,
a simple alternative would be for the property to be left to Lady Y absolutely
and to rely upon her to then make PETs. However, wealthy male testators may be
reluctant to leave matters in the control of the surviving spouse. [30.152]
6
Disclaimers and variations (post mortem tax planning)
It will
often be desirable to effect changes in a will after the death of the testator,
for instance, to rearrange the dispositions with a view to saving tax (and
especially IHT) or to provide for someone who is omitted from the will or who
is inadequately provided for. In these cases, persons named in the original
will reject a portion of their inheritance; hence, they will (usually) be
making a gift. Similar problems arise on an intestacy--indeed the statutory
intestacy provisions will often prove even less satisfactory than a will.
So far as
both IHT and CGT are concerned certain changes to a will, or to the intestacy
rules, are permitted, if made within two years of death, to take effect as if
they had been provided for in the original will or intestacy' (for IHT, see
IHTA 1984 s 142; for CGT, TCGA 1992 s 62(6)-(9): the CGT rules are considered
at [21.121]). The effect of 'reading back' these changes into the will or
amending the intestacy rules is to avoid the possibility of a second charge to
IHT and to require a recalculation of the IHT charged on death.
EXAMPLE
30.27
T by will
leaves property to his three daughters equally. He omits his son with whom he
had quarrelled bitterly. The daughters agree to vary the will by providing that
the four children take equally and, for the capital taxes, T's original will
can be varied to make the desired provision. Provided that the rearrangement is
made in writing within two years of T's death no daughter will be taxed on the
gift of a part of her share to her brother. Instead tax will be charged as if T
had left his estate to his four children equally (so that the IHT liability
will be unchanged).
To take
advantage of these provisions there must be a voluntary alteration of the
testamentary provisions; in the case of enforced alterations: eg as a result of
applications under the Inheritance (Provision for Family and Dependants) Act
1975, different provisions apply, see [30.67].
No
specific alterations were made to IHTA 198,1 s 142 by FA 2006. Accordingly,
where a testator died prior to 22 March 2006, and a variation to the will has
been made on or after that date giving rise to an interest in possession, it
will be treated as an interest in possession in existence prior to 22 March
2006 and subject to the former regime applying to interests in possession (see
Chapter 33). Where the death occurs on or after 22 March 2006, followed by a
variation, the new interest in possession will be an immediate post-death
interest. This means that it remains possible to take advantage of the
spouse/civil partner exemption for interests in possession created by deed of
variation within s 142 whenever the deceased died.
Where an
A&M trust is created under a variation made on or after 22 March 2006, and
is deemed to arise on the testator's death prior to that [*745] date, for the purposes of the new regime under FA 2006, it
will be treated as in existence on that date and, provided the beneficiaries
will become entitled to the trust property itself by the age of 18, then it
will receive relief from the relevant property regime (IHTA 1984 s 71(1)(a) as
amended by FA 2006 Sch 20, para 3).
[30.153]
a) Permitted
ways of altering the will or intestacy
There are
two methods of altering the dispositions of a will or intestacy; by disclaimer
or by variation. A disclaimer operates as a refusal to accept property and,
hence, to be valid, should be made before any act of acceptance has occurred
(such as receiving any benefit). When a disclaimer is effected the property
passes according to fixed rules of law. It is not possible to disclaim in
favour of a particular person. Hence, if a specific bequest is disclaimed the
property falls into the residue of the will; if it is the residue itself which
is disclaimed the property will pass as on an intestacy. Property can also be
disclaimed on intestacy. A disclaimer is, therefore, an all or nothing event;
it is not possible to retain part and disclaim the rest of a single gift. If,
however, both a specific bequest and a share of residue are left to thˇ same
person, the benefit of one could be accepted and the other disclaimed. For a
consideration of when a disclaimer can be implied by conduct, see Cook (exor
of Wathins Dec'd) v IRC (2002).
In a
variation, the deceased's provisions are altered at the choice of the person
effecting the alteration so that the gift is redirected and the fact that some
benefit had already accrued before the change (and that the estate had been
fully administered) is irrelevant. Any part of a gift can be redirected. Unlike
a beneficiary who disclaims, the person who makes the variation has owned an
interest in the property of the deceased from the death up to the
variation. [30.154]
b) The
IHT rules on variations and disclaimers
If the
following conditions are satisfied the variation or disclaimer is not itself a
transfer of value but instead takes effect as if the original will or intestacy
had so provided:
(1) The
variation or disclaimer must occur within two years of death. In the case of
disclaimers it is likely that action will need to be taken soon after the death
otherwise the benefit will have been accepted.
(2) The
variation or disclaimer must be effected by an instrument in writing (in
practice a deed should be used), executed by the person who would otherwise
benefit.
(3) In
the case of variations, where it is desired to 'read them back' into the
original will, it was formerly the case that an election in writing to that
effect had to be made to the Revenue (within six months of the variation). This
election should have referred to the appropriate statutory provisions and was
made by the person making the variation and, where the effect of that election
would be to increase the IHT chargeable on the death, also by the PRs. PRs
could only refuse to join in the election, however, if they had insufficient
assets in their hands to discharge the extra IHT bill (for instance, where
administration of the estate had been completed and the assets distributed). No
election was [*746] necessary in the case of a disclaimer
that, assuming that the other requirements are satisfied, is automatically
'read back' into the will. The separate election required when it was desired
to 'read back' the effect of an instrument of variation was abolished for
instruments executed after 31 July 2002. To obtain reading back it is now
essential that the instrument itself contains a statement to that effect. For
many practitioners this change was of limited significance given that they had
always included the relevant election in the instrument itself.
(4) A
variation or disclaimer cannot be for money or money's worth, except where
there are reciprocal disclaimers or other beneficiaries also disclaim for the
ultimate benefit of a third person.
(5) All
property comprised in the deceased's estate immediately before death can be
redirected under these provisions except for property which the deceased was
treated as owning by virtue of an interest in possession in a settlement
(although in this case relief may be afforded by IHTA 1984 s 93) and property
included in the estate at death because of the reservation of benefit rules.
EXAMPLE
30.28
(1) A and
T were beneficial joint tenants of the house they lived in. On the death of T,
A can redirect the half share of the property that he acquired by right of
survivorship taking advantage of IHTA 1984 s 142 (expressly confirmed in Tax
Bulletin, October
1995, p 254).
(2) T by
will created a settlement giving C a life interest. C can redirect that
interest under IHTA 1984 s 142 (but see below for the position if after C's
death it is desired to effect the variation).
(3) T was
the life tenant of a fund--the property now vests in D absolutely. D cannot
take advantage of IHTA 1984 s 142 to assign his interest in the settled
property. (Notice, however, that IHTA 1984 s 93 permits a beneficiary to
disclaim an interest in settled property without that disclaimer being subject
to IHT.)
(4) Mort
had been life tenant of a trust fund and on his death the assets passed to his
sister Mildred absolutely. He left his free estate equally to his widow and
daughter. By a post-death variation the widow gave her half share to the
daughter. Assuming that this variation is read back for IHT purposes the extra
tax charged on Mort's death will adversely affect the trustees who are not
required to consent to the election and are not protected by a deed of
discharge (IHTA 1984 s 239(4)).
(5)
Father leaves £100,000 shares in J Sainsbury pic to his daughter. She
gives those shares to her son, within two years of his death, but continues to
be paid the dividends. She elects to read the gift back into the will of her
father and as her gift thereupon takes effect for all [HT purposes as if it had
been made by the deceased the reservation of benefit rules are inapplicable
(see [29.141]).
(6)
Boris, domiciled in France, leaves his villa in Tuscany and moneys in his Swiss
bank account to his son Gaspard, a UK resident. By a variation of the terms of
his will made within two years of Boris' death, the property is settled on
discretionary Liechtenstein trusts for the benefit of Gaspard's family. For
IHT, reading back ensures that the settlement is excluded property (see
[35.20]). For the CGT position, see Example 22.10.
In the
case of variations, the choice to elect or not to elect is with the taxpayer. A
similar election operates for CGT but it is not necessary to exercise both IHT
and CGT elections; either can be exercised (see [21.123]).
PRs of
deceased beneficiaries can enter into variations and disclaimers which can be
read back into the original will. Further, the estate of a beneficiary alive at
the testator's death can be increased by such a variation or disclaimer (see Tax
Bulletin,
February 1995, p 194). [30.155]
EXAMPLE
30.29
(1) T
leaves property to his wealthy brother. The brother wishes to redirect it to
grandchildren. An election for IHT purposes is advisable since (a) it will not
increase the IHT charged on T's death and (b) it will avoid a second charge at
the brother's rates if the brother were to die within seven years of the gift
(for which quick succession relief would not be available--see 130.144]).
(2) T leaves
residue to his widow. She wishes to redirect a portion to her daughter. If the
election is made, the IHT on T's death may be increased because an exempt
bequest is being replaced with one that is chargeable. If the election is not
made, on T's death the residue remains spouse exempt but the widow will make a
PET. If she survives by seven years, no IHT will be payable: if she survives by
three years, tapering relief will apply. Even if the PET becomes chargeable,
any IHT may be reduced by the widow's annual exemption (in the year when the
transfer is made) and the chargeable transfer may fall within her nil rate
band. In cases like this, it will be advantageous to ensure that T's nil rate
band is fully used up by a reading back election but, once that has been done,
given a single rate of tax (40%), there is no advantage in reading back the
variation since the rate of tax on the death of the widow will be the same and,
moreover, tax will not be charged at once.
(3) In
examples like (2) above a variation may be employed to redirect a posthumous
increase in the value of the estate without any IHT charge. Assume for instance
that the death estate of £200,000 has increased in value to
£325,000. T's widow could vary the will (electing to read the charge
back) to provide for a specific legacy of £200,000 to herself with
the residue to her daughter. Under the provisions of IHTA 1984 ss 36-42 the
death estate (200,000) is attributed to the exempt legacy.
(4) H
leaves Lira to his only daughter, D. His widow, W, dies soon afterwards leaving
a small estate to D. D should consider varying H's will so that (say) she
retains £275,000 (to use up the nil rate band) and the remainder is
left to W. D will then receive that sum from W's estate.
Note: In (4) above the variation may
be considered artificial since it is designed solely to reduce the total IHT
bill. D is left with all the property. Accordingly it may be vulnerable to
attack either under the Ramsay principle or on the basis that the dispositions of H's
will have not been varied (although it is understood that the Capital Taxes
Office does not at present take this point). Were D to redirect the benefit to
her own children it would be more difficult to view the arrangement as wholly
artificial.
e) Other
taxes
So far as
stamp duty is concerned variations in writing made within two years after the
death are not subject to ad valorem duty provided that the appropriately worded
certificate is included (normally Category L, see Chapter 49). No duty is
payable on disclaimers which are treated as a refusal to accept, not [*748] a disposition of prope1tY. No stamp duty land tax charge
arises in respect of post-death variatiosm made within two years of the death
(FA 2003 Sch 3 para 4). A variation is not a notifiable transaction for stamp
duty land tax purposes (FA 2003 s 77(3)).
There are
no specific relieving income tax provisions for variations and disclaimers.
Accordingly, income arising between the date of death and the date of a
variation will be taxed in accordance with the terms of the will and the rules
governing the treatment of estate income (as to which see Chapter 17). Of
course, residuary income is taxed only when actually paid to the beneficiary:
consequently if no income has been paid to a beneficiary who effects a
variation of his residuary entitlement, income tax will be charged only on
future distributions to the 'new' beneficiary. To this extent a form of reading
back can apply for income tax purposes.
So far as
a disclaimer is concerned HMRC apparently considers that the basic income tax
position is the same as for a variation, since the beneficiary's interest under
the will remains intact up to the date of the disclaimer (see further (1984) 5
CTT News 142: it may be doubted whether this view is consistent with a
disclaimer operating as a refusal to accept property).
A
variation made by a beneficiary in favour of his own infant unmarried child creates a
settlement for income tax purposes within the settlenent provisions in ITTOIA
2005 s 619 et seq (see [16.95]). Hence, income arising from the redirected
property will be assessed as that of the parent (unless accumulated in a
capital settlement). A disclaimer will escape these problems, if it is accepted
that the property has never been owned by the disclaiming beneficiary. [30.156]
d) Technical
difficulties and traps
A number
of technical problems have arisen in connection with instruments of variation.
First, it
was argued by the Revenue that for a variation to fall within the IHT relieving
provision (IHTA 1984 s 142), the operative clause in the instrument of
variation had to state that the transfer of property took effect as a variation
to the provisions of a will or intestacy in order to avoid it being construed
as a lifetime gift. Accordingly it was suggested that any variation should
follow the wording of that section and provide as follows:
'The
dispositions of property comprised in the estate of the testator (intestate)
immediately before his death, shall be varied as follows ...'
After
further advice the Revenue apparently abandoned this view (see Law Society's
Gazette, 1985, p
1454), but will, nevertheless, require the variation to indicate clearly the
dispositions that are subject to it and vary their destination from that
provided in the will or under the intestacy rules. The notice of election must
refer to the appropriate statutory provisions. Further, as the Revenue
considers that the instrument itselfmust vary the dispositions the use of a
deed would appear to be necessary (although a written instrument is sufficient
to transfer an existing equitable interest under LPA 1925 s 53(1) (c)).
Secondly,
multiple variations had been employed (before 1985) in an attempt to avoid ad
valorem stamp duty. Although this is no longer necessary it resulted in the
Revenue interpreting IHTA 1984 s 142 as permitting only [*749] one variation per beneficiary. Again this is a position from
which it has retreated, at least in part (see Law Society's Gazette, 1985, p
1454); it now considers that an election, once made, is irrevocable and that s
142 will not apply to an instrument redirecting any item or part of any item
that had already been redirected under an earlier instrument. Variations
covering a number of items should ideally be made in one instrument 'to avoid
any uncertainty', although the Revenue accepts that multiple variations by a
single beneficiary are not, as such, prohibited.
EXAMPLE
30.30
Under
Eric's will £50,000 is left to his brother Wally and
£100,000 to his surviving spouse Berta. The following events then
occur within two years of Eric's death:
(1) Wally
executes a deed of variation in favour of his own children.
(2) Berta
executes a deed varying £2,500 in favour of her sister Jennie and subsequently
a second variation of £47,500 tojennie.
(3)
Jennie executes a deed of variation of £25,000 in favour of her
boyfriend Jonnie.
The
variations in (1) and (2) satisfy the requirements of IHTA 1984 s 142 as
interpreted by HMRC and so may be read back into Eric's will, whereas the
variation in (3) will not be so treated and, accordingly, will be a PET by
Jennie.
The
decision of Russell v IRC (1988) confirmed that a redirection of property already
varied does not fall within s 142. The deceased had died in 1983 survived by
his wife and four daughters. His estate included business assets (Lloyd's
underwriting interests) that qualified for business property relief. Under his
will, most of the estate passed to his widow and was not therefore subject to a
tax charge. As a corollary, however, business property relief was wasted as was
the deceased's nil rate band. Not surprisingly, therefore, the family decided
to vary the dispositions of his will by providing for each daughter to receive
a pecuniary legacy of £25,000 to be raised out of the business
property. They hoped that by giving away the business property worth
£100,000 that would qualify for a reduction in value of 50%, some
£50,000 of the testator's nil rate band would thereby be utilised.
The Revenue, however, took the view that these legacies were gifts of cash not
of qualifying business assets with the result that as no 50% relief was
available a tax charge would arise since part of each legacy would then fall
outside the nil rate band. Although the family did not accept this, they tried
again in 1985 by executing a fresh deed of variation whereby each daughter was
to receive instead of a cash legacy a proportionate share of the business
assets worth £25,000.
Knox J
had to decide whether this second deed was effective to carry out the family's
intentions and, if not, whether the Revenue was correct in its interpretation
of the 1983 deed. He decided that under the relevant statutory provision a
benefit which had already been redirected once could not be further redirected
and read back into the testator's will.
'My
principal reason for accepting the Crown's submission that the hypothesis
contained in s 142(1) should not be applied to that subsection itself is that this
involves taking the hypothesis further than is necessary. No authority was
cited to me of a statutory hypothesis being applied to the very provision which
enacts the hypothesis. Such a tortuous process would merit a specific reference
in the enactment to itself ...' (Knox J).
[*750]
Accordingly,
as there had already been a valid variation in 1983, the further amendment in
1985 could not be read back. Having so decided he then concluded, however, that
the Revenue's arguments that the 1983 variation did not have the effect of
varying interests in business property was misconceived. He pointed out that
the relevant cash gifts could only be satisfied (in this particular case) by
resorting to business assets and therefore he was of the opinion that a division
of that property by reference to a cash sum should be treated in the same way
as a division by reference to a fraction of the assets.
In Lake
v Lake (1989)
Mervyn Davis J held that a deed of variation can be rectified by the court if
words mistakenly used mean that it does not give effect to the parties' joint
intention. It does not matter that the rectification achieves a tax advantage
nor that it is made more than two years after the death. The courts must,
however, be satisfied that the deed as executed contains errors: in this case
the variation was designed to give legacies to children of the deceased but as
the result of a clerical error such gifts were expressed to be 'free of tax'.
As residue passed to an exempt beneficiary (the surviving spouse), grossing-up
was therefore necessary (see [30.96]). The order for rectification substituted
'such gifts to bear their own tax' for 'free of tax' (see also Matthews v
Martin (1991) and
Schnieder v Mills
(1993)).
Thirdly,
s 142(4) contains a trap for the unwary by providing that if a variation
results in property being held for a person 'for a period which ends not more
than two years after the death' the interest of that person is ignored in
applying the section.
EXAMPLE
30.31
Dan died
on 1 January 2001 leaving all his estate to his daughter Delia. By a deed of
variation dated 1 January 2002 she gave her mother a six-month interest in
possession in that property remainder to her children and made the necessary
election. As the mother's interest ends before 1 January 2003 it will be
ignored under s 142(4) and IHT calculated as if Dan had left his estate
directly to his grandchildren.
Finally,
in December 2001 the Revenue announced a change of policy based on the somewhat
curious idea that variations had to operate in the real world! [30.157]
EXAMPLE
30.32
Sid died
on 6 April 2003 leaving his estate of £275,000 to his wife Mabel for
life with remainder to their only child, Doris. Grief-stricken Mabel died soon
afterwards and her entire estate (worth £275,000) then passes to
Doris.
(1) The
current position: On Mabel's death IHT payable will be £110,000 on
the basis that she left a chargeable free estate of £275,000 and had
enjoyed a life interest in a trust fund also worth £275,000. Doris
would be advised to consider using s 142 to amend Sid's will: specifically to
get rid of the gift to Mabel.
(2) Disclaimer of the life interest It may be
that Mabel's PRs can disclaim the benefit of this life interest and HMRC
accepts that if this is done the tax on Sid's death will be recalculated on the
basis that the property passes to Doris. Full use will therefore have been made
of Sid's IHT nil rate band and on Doris'
[*751] death her estate is
within her nil rate band. Of course, a disclaimer will not be possible if
benefits have been received.
(3) Varying Sid's will. Prior to the 2001
statement, variations were accepted in such cases: typically Sid's will would
be varied to delete Mabel's life interest. HMRC now considers, however, that
because Mabel's life interest has ended there is no property that can form the
subject matter of such a variation. It is considered that this view is
misconceived since what is being redirected is the property passing under Sids
will so that the death of Mabel is irrelevant (see also Soutter's Executry v
IRC (2002), a
Scottish Special Commissioners case which affords some support for the
Revenue's views).
7 IHT and
estate duty
Up to 13
March 1975 the estate duty regime operated. The various transitional provisions
for estate duty are beyond the scope of this book although mention should be
made of IHTA 1984 Sch 6 para 2 that preserves for IHT purposes the estate duty
surviving spouse exemption. This exemption provided that where property was
left to a surviving spouse in such circumstances that the spouse was not
competent to dispose of it (for instance was given a life interest therein)
estate duty would be charged on the first death but not again on the death of
the survivor. This exemption was continued into the CTT (and now IHT) era by
IHTA 1984 Sch 6 para 2 which excludes such property from charge whether the
limited interest is terminated inter vivos or by the death of the surviving spouse. All too
often this valuable exemption may be overlooked and an over-emphasis on the
attractions of making PETs may have unfortunate results. [30.158]
EXAMPLE
30.33
(1) On
his death in 1973, Samson left his wife Delilah a life interest in his share
portfolio. She is still alive and in robust health and the trustees have a
power to advance capital to her. Estate duty was charged on Samson's death but
because of IHTA 1984 Sch 6 para 2 there will be no charge to IHT when Delilah's
interest comes to an end. At first sight, there appear to be advantages if the
trustees advance capital to Delilah which she then transfers by means of a PET.
However, this arrangement carries with it the risk of that capital being
subject to an IHT charge if Delilah dies within seven years of her gift.
Accordingly, an interest which is tax free is being replaced by a potentially
chargeable transfer.
(2)
Terminating Delilah's interest during her life may, however, have other
attractions. In particular, the exemption from charge in IHTA 1984 Sch 6 para 2
is limited to the value of the property in which the limited interest subsists
but that property may, by forming part of Delilah's estate, affect the value of
other assets in that estate. Assume, for instance, that Delilah owns 30% of the
shares in a private company (Galilee Ltd) in her own name and that a further
30% are subject to the life interest trust. When she dies she will be treated
as owning 60% of the shares: a controlling holding which will be valued as
such. Although one half of the value of that holding will be free from charge under
para 2, the remaining portion will be taxed. Accordingly, it may be better in
such cases for her life interest to be surrendered inter vi vos even if that
operation is only carried out on her deathbed. [*752] [*753]
31
IHT-exemptions and reliefs
Updated
by Natalie Lee, Senior Lecturer in Law, University of Southampton and Aparna
Nathan, Lii) Hons, LLM, Barrister, Gra''s Inn Tax
Chambers
I Lifetime exemptions and reliefs [31.3]
II Death exemptions and reliefs [31.21]
III Exemptions for lifetime and death
transfers [31.41]
1 Policy
issues
Predictably,
although in marked contrast to CUT, whole categories of property are not
exempted from the IHT net. Hence, excluded property, which is ignored if
transferred inter vivos and not taxed as part of the death estate, is
restrictively defined in IHTA 1984 s 6 (see [35.20]).
Exemptions
and reliefs apply in a number of situations: some for lifetime transfers only;
some for death only; and some for all transfers, whether in lifetime or on
death.
The
exemptions may be justified on the grounds of necessity-some gifts must be
permitted (eg Christmas and wedding presents); or, in the case of reliefs
applicable to particular property, because it is desirable that the property
should he preserved and not sold to pay the tax bill (cg business and
agricultural property where relief up to 100% of the value is available).
[31.1]
2 The nil
rate band
The nil
rate band (currently £275,000) is not an exempt transfer since
transfers within this band are chargeable transfers, albeit taxed at 0%.
Accordingly, exemptions and reliefs should be exhausted first so that the
taxpayer's nil rate band is retained intact as long as possible. [31.2]
I
LIFETIME EXEMPTIONS AND RELIEFS
I
Transfers not exceeding £3,000 pa (IHTA 1984 s 19)
Up to
£3,000 can be transferred free from IHT each tax year (6 April to 5
April). To the extent that this relief is unused in any one year it can be [*754] rolled forward for one tax year
only. There is no general roll-forward since only where the value transferred
in any year exceeds £3,000 is the shortfall from the previous year's
£3,000 used.
EXAMPLE
31.1
A makes
chargeable transfers of £2,500 in 2004-05; £2,800 in
2005-06; and £3,700 in 2006-07.
For
2004-05: no IHT (£3,000 exemption) and £500 is carried
forward.
For
2005-06: no IHT (f3,000 exemption) and £200 only is carried forward.
The £500 from 2004-05 could only have been used to the extent that
the transfer in 2005-06 exceeded £3,000.
For
2006-07: IHT on £500 (f3,200 is exempt).
The
relief can operate by deducting £3,000 from a larger gift. Where
several chargeable gifts are made in the same tax year, earlier gifts will be
given the relief first; if several gifts are made on the same day there is a
pro rata apportionment of the relief irrespective of the actual order of gifts.
The relief applies also to settlements with interests in possession although in
this case it will only be given if the life tenant so elects (see [33.35]).
The
relationship between the annual exemption and the PET depends on the definition
of a PET in IHTA 1984 s 3A:
'a
transfer of value ... which, apart from this section, would be a chargeable
transfer (or to the, extent which, apart from this section, it would be such a
transfer)
The
position can therefore be stated in two propositions:
(1) a
transfer of value which is wholly covered by the annual exemption is not a PET
but an exempt transfer in its own right',
(2) a
transfer of value which exceeds the annual exempt amount is to that extent a
PET.
EXAMPLE
31.2
(1) In
200l7 Peta gives her father £2,500. This gift is an exempt transfer.
(2) In
the same tax year Beta, who made no gifts in the previous year, gives her
mother £6,500. Two annual exemptions mean that £6,000 is
exempt: £500 is a PET.
(3)
Cheeta intends to set up a discretionary trust for his family and to make an
outright gift to his sister. He should make the discretionary trust first
thereby using up his annual exemption and on a subsequent day make a PET to his
sister.
What
should a would-be donor do who does not wish to transfer assets/money to the
value of £3,000, but at the same time is reluctant to see the exemption
lost? One solution is to vest an interest in property in the donee whilst
retaining control of the asset (although great care must be taken to ensure
that a benefit is not retained in the portion given since a transfer falling
within the annual exemption is still a gift for the reservation of benefit
rules: see Chapter 29). Selling the asset with the purchase price outstanding
and releasing part of the debt each year equal to the annual exemption may fall
foul of the associated operations rules (see [28.101]). [31.3] [*755]
EXAMPLE
31.3
On 21
December the Deceased wrote a cheque for £6,000 in favour of his son
who paid it into his bank account on the same day. The Deceased died on 22
December and the bank agreed to honour the cheque which was cleared on 27
December. There was no completed gift in the Deceased's lifetime (since the
cheque had not cleared) and the cheque was not a liability in the Deceased's
estate (since it had not been incurred for full consideration). The Deceased
had therefore failed to use his annual exemption (see Curnock (PR of Curnock
Decd) vIRC (2003)).
2 Normal
expenditure out of income (IHTA 1984 s 21)
Section
21 provides as follows:
'a
transfer of value is an exempt transfer if, or to the extent that, it is shown-
(a) that
it was made as part of the normal expenditure of the transferor,
(b) that
(taking one year with another) it was made out of his income, and
(c) that,
after allowing for all transfers of value forming part of his normal
expenditure, the transferor is left with sufficient income to maintain his
usual standard of living.'
The
legislation does not define (nor indeed seek to explain) 'usual standard of
living' but HMRC accepts that the gifts do not have to be of cash: regular
gifts of shares will, for instance, suffice. Particular difficulties are
presented by requirement (a): what evidence is required to prove that payments
(or any payment) constitute normal expenditure? A pattern of payments is
presumably required and this is most easily shown where the taxpayer is
committed to making a series of payments as, for instance, where he enters into
a deed of covenant. In other cases (eg where there is no legal commitment to
make a series of payments) it has usually been assumed that a number of
payments would have to be made before there was sufficient evidence of
regularity.
Bennett
v IRC (1995)
casts some light on this problem. Mrs Bennett was the life tenant of a will
trust established by her late husband, the gross annual income from which was,
until 1987, £300 pa. In that year, as a result of the sale of the
trust assets, the income of the trust increased enormously and Mrs Bennett (a
lady of settled habits) indicated to the trustees that she wished her sons to
have surplus trust income above what was needed to satisfy her relatively
modest needs. Accordingly in 1989 each of the three sons received a
distribution of £9,300 and in the following year £60,000.
Mrs Bennett then unexpectedly died. The Inland Revenue contended that the 1989 and
1990 payments were failed PETs: the executors argued that they were exempt
under s 21. The court acknowledged that requirements (b) and (c) were satisfied
and so the matter turned on the meaning of 'normal expenditure'. This was
explained by Lightman J as follows:
'the term
"normal expenditure" connotes expenditure which at the time it took
place accorded with the settled pattern of expenditure adopted by the
transferor.
The
existence of the settled pattern may be established in two ways. First, an examination
of the expenditure by the transferor over a neriod of time may throw [*756] into relief a pattern, eg a
payment each year of 10% of all income to charity or members of the
individual's family or a payment of a fixed sum or a sum rising with inflation
as a pension to a former employee. Second, the individual may be shown to have
assumed a commitment, or adopted a firm resolution, regarding his future
expenditure and thereafter complied with it. The commitment may be legal (eg a
deed of covenant), religious (cg a vow to give all earnings beyond the sum
needed for subsistence to those in need) or moral (eg to support aged parents
or invalid relatives). The commitment or resolution need have none of these
characteristics but nonetheless be likewise effective as establishing a
pattern, eg to pay the annual premiums on a life insurance qualifying policy
gifted to a third party or to give a pre-determined part of his income to his
children.
For
expenditure to be "normal" there is no fixed minimum period during
which the expenditure should have occurred. All that is necessary is that on
the totality of the evidence the pattern of actual or intended regular payment
shall have been established and that the item in question conforms with that
pattern. If the prior commitment or resolution can be shown, a single payment
implementing the commitment or resolution may be sufficient. On the other hand
if no such commitment or resolution can be shown, a series of payments may be
required before the existence of the necessary pattern will emerge. The pattern
need not be immutable; it must, however, be established that the pattern was
intended to remain in place for more than a nominal period and indeed for a
sufficient period (barring unforeseen circumstances) in order for any payment
fairly to be regardea as a regular feature of the transferor's annual
expenditure. Thus a "deathbed" resolution to make periodic payments
"for life" and a payment made in accordance with such a determination
will not suffice.
The
amount of the expenditure need not be fixed in amount nor indeed the individual
recipient be the same. As regards quantum, it is sufficient that a formula or
standard has been adopted by application of which the payment (which may be of
a fluctuating amount) can be quantified eg 10% of any earnings whatever they
may be, or the costs of a sick or elderly dependant's residence at a nursing
home.'
On the
basis of this analysis he concluded that the two payments were exempted under s
21. In the later ease of Nadin v IRC (1997) not only did the payments exceed the taxpayer's
income for the year but there was no evidence of a prior commitment or
resolution and the payments did not form part of any pattern of expenditure. In
McDowall v IRC
[2004] SSCD 22 an attorney under a power of attorney purported to make lifetime
gifts in keeping with the taxpayer's established practice of making gifts to
his children, their spouses and grandchildren. The power of attorney contained
no express power for gifts to be made. The Special Commissioners held that the
gifts were invalid because the attorney was not permitted by the power of
attorney to make gifts. However, had the gifts been valid, they would have been
exempt under IHTA 1984 s 21 because there was a settled pattern of making gifts
and the gifts were made out of income.
EXAMPLE
31.4
A takes
out a life insurance policy on his own life for £60,000 with the
benefit of that policy being held on a trust for his grandchildren. A pays the
premiums on the policy of £3,500 pa. He makes a transfer of value of
£3,500 pa but he can make use of the normal expenditure exemption to
avoid IHT so long as all the
[*757] requirements for
that exemption are satisfied. Alternatively, the £3,000 annual
exemption would relieve most of the annual premium. (It is thought that even if
the first premium was paid before the policy was settled, the normal
expenditure exemption would apply to the value of the policy settled.)
Anti-avoidance
rules provide that:
(1) The
normal expenditure exemption will not cover a life insurance premium unless the
transferor can show that the life cover was not facilitated by and associated
with an annuity purchased on his own life (IHTA 1984 s 21(2)).
(2) Under
IHTA 1984 s 263 (unless the transferor can disprove the presumption of
associated transactions, as above) an IHT charge can arise when the benefit of
the life policy is vested in the douce. In general,
if a charge arises, the sum assured by the life policy is treated as a transfer of value. These
special rules exist to prevent tax saving by the use of back-to-back insurance
policies, as in the following example:
EXAMPLE
31.5
Tony pays
an insurance company £50,000 in return for an annuity of
£7,000 pa for the rest of his life. At the same time he enters into a
life insurance contract on his own life for £50,000 written in favour
of his brother Ted. The potential advantages
are that
on the death of Tony the sum of £50,000 is no longer part of his
estate and the annuity has no value when he dies but can be used during his
life to pay the premiums on the life insurance contract. The insurance proceeds
will not attract IHT because they do not form part of his estate and Tony could
claim that the premiums amounted to regular payments out of his income and so
were free of
IHT. HMRC
accepts that such arrangements are effective so long as the policies are not
linked and, ideally, are taken out with different companies.
As with
the annual exemption, this exemption does not prevent a gift from being caught
by the reservation of benefit rules.
[31.4]
3 Small
gifts (IHTA 1984 s 20)
Any
number of £250 gifts can be made in any tax year by a donor provided
that the gifts are to different donees. It must be an outright gift (not a gift
into settlement) and the sum cannot be severed from a larger gift. The section
provides that the transfers of value made to any one person in any one year
must not exceed £250: accordingly, it is not possible to combine this
small gifts exemption with the annual £3,000 exemption. A gift of
£3,250 would, therefore, be exempt as to £3,000 (assuming
that exemption was available) but the excess of £250 would not fall
under s 20 even if the gift had been structured by means of two separate
cheques. [31.5]
4 Gifts
in consideration of marriage (IHTA 1984 s 22)
The gift
must be made before or contemporaneously with the marriage and only after
marriage if in satisfaction of a prior legal obligation. It must be conditional
upon the marriage taking place so that should the marriage not [*758] occur the donor must have
the right to recover the gift (if this right is not
exercised,
there may be an IHT charge on the failure to exercise that right under IHTA
1984 s 3(3)). A particular marriage must be in contemplation; it will not
suffice, for instance, for a father to make a gift to his two-year-old daughter
expressed to be conditional upon her marriage on the fatalistic assumption that
she is bound to get married eventually The exemption can be used to settle
property, but only if the beneficiaries are limited to (generally) the couple,
any issue, and spouses of such issue (see IHTA 1984 s 22(4)). Hence, a marriage
cannot be used to effect a general settlement of assets within the family.
The sum
exempt from IHT is:
(1)
£5,000, if the donor is a parent of either party to the marriage.
Thus, each of four parents can give £5,000 to the couple.
(2)
£2,500, if the transferor is a remoter ancestor of either party to
the marriage (cg a grandparent or great-grandparent) or if the transferor is a
party to the marriage. The latter is designed to cover ante nuptial gifts since
after marriage transfers between spouses are normally exempt without limit (see
[31.41]).
(3)
£1,000, in the case of any other transferors (eg a wedding guest).
When a
gift of property is an exempt transfer because it was made in consideration of
marriage, the reservation of benefit provisions do not apply. [31.6]
EXAMPLE
31.6
(1)
Father gives son a Matisse sculpture on the occasion of the son's marriage. It
is worth £5,000. Possession of the piece is retained by the father
but as the transfer is covered by the marriage exemption his continued
possession does not fall within the reservation rules (FA 1986 s 1102(5)).
(2) Mum
gives daughter an interest in her house equal to £5,000 when the
daughter marries. Although Mum continues to live in the house the reservation
rules do not apply.
5
Dispositions for maintenance etc (IHTA 1984 s 11)
Dispositions
listed in IHTA 1984 s 11 are not transfers of value and so are ignored for IHT
purposes. HMRC takes the view that this exemption only applies to inter vi vos
dispositions, because 'disposition' does not cover the deemed disposition on
death. [31.7]
a) Maintenance
of a former spouse (IHTA 1984 s 11(1) (a))
Even
without this provision such payments would in many cases escape IHT. If made
before decree absolute, the exemption for gifts between spouses (see [31.41])
would operate and even after divorce they might escape IHT as regular payments
out of income; or fall within the annual exemption; or be non-gratuitous
transfers. What s 11 does is to put the matter beyond all doubt.
Two
problems may be mentioned. First, maintenance is not defined, so that whether
it would cover the transfer of capital assets (cg the former
matrimo-[*759]-nial home) is uncertain. Secondl't, if the payer dies but
payment is to continue for the lifetime of the recipient, the position is
unclear in the light of HMRC's view that this exemption is limited to inter
vivos dispositions. [31.8]
b) Maintenance
of children
Provision
for the maintenance, education or training of a child of either party to a
marriage (including stepchildren and adopted children) is not a transfer of
value (IHTA 1984 s 1l(1)(b): HMRC accepts that 'party to a marriage' includes a
widow or widower). The maintenance can continue beyond the age of 18 if the
child is in full-time education. Thus, school fees paid by parents escape IHT.
Similar principles operate where the disposition is for the maintenance of a
parent's illegitimate child (IHTA 1984 s 11(4)). Relief is also given for the
maintenance of other people's children if the child is an infant and not in the
care of either parent; once the child is 18, not only must he be undergoing
full-time education, but also the disponer must (in effect) have been in loco
parentis to the child during his minority (IHTA 1984 s 11(2)). Hence, payment
of school and college fees by grandparents will seldom escape IHT under this
provision. [31.9]
c) Care
or maintenance of a dependent relative
The
provision of maintenance whether direct or indirect must be reasonable and the
relative (as defined in IHTA 1984 s 11(6)) must be incapacitated by old age or infirmity
from maintaining himself (although mothers and mothers-in-law who are widowed
or separated are always dependent relatives). [31.1O]-[31.20]
11 DEATH
EXEMPTIONS AND RELIEFS
1
Woodlands (IHTA 1984 ss 125-130)
This
relief takes effect by deferring IHT on growing trees and underwood forming
part of the deceased's estate. Their value is left out of account on the death.
An election must be made for the relief by written notice given (normally)
within two years after the death (s 125(3)). It is not available where the
woodlands qualify for agricultural relief (see [31.62]) and commercial
woodlands will commonly qualify for business property relief ('BPR') (see
[31.42]): with the introduction of 100% BPR in 1992 for 'relevant business
property', woodland relief has become less important).
To
prevent deathbed IHT saving schemes the land must not have been purchased by
the deceased in the five years before his death (note, however, that the relief
is available if the woodlands were obtained by gift or inheritance within the
five-year period). If the timber is transferred on a second death no tax is
chargeable on later disposals by reference to the first death (s 126). The
relief does not apply to the land itself, but any IHT charged as a result of
death can be paid in instalments. The deferred tax on the timber may become
chargeable as follows: [31.21]
a) Sale
of the timber with or without the land
IHT will
be charged on the net proceeds of sale, but deductions can be made for costs of
selling the timber and also for the costs of replanting. The net [*760] proceeds arc taxed according to
full IHT rates at the date of the disposal and the tax is calculated by
treating those proceeds as forming the highest part of the deceased's estate.
Business property relief (at 50%) may be available where the trees or underwood
formed a business asset at the date of death and, but for the deferment
election, would have qualified for that relief at that time (see s 127 and
[31.42]). In such cases the relief is given against the net proceeds of sale
(IHTA 1984 s 127). [31.22]
b) A
gift of the timber
Not only
is the deferred charge triggered by a gift of the timber, but also the gift
itself may be subject to IHT subject to the availability of BPR. In calculating
the tax payable on the lifetime gift the value transferred is reduced by the
triggered IHT charged on the death and the tax can be paid by interest-free
instalments (whoever pays the IHT) spread over ten years (IHTA 1984 s 229). [31.23]
EXAMPLE
81.7
(1) Wally
Wood dies in January 1991 with a death estate of £200,000. In
addition, he owns at death woodlands with the growing timber valued at
£40,000 anti the land etc valued at £30,000. The woodlands
exemption is claimed by his daughter Wilma. In 1998 she sells the timber; the
net proceeds of sale are £50,000.
(i)
Position on Walli death: The timber is left out of account. The value of the
rest of the business (f30,000) attracts 50% business relief (the relevant level
of relief in 1991: see (3) below), so that only £15,000 will be added
to the £200,000 chargeable estate.
(ii)
Position on Wilma m sale: The IHT charge is triggered. The net proceeds are
reduced by 50% business relief to £25,000 which will be taxed
according to the rates of IHT in force in 1998 for transfers between
£215,000 (ie Wally's total chargeable death estate) and
£240,000.
(2) As in
(1), above except that Wilma settles the timber on her brother Woad in 1998
when its net value is £50,000. The deferred charge will be triggered
as in para (ii) of (1), above. IHT on Wilma's gift will be calculated according
to IHT rates in force for 1998. She can deduct from the net value of the timber
the deferred tax ((1), above) and any IHT can be paid by instalments whether it
is paid by her or by Woad.
(3) With
the increase in the level of BPR to 100% in 1992, the woodlands election should
not be made if the woodlands form part of a qualifying business: instead of a
partial deferment of charge the business is wholly tax free.
e) PETs
and estate duty
Estate
duty was not charged on the value of timber, trees, wood or underwood growing
on land comprised in an estate at death. Instead, tax was deferred until such
time as the woodlands were sold and was then levied at the death estate rate on
the net proceeds of sale (subject to the proviso that duty could not exceed tax
on the value of the timber at the date of the death). Pending sale, duty was
therefore held in suspense and this deferral period only ceased on the
happening of a later death when the woodlands again became subject to duty. The
introduction of a charge on lifetime gifts [*761] with the
advent of CTT resulted in this deferral period terminating immediately after
the first transfer of value occurring after 12 March 1975 in which the value
transferred was determined by reference to the land in question (subject only
to an exclusion if that transfer was to the transferor's spouse and therefore
exempt from CTT: see FA 1975 s 49(4)). In such cases, the deferred estate duty
charge was superseded by a charge to CTT on the transfer value.
With the
introduction of the PET it was realised that a transfer of value of woodlands
subject to estate duty deferral to another individual would, prima face, be a PET but that the transfer
would have the effect of ending the deferral period thereby cancelling any
charge to duty without a compensating charge to IHT. Hence, IHITA 1984 Sch 19
para 46 provides that transfers of value which fall within FA 1975 s 49(4) and
thereby bring to an end the estate duty deferral period shall not be PETs.
Accordingly, such transfers remain immediately chargeable to IHT at the
transferor's rates (with the possibility of a supplementary charge should he
die within the following seven years).
[31.24]
EXAMPLE
31.8
On his
death in May 1973 Claude left his landed estate to his son Charles. That estate
included woodlands valued, in 1973, at £6,000. Consider the tax
position in the following three situations:
(1) If
Charles sells the timber in 1999 for £16,00a The net proceeds of sale
will be subject to an estate duty charge levied at Claude's estate rate but
duty will be limited by reference to the value of the timber in 1973 (ie it
will be charged on £6,000).
(2) If
Charles mains the timber until his death in 1999 when it passes to his
daughter.
This
transfer of value will end the estate duty deferral period so that the
potential charge to duty will be removed. However, the transfer to his daughter
will be subject to an IHT charge unless the woodlands deferral election under
IHTA 1984, ss 125 ff is claimed.
(3) If
Charles makes an inter vi vos gift of his estate (including the woodlands) in
August 1999 to his daughter. Such a gift will not be potentially exempt because
of IHTA 1984 Sch 19 para 46. Accordingly, it will terminate the estate duty
suspense period, and will result in an immediate IHT charge levied according to
Charles' rates. From the wording of para 46 it is not clear whether any part of
this transfer can be potentially exempt or whether the entire value transferred
is subject to an immediate charge. Undoubtedly the value of the timber will
attract such a charge and likewise it would seem that the value of the land on
which the timber is growing will fall outside the definition of a PET (see the
wording of FA 1975 s 49(4)). What, however, if the transfer of value made by
Charles includes other property, eg other parts of a landed estate which are
not afforested? There was a danger that none of the value transferred would be
a PET since para 46 is not limited to that part of any transfer of value
comprising the woodlands. The injustice is recognised by ESC F15 which states
that 'the scope of [para 46] will henceforth be restricted solely to that part
of the value transferred which is attributable to the woodlands which are the
subject of the deferred charge'.
2 Death
on active service (IHTA 1984 s 154)
IHTA 1984
s 154 ensures that the estates of persons dying on active service, including
members of the UDR and RUC killed by terrorists in Northern [*762] Ireland, are exempt from IHT.
This provision has been generously interpreted to cover a death arising many
years after a wound inflicted whilst on active service, so long as that wound
was one of the causes of death; it need not have been the only, or even the
direct cause (Barty-King v Ministry of Defence (1979)). Although a donatio
mortis causa is covered by the exemption it does not apply to lifetime
transfers. [31.25]-[31.40]
III
EXEMPTIONS FOR LIFETIME AND DEATH TRANSFERS
1 The
inter-spouse/civil partners exemption (IHTA 1984 s 18)
This most
valuable exemption from IHT for transfers between spouses is unlimited in
amount except where the donor spouse is but the donee spouse is not domiciled
in the UK when the amount excluded from IHT is £55,000. In Holland
(Exor of Holland Deceased) v IRC (2003) the Special Commissioners decided that a couple
who had lived together as husband and wife for 31 years did not qualify for the
spouse exemption. A spouse for this purpose was a person who was legally
married. The Commissioners further expressed the view that this did not involve
discrimination against unmarried couples under the HRA 1998 (see [55.42]).
The Civil
Partnership Act 2004 introduced the concept of 'civil partnerships' with the
aim of putting same-sex couples on a similar footing to married couples. For
tax purposes, this has been achieved through FA 2005, and regulations that
provide for reliefs applying to married couples to apply equally to civil
partners eg the inter-spousal exemption. For the sake of simplicity, references
to spouses in the inheritance chapters in this book will generally be deemed to
include civil partners.
The use
of this exemption is considered in different parts of this book and the
following points represent a summary of those sections:
(1) For
tax planning purposes the lowest total IHT bill is produced if both spouses use
up their nil rate bands (see [51.741). Particular problems may result on the
death of the first to die if the only substantial asset in his estate is the
main residence that is needed by his surviving spouse: for a consideration of
the Lloyds Private Banking case, see [32.3].
(2) Both
should take advantage of the lifetime exemptions. HMRC will normally not invoke
the associated operations provisions to challenge a transfer between spouses
even if it enables this to occur ([28.101]).
(3) The
rules for related property are designed to counter tax saving by splitting
assets between spouses (see [28.70]).
(4) IHT
on a chargeable transfer by one spouse to a third party may be collected from
the other spouse in certain circumstances (see [28.171]). [31.41]
2
Business property relief ('BPR': IHTA 1984 ss 103-114)
Business
(and agricultural property) relief was introduced in order to ensure that
businesses were not broken up by the imposition of an IHT charge. BPR takes
effect by a percentage reduction in the value transferred by a transfer of
value and, prior to 10 March 1992, that reduction was at either 50% or 30%.
Exemptions
for lifetime and death transfers 763
For
transfers made on and after that date the levels were increased to 100% and 50%
with the result that most family businesses and farms were taken outside the
tax net. The relief is given automatically. [31.42]
a) Meaning
of 'relevant business property'
Business
property relief is given in respect of transfers of 'relevant business
property' which is defined as any of the following:
(1) A
business: For example, that of a sole trader or sole practitioner (s
l05(1)(a)). A sole trader who transfers a part of his trade falls within this
category and this may include a transfer of settled land (of which he is the
life tenant) which is used in the business (Fetherstonehaugh v IRC (1984)).
(2) An
interest in a business: For example, the share of a partner in either a trading
or professional partnership (s 105(1)(a)).
(3)
Listed shares or securities which gave the transferor control of the company (s
105(l)(cc): Control itself does not have to be transferred; the requirement is
simply that at the time of transfer the transferor should have such control
(see [31.54]).
(4)
Unquoted securities which gave the transferor control of the company (s
105(1)(b)): Similar comments to those in (3) apply: unquoted shares include
shares dealt in on the Alternative Investment Market (AIM).
(5) Any
unquoted shares in a company (s 105(1)(bb)).
(6) An
land or building, plant or machinery which immediately before the transfer was
used by a partnership in which the transferor was a partner or by a company of
which he had control (s 105(1)(d)).
Control
for these purposes requires a majority of votes (50%+) on all questions
affecting the company as a whole (see (3) and (4), above). Hence, an apparently
unjust result is produced if the appropriate asset is used by a company in
which the transferor owned a minority of the ordinary shares when no relief
will be available, whereas had the asset been used by a partnership, then,
irrespective of his profit share, relief would be available. Relief is also
available if the asset is held in a trust but is used by a life tenant for his
own business or by a company which he controls. The relief is given
irrespective of whether a rent is charged for the use of the asset.
In Beckman
v IRC (2000) H
retired as a partner and her capital account (reflecting capital introduced
into the business) was left outstanding as a debt of the business. On H's
subsequent death she had ceased to own a share in the business of which she had
become a creditor. No relief was therefore available. [31.43]
b) Relief
is on the net value of the business
Relief is
given on the net value of the business and IHTA 1984 s 110(b) states that the
net value is:
the value
of the assets used in the business (including goodwill) reduced by the
aggregate amount of any liabilities incurred for the purposes of the business.'
A number
of matters are worthy of note in connection with the above definition: [*764]
(1) The
definition is limiting--there will he assets and liabilities which are
connected with the business but which do not satisfy the wording of s 110(h).
Such assets and liabilities will, of course, still form part of the estate of
the taxpayer under s 5 but will not benefit from the relief (or, in the case of
liabilities, will not reduce the relief).
EXAMPLE
31.9
(a) H was
a Lloyd's Name at the time of his death. He had deposited funds at Lloyd's and
had borrowed moneys to fund those deposits. At his death he owed amounts on
accounts for which a result had not been announced. The Special Commissioner
decided that the amounts owed on those accounts were trading losses and did not
reduce the assets on which relief was available (although these liabilities did
reduce the value of H's estate under s5(4): see [31.13]). It was accepted that
the deposited sum and borrowings taken out in connection with it fell within s
110(b) as being assets used in the business and liabilities incurred for the
purposes of the business but the losses were trading losses and not liabilities
incurred for the purposes of the business. Rather, they arose out of the
running of the business: in the language used in a line of income tax eases,
they were the fruit (income) produced by the tree (capital) (see, for instance,
Van den Beighs Ltd v Clark (1935) at [10.106]). Of course, in this case the result
produced enhanced BPR but the position will often be the opposite since trading
receipts will not constitute assets used in the business. The Revenue has
indicated that it considers the ease to be limited to its own facts but this
does not appear to be correct (Hardcastle v IRC (2000)).
(1) Sid
acquires Roy's flower business with the aid of a loan from Finance for Flowers
(FFF). That debt is not incurred for the purposes of the business and so does
not reduce the value of the business assets.
(2) The
value qualifying for BPR cannot be increased by charging business debts on
non-business property (contrast Example 31.19 in the context of APR).
(3) In IRC
v Mallender
(2001) a Lloyd's underwriter provided a bank guarantee for £100,000
in support of his business. That guarantee was secured by a legal charge on a
property worth £1m. The Special Commissioner decided that the £lm
property was one of the assets used in the business. Not surprisingly, this was
reversed by the High Court: in practice, HMRC accepts that the
£100,000 guarantee attracts relief as an asset used in the business
(see Taxation,
8 August 2002, p 514). [31.44]
e) Amount
of relief
Relief is
given by percentage reduction in the value of the business property
transferred. The chargeable transfer will be of that reduced sum. Business
property relief is applied before other reliefs (for instance, the
£3,000 inter vivos annual exemption). The appropriate percentage depends
upon which category of business property is involved.
100%
relief is available for businesses, interests in businesses, and all
shareholdings in unquoted companies (ie categories (1), (2), (4) and (5),
above).
50%
relief is available for controlling shareholdings in listed companies (category
(3), above) and for assets used by a business (category (6), above). [31.45] [*765]
EXAMPLE
31.10
Topsy is
a partner in the firm of Topsy & Tim (builders). He owns the site of the
firm's offices and goods yard. He settles the following property on his
daughter Teasy for life: (1) his share of the business (value
£500,000) and (2) the site (value £50,000). Business
property relief will be available on the business at 100% so that the value
transferred is reduced to nil and on the site at 50% SO that the value
transferred is £25,000.
Notes:
(1)
Topsy's total transfers amount to £25,000 which may be further
reduced if other exemptions are available.
(2) IHT
may remain payable on business property after deducting the 50% (and any other)
relief(s). Whether the chargeable transfer is made during lifetime or on death,
it will usually be possible to pay the tax by interest-free instalments (see
[31.58] for a discussion of the position when IHT or additional IHT is charged
because of death within seven years of a chargeable transfer and for the
clawback rules).
d) The
two-year ownership requirement
In
general, relevant business property which has been owned for less than two years
attracts no relief (IHTA 1984 s 106). However, the incorporation of a business
will not affect the running of the two-year period (IHTA 1984 s 107) and if a
transfer of a business is made between spouses on death, the recipient can
include the ownership period of the deceased spouse. This is not, however, the
case with an inter vivos transfer (IHTA 1984 s 108). If the spouse takes the
property as the result of a written variation read back into the will under
IHTA 1984 s 142 the recipient is treated as being entitled to property on the
death of the other spouse. When entitlement results from an appropriation of
assets by the PRs this provision would not, however, apply. [31.46]
EXAMPLE
31.11
(1)
Solomon incorporated his leather business by forming Solomon Ltd in which he
holds 100% of the issued shares. For BPR the two-year ownership period begins
with the commencement of Solomon's original leather business.
(2)
Solomon set up his family company one year before his death and left the shares to his wife in
his will. She can include his one-year ownership period towards satisfying the
two-year requirement. If he made a lifetime gift to her, aggregation is not
possible.
(3) If
Mrs Solomon had died within two years of the gift from her husband (whether that
gift had been made inter amos or on death) business relief will be available on
her death so long as the conditions for relief were satisfied at the time of
the earlier transfer by her husband (IHTA 1984 s 109). A similar result follows
if the gift from her husband had been by will and she had
made a
lifetime chargeable transfer of the property within two years of his death (in
this ease relief could be afforded under s 109 and, if Mr Solomon had not
satisfied the two-year requirement, his period of ownership could be aggregated
with that of Mrs Solomon under s 108).
[*766]
e) Non
qualifying activities: the wholly or mainly test
'Business'
is a word of wide import and a landlord who lets properties with a view to
profit may fall within its ambit. IHTA 1984 s 105(3) makes clear, however, that
there are certain businesses for which relief is not available ('if the
business ... consists wholly or mainly of one or more of the following, that is
to say, dealing in securities, stocks or shares, land or buildings or making or
holding investments'). It was held in ((2006) SpC) that a company whose
activity was the making of loans Phillips v R&C Commrs to related companies was not in
the business of investing in loans and, accordingly, could not be classed as a company
whose business consisted wholly or mainly in the making or holding of
investments. However, the Special Commissioner made it clear that it could
never be said that the making of loans was never the making of an investment or that it always was; it 'was
necessary to have regard to
all the facts in the round'). Note that a wholly or mainly test is to be applied and that the legislation does
not seek to define this phrase. This means that a taxpayer may conduct, within
a single business, two activities one of
which may fall on the 'investment' side of the line, eg a trade may have income
from managed investments held as a reserve, but the wholly or mainly test may
result in that entire business attracting relief. The business must be carried
on with a view to making a profit (Grimwood Taylor v IRC (1999)). [31.47]
f) Commercial
landlords
An
unreported Special Commissioner case decided that a commercial landlord who
maintained a high quality of service to his professional tenants (the services
embracing cleaning operations, maintenance and decoration) was entitled to the
relief. The taxpayer was considered to be acting as managing agent: his daily
activities and his obligations far exceeded those which would normally be
placed on the holder of an investment (see Taxation, 3 May 1990, p 1126: the
Special Commissioner has since commented that the facts of this case were
'exceptional': see Powell v IRC (1997)). Two later (and reported) Special Commissioner
cases have, however, rejected any suggestion that a line can be drawn between
'passive' property investment on the one hand and 'active' management on the
other (see Martin (Executors of Moore) v IRC (1995); Burkinyoung (Executor
of Burkinyoung) v IRC
(1995)). In the latter case the Special Commissioner commented as follows:
'The
construction sought by the taxpayer which seeks to distinguish between the
operations of the active and of the passive landlord is too vague and too
dependent on degrees of involvement to have been what Parliament contemplated
when the relief was designed.
Here the
whole gain derived by Mrs Burkinyoung from the property came to her as rent. It
all arose from the investment in the property and the leases granted out of it;
it all arose from the making or holding investment activities carried on by
her. She provided no additional services and so earned nothing from any other
sources or activities. The business was, therefore, wholly one of making or
holding investments and so is excluded from being "relevant business property"
by the words of section 105(3).
[31.48] [*767]
g) Static
caravan sites and residential home parks
Other
cases before the Special Commissioners have considered whether owner/managers
of caravan parks qualify for business property relief. In both Hall (Executors
of Hall) v IRC
(1997) and Powell v IRC (1997) it was decided that relief was not available because the
business 'mainly' involved the making or holding of investments. In the Hall case, of the total income of the
business (£36,741) the greatest component (amounting tO either 84% or
65% depending on how the calculation was performed) was attributable to rents
and standing charges. The Special Commissioners concluded therefore that:
'In such
circumstances we have come to the conclusion that the activities of the
business carried on at Tanat Caravan Park consisted mainly of the making or
holding investments. Although the receipt of commissions on the sale of
caravans forms part of the business we find that it was ancillary to the main
business of receiving rents from owners of caravans and lessees of chalets. The
business was preponderantly one of the receipt of rents.'
By
contrast, in Furness v IRC (1999), net profit from caravan sales exceeded the net
profit produced by caravan rents and the Special Commissioner decided that s
105(3) was inapplicable. In Weston v IRC (2000), another case where the taxpayer lost, the
High Court confirmed that whether assets were investments or were held as part
of the business and whether the business consisted wholly or mainly of the
holding of those investments were questions of fact to be determined by the
Commissioners. [31.49]
h) A
mixed business: The Farmer case
It was
accepted in this case that there was a single composite business comprising
farming and the letting of various former farm buildings. The Special
Commissioner concluded that on the application of the 'wholly or mainly' test
and taking the business in the round the business consisted mainly of farming.
The relevant factors considered by the Commissioner were:
(1) the
business property was a landed estate with most of the land being used for
farming. Lettings were subsidiary to the farming business and were of short
duration;
(2) of
the capital employed in the business (3.5m), £1.25m could be appropriated to the lettings and
£2.25m to farming;
(3) the
employees and consultants spent more time on the farming activities than on the
lettings;
(4) farm
turnover exceeded letting turnover in six years out of eight;
(5) in
every year the net profit of the lettings exceeded the net profit of the farm.
Three
points should be stressed. First, that in all such cases it is necessary to
consider the position over a period of time rather than at a particular moment.
Secondly, that the Revenue's argument that the 'wholly or mainly' test fell to
be determined on the basis of net profits was rejected in favour of a test
based on the character of the business as a whole. Thirdly, there is the tie-in
with the test laid down in TCGA 1992 Sch Al para 22 where a company [*768] is a trading company, so that
business asset taper is available on the shares (see Tax Bulletin, June 2001).
In the context of determining whether a company's non-trading purposes are
capable of having a 'substantial' effect on the extent of the Company's
activities, the various factors identified in Farmer are considered to be
relevant (eg turnover from non-trading activities; the assets base of the
company; expenses incurred by or time spent by officers and employees in undertaking
the activities of the company; the
historical
context of the company. [31.50]
i) A
mixed business: The Stedman case
In IRC
v George (Stedman Decd) (2003) the company owned a caravan site and carried on the following
activities:
residential
homes park-site fees and connected to sewerage, water,
-
electricity and gas; sale of caravans; business of buying arid selling gas,
electricity, water etc at a profit;
- storage
of touring caravans when not in use (investment)
- income
from letting a warehouse and a grazing agreement (investment);
- a club
for residents and non residents.
Laddie J
held (confirming Weston on this point) that the correct approach in deciding
whether business property relief was available was first to identify what
investments the company had and then to decide if the business was mainly one
of holding investments. Dealing with this first question he concluded that:
'the
business of receiving site fees from each of the mobile home owners for the
right to place their vehicles on the Company's land . and the receipt of fees
for allowing others to store mobile homes ... constitute exploitation of the
Company's proprietary rights in the land. They constitute the business of
holding an investment.'
Having so
decided, he then concluded that all of the services (the supply of water,
electricity and gas) were ancillary to that investment business.
'It
appears to me that what falls within the investment business "bag" is
not only the core holding of the land and the receipt of fees or rent in
respect of its use, but also all those activities which, viewed through the
eyes of an average businessman, would be regarded as "incidental' to that
core activity ... activities which are incidental to the letting of land are
not severable from it and take on the investment character of the letting.
Activities which have minor commercial justification by themselves are likely
to be regarded as part of the business which they support ... the extent to
which such subsidiary activity makes a profit will be some indication of
whether it is a stand alone business or should be regarded as merely incidental
to the business it supports. Put another way, an activity which is incidental
to, say, an investment business does not cease to be so because the landlord
decides to make an additional profit on it.'
Whilst
this concept of 'incidental activities' appears straightforward in the
application to (say) let industrial units in respect of compliance and
management activities designed to keep up the standard of the investment
properties, in other cases it may be difficult to identify the core business to
which [*769] other activities may then be classified
as subsidiary. In the case of caravan/mobile home parks it is a little
difficult to say that the core activity is a simple letting of land given that
it is the services provided which are an integral part of the letting. As a not
wholly dissimilar example take the business of an hotelier or of providing bed
and breakfast, where, although there is an exploitation of land (in the form of
the relevant building), the predominant activity is the services provided. The
Furness case was not mentioned in the judgment: it is perhaps distinguishable
on the basis that the most profitable activity involved the selling of caravans
and that the site was also used by touring caravans.
Having
classified the business as predominantly investment and classified the
facilities provided by the company as incidental thereto Laddie J concluded
that only the operation of the Country Club and the caravan sales were not
investment activities and so the bulk of the gain and net profit flowed from
site fees and storage. Hence he concluded that the main activity of the company
was the holding of an investment in land so that no business relief was
available.
The case
came before the Court of Appeal which held that it was difficult to see any
reason why an active family business of the kind in this case should be denied
business property relief merely because a necessary component of its profits
making activity was the use of land. It was further held that IHTA 1984 s 105
did not require the opening of an investment bag into which were placed all the
acticities linked to the activity that required the use of land je the caravan
park just because it could be said that such activities were ancillary to the
caravan business. Attempting to identify 'the very business' of the company was
not required by s 105 nor did it give adequate weight to the hybrid nature of a
caravan site business. Further, just because services were provided under the
terms of the lease did not mean that they lost their character as services and
became part of the investment activity.
This is a
welcome decision for the taxpayer because it now means that activities will not
be denied relief just because they support or and related to an investment
activity. Clearly, whether relief is available in any given case will depend on
the facts.
The
decision in the Sted man case was followed in Clark (Executors of Clark
(decd) v Revenue & Customs Comrs [2005] (SpC).
[31.51]
j) Excepted
assets
Non-business
assets cannot be included as a part of the business in an attempt to take
advantage of the relief (IHTA 1984 s 112. Problems commonly arise when surplus
cash is retained within the business: relief will only be available if that
cash 'was required at the time of transfer for future use for (the purposes of
the business)' (see s 112(2)(b) and Barclays Bank Trust Co Ltd v IRC (1998)). HMRC may also query sums
held in deposits at Lloyd's by Names.
[31.52]
k) Contracts
to sell the business and options
Relief is
not available for transfers of the sale proceeds from a business and the relief
does not extend to business property subject to a 'buy and sell' agreement.
Arrangements are common in partnership agreements and [*770] amongst
shareholder/directors of companies to provide that if one of the partners or
shareholder/directors dies then his PRs are obliged to sell the share(s) and
the survivors are obliged to purchase them. As this is a binding contract, the
beneficial ownership in the business or shares has passed to the purchaser so
that business relief is not available.
EXAMPLE
31.12
The
shares of Zerzes Ltd are owned equally by the four directors. The articles of
association provide that on the death of a shareholder his shares shall be sold
to the remaining shareholder/directors who must purchase them. Business relief
is not available on that death. If the other shareholders had merely possessed
pre-emption rights or if the arrangement had involved the use of options, as no
binding contract of sale exists, the relief would apply.
Particular
problems may arise to the context of partnership agreements: professional
partnerships, for instance, commonly include automatic accruer clauses whereby
the share of a deceased partner passes automatically to the surviving partners
with his estate being entitled to payment either on a -; valuation or in
accordance with a formula. Alter some uncertainty the Revenue now accepts that
accruer clauses do not constitute binding contracts for sale and nor do option
arrangements (Law Society's Gazette, 4 September 1996, p 35). It appears that the section
applies only if the contract is to sell a business or part of a business: by
contrasta contract to sell assets used in a business is not caught. [31.53]
1)
Businesses held in settlements
For
interest in possession trusts the relief is given, as one would expect, by
reference to the life tenant. (It should be noted that the changes made by FA
2006 in respect of interests in possession do not appear to affect the issue of
business property relief as it applies to settled property, because all that is
required for the relief to be claimed is for the transferor to have a
'beneficial interest in possession'; the deemed ownership of the underlying
capital is not at issue in these circumstances. Whether this was intentional or
an oversight remains to be seen). So long as the life tenant satisfies the
two-year ownership test, relief will be given at the following rates:
(1) 100%
relief for all unquoted shares and for businesses belonging to the trust;
(2) 50%
relief for controlling shareholdings in listed companies held in the trust; and
(3) 50%
relief for the assets listed in (6) at [31.43] which are held in the trust and
which are either used by the life tenant for his own business or by a company
controlled by him.
Fetherstonehaugh
v IRC (1984)
concerned the availability of relief when land held under a strict settlement
was used by the life tenant as part of his farming business (he was a sole
trader absolutely entitled to the other business assets). The Court of Appeal
held that 100% (then 50%) relief was available under s 105(1) (a) on the land
in the settlement with the result that the subsequent introduction of 50% (then
30%) relief is apparently redundant in such cases. HMRC now accepts that in
cases similar to Fetherstonehaugh [*771] the maximum 100% relief will be
available since the land will be treated as an 'asset used in the business'
and, as its value is included in the transfer of value, the land will be taxed
on the basis that the deceased was the absolute owner of it.
For
trusts without interests in possession, relief is given so long as the
conditions are satisfied by the trustees. The relief will be given against the
anniversary charge and when the business ceases to be relevant property (eg
when it leaves the trust) on fulfilment of the normal conditions. [31.54]
m) 'Control'
Control
is defined as follows:
'a person
has control of a company at any time if he then has the control of powers of
voting on all questions affecting the company as a whole which if exercised
would yield a majority of the votes capable of being exercised thereon ...'
(IHTA 1984
s
269(1)).
Hence,
control of more than 50% of the votes exercisable in general meeting will
ensure that the transferor has 'control' for the purposes of BPR. A transfer of
his shares in a listed company will attract 50% relief and a transfer of
qualifying assets used by a company which the taxpayer controls 50% relief
(control is also important in the context of APR: see [31.67]). In calculating
whether he has control, a life tenant can aggregate shares held by the
seulement with shares in his free estate, whilst the related property rules
(see [28.70]) result in shares of husband and wife being treated as one
holding.
In Walker
v IRC (2001) a
Special Commissioner decided that a 50% shareholder, who was the chairman of
the company and who had a casting vote at meetings, was able to control a
majority of votes at any meeting as required by s 269. In Walding v IRC (1996) Knox J decided that all
votes had to be taken into account for the purpose of deciding whether the s
269 test was satisfied. The fact that shares were held by a five-year-old child
did not therefore mean that those votes could be ignored for this purpose. [31.55]
n) Relief
for minority shareholdings in unquoted companies
For
transfers of value made and other events occurring on or after 6 April 1996
relief at 100% is available for all minority shareholdings in unquoted
conipanies (including companies listed on AIM). Prior to that date relief at
100% was only available for substantial minority shareholdings (ie 25% plus) in
such companies with smaller shareholdings attracting only 50% relief. As a
result of the change all shares in unquoted companies may now attract 100%
relief irrespective of the size of holding: the continuing distinction in the
legislation between controlling shareholdings and others remains important, however,
where assets are owned outside the company. [31.56]
o) Switching
control
It might
be assumed that because of the two-year ownership requirement, both the
business property (eg the shares and control must have been [*772] owned throughout this period.
This, however, does not appear to be the case for relief under s 105(1)(b)
since it is only the shares transferred which must have been owned for two
years and control is only required immediately before the relevant transfer.
Thus the taxpayer may-for instance as the result of a buy-back-obtain control
of the company many years after acquiring his shares.
EXAMPLE
31.13
Of the
100 issued ordinary shares in Buy-Back Ltd Zack owns 40, Jed 40 and the
remaining 20 are split amongst miscellaneous charities. Assume that in July
2002 Buy-Back buys Zack's holding. As those shares are cancelled the issued
capital falls to 60 shares of which Jed owns 40. Were he to die in September
2002, his shareholding would fall under s 105(1)(b).
It may be
possible for the partners in a quasi-partnership company to ensure that each
obtains control for a short period (eg one month) to produce enhanced business
relief. [31.57]
EXAMPLE
31.14
The
shares in ABCD Ltd are owned as to 25% each by A, B, C and D. The shares are
divided into four classes in December 2002 which will carry control in January,
February, March and April 2003 respectively. In January 2003 A transfers his
shares.
(1) As A
has control (under s 269U) in January 2003 he is entitled to relief at 50% on
land which he transfers and which had been used by the company.
(2) Might
temporary shifts of control be nullified under the Ramsay principle? It is arguable that,
as the legislation expressly requires control at one moment only (namely
immediately before the transfer), that is an end to the matter. It is, however,
desirable that A should at the time of transfer actually possess control of the
business: ie the other shareholders must accept that A could, if he wished,
exercise his voting control over the affairs of the company.
p) Business
relief and the instalment option
Any value
transferred after deduction of BPR may be further reduced by the normal IHT
exemptions and reliefs which are deducted after business relief so that a
lifetime gift, for instance, may be reduced by the £3,000 annual
exemption. Further, any tax payable may normally be spread over ten years and
paid by annual interest-free instalments (see [30.51]). This instalment
election is only available, in the case of lifetime gifts, if the IHT is borne
by the donee: on death the election should be made by the PRs. Although there
is a similarity between assets which attract business relief and assets
qualifying for the instalment option, the option may be valuable where there
are excepted assets or where the business is disqualified under the s 105(3)
test (see [31.47]). This is because the definition of 'qualifying property' for
the purposes of s 227 (the instalment option) and s 234 (interest-free
instalments) is wider than for the purposes of BPR. There are limitations on
the availability of instalment relief in the case of a transfer of unquoted
shares not giving control (see [31.54]), as the following table indicates: [*773]
Relevant business property
Instalment assets
IHTA 1984 Part V Chapter 1)
(IHTA 1984 Part VIII)
---------------------------
-------------------------
s 105(1) (a): a business or an s 227: a business or an interest in a
interest in a business
business
s 105(1)(b): shares etc, giving s 227(2): land s 228(1)(a): shares
control
etc, giving control
s 105(1)(bb): unquoted shares s 228(1)(b): on death, unquoted
.
shares being at least 20%, of the
.
total
transfer
.
s 228(l)(c): unquoted shares with
.
hardship
.
s 228(1)(d) and 228(3): unquoted
.
shares within the 10% and 20,000
.
rule s 222 woodlands.
These limitations on the instalment option have been
defended by HMRC on the grounds that 'it has been considered inappropriate for
the instalment facility to apply in cases involving less than substantial
interests in unquoted companies' (see further (1985) 6 CTT News 284). [31.58]
q) Clawback
When a transferor makes a lifetime chargeable transfer or
a PET and dies within seven years, the IHT or extra IHT payable is calculated
on the basis that business relief is not available unless the original (or
substituted) property remains owned by the transferee at the death of the
transferor (or at the death of the transferee if earlier) and would qualify for
business relief immediately before the transferor's death (ignoring, however,
the two-year ownership requirement). This 'clawback' of relief is anomalous:
relief on death is not similarly withdrawn if the business property is sold
after the death. Of course, the instalment option is similarly restricted since
it is only available if the original or substituted business property is owned
by the transferee at death. Relief is given for substituted property when the
entire (net) proceeds of sale of the original property are reinvested within
three years (or such longer period as the Board may allow) in replacement
qualifying property (for the position where business property is replaced by
agricultural property and vice versa see Tax Bulletin, 1994, p 182 and
[31.74]).
EXAMPLE
31.15
(1) Sim
gave his ironmonger's business to his daughter, Sammy, in 2001 (a PET) and died
in 2007. Sammy has continued to run the business. Although the PET became
chargeable because of Sim's death within seven years, 100% relief is available
(qualifying property retained by donee).
(2) As in
(1) save that Sammy immediately sold the business (or the business was closed
down) in 2001. No business relief is available on Sim's death. The value of the
business in 2001 is taxed and forms part of Sim's cumulative total on
death. [*774]
(3) As in
(1) save that Sammy had incorporated the business late in 2001 and had
continued to run it as the sole shareholder/director. Business relief is
available on Sims death (substituted qualifying property).
(4) Sim
settled business property on A&M trusts (a PET since the settlement was
made prior to 22 March 2006). Before the death of Sim in 2007 a beneficiary
either becomes entitled to an interest in possession in the settled property
(prior to 22 March 2006) or, alternatively, absolutely entitled. Has the
transferee retained business property in these cases so that the original gift continues to qualify for relief? In
the former situation (where a life interest has come into being) common sense
would suggest the answer is 'yes' since the property is owned throughout the
period by the transferee who in this case would be the trustees. HMRC
disagrees, however, on the basis that under IHTA 1984 s 49(1) the life tenant
is treated as owning the capital assets. In the latter case beneficial title
has passed to the beneficiary. Accordingly, a clawback charge arises in both
cases. If the original settlement had been
on interest in possession trusts and by the time of the settlor's death the
trustees had advanced the property (under the terms of the trust) to the life
tenant there would be no clawback since the life tenant is treated as the
'transferee' throughout.
EXAMPLE
31.16
Jock
settles his business (then worth £500,000) on discretionary trusts in
199 (a chargeable lifetime transfer). He dies in 2003 when the business has
been sold by the trustees.
(1) On
the 1997 transfer. 100% relief is available so that the value transferred is
nil.
(2) On
his death in 2003: no relief is available so that extra IHT is calculated on a
value transferred of £500,000. Note that the result of a withdrawal
of relief is that the additional tax is charged on the entire value of the
business but this does not alter Jock's cumulative total (contrast the effect
of loss of relief when the original transfer was a PET: see Example 31.14(5)).
There was
a technical argument that if the gifted property attracted 100% relief it was
an exempt transfer either under IHTA 1984 s 20 (see [31.5]) or under s 19 (see
[31.3]). If so, the transfer could be neither chargeable nor potentially exempt
with the result that the clawback rules did not apply (See Private Client
Business (1992) p 7.) 'For the removal of doubt' FA 1996 inserted a new
subsection (7A) into s 113A which provided that in determining whether there
was a PET or chargeable transfer for the purposes of the clawback rules any
reduction in value under the BPR rules is ignored. [31.59]
r) Business
property subject to a reservation
Business
property subject to a reservation is treated as comprised in the donor's estate
at death (if the reservation is still then subsisting) or, if the reservation
ceases inter vivos, as forming the subject matter of a deemed PET made at that
time (see Chapter 29). In both cases business relief may be available to reduce
the value of the property subject to charge. Whether the relief is available or
not is generally decided by treating the transfer as made by the donee who must
therefore satisfy the BPR requirements (FA 1986 Sch 20 para 8). However, for
these purposes, the period of ownership of the donor can be included with that
of the donee in order to satisfy the two-year
requirement [*775]
Any
question of whether shares or securities qualify for 100% BPR must be decided
as if the shares or securities were owned by the donor and had been owned by
him since the date of the gift. Accordingly, other shares of the donor (or
related property of the donor) will be relevant in deciding if these
requirements are satisfied.
[31.60]
EXAMPLE
31.17
(1)
Wainwright gives his ironmonger's business to his daughter Tina and it is
agreed that he shall be paid one half of the net profits from the business each
year (a gift with reservation).
(i) At
the time of the original gift (a PET) the property satisfied the requirements
for business relief. 1f the PET becomes chargeable as the result of
Wainwright's death within the following seven years, relief continues to be
available if Tina has retained the original property or acquired replacement
property.
(ii) The
business is also treated as forming part of Wainwright's estate on his death
under FA 1986 s 102, but business relief may be available to reduce its value
under FA 1986 Sch 20 para 8. Whether relief is available (and if so at what
percentage) is decided by treating the transfer of value as made by the donee.
Accordingly, Tina must satisfy the conditions for relief although she can
include the period of ownership/occupation of Wainwright before the gift. (A
similar provision applies if the reservation ceases during Wainwright's
lifetime so that he is treated as making a PET.)
(2)
Assume that Wainwright owns 100% of the shares in Widgett's Ltd and gives 20%
of those shares to Tina subject to a reserved benefit. Assuming that he dies
within seven years:
(i)
Relief at 100% was originally available under s 105(1)(b) when the gift was
made and continues to apply to that chargeable PET if Tina has retained the
shares.
(ii) The
shares are treated as forming part of Wainwright's estate because of the
reserved benefit. Business relief will be available if Tina satisfies the basic
requirements: ie she must have retained the original shares which must still
qualify as business property.
Note Where property attracting 100%
relief is transferred by outright gift it may be argued that this is an exempt
gift under IHTA 1984 s 20 (see [31.51) with the result that the reservation of
benefit rules cannot apply (see FA l986 s 102(5)(b)).
s) The
consequences of relief at 100%
The
introduction of 100% relief has had far-reaching consequences. For instance:
(1) It is
more important than ever to ensure that full relief is not lost because of a
technicality. Consider, for instance, whether cash reserves will be excepted
assets: are they required for use in the business? (see [31.51]).
(2) Consideration
should be given to the structuring of business activity so that the relief is
readily available: simple structures are likely to be best and fragmentation
arrangements that have been common in the past may prove disadvantageous.
(3)
Relief at 100% is equally available in the case of unquoted companies, sole
traders and partnerships. [*776]
(4) In
contrast to the relief available for heritage property, there is no clawback of
the 100% relief on death if the heir immediately sells the assets: if heritage
property is or can be run as a business it would be more attractive to use BPR
than the heritage exemption.
(5) If
lifetime gifts are made and the donor dies within seven years, relief may not
be available if the donee has already sold the assets (see [31.58]). Because
there is no clawback on death, taxpayers may be encouraged to delay passing on
property qualifying for 100% relief.
(6) If it
is feared that the new reliefs will be withdrawn in the future, a gift of
property on to flexible trusts under which the donor retains control as trustee
should be considered (note, however, the trap if it is envisaged that the
property will be distributed within the first ten years of the trust: see
[34.34]).
(7) Wills
should be reviewed to ensure that, whenever this is practicable, property which
is eligible for 100% BPR is left to a person other than a surviving spouse so
that BPR is not lost.
EXAMPLE
31.18
Assume
that X owns a farm worth Lim; farmhouse worth £400,000 and
investments worth £1.5m. Mrs X will run the farm on his death and he
therefore envisages a will in the following terms: (j) nil rate band (f285000)
to his children; (ii) residue to Mrs X.
No IHT
will be payable on Mr X's death but the position would be much improved if the
will had provided: (i) farm and nil rate band to/on trust for children; (ii)
residue to Mrs X.
Again no
IHT will be payable but assets passing tax free to the children now total
£1,285,000.
And after
X's death Mrs X purchases the farm for Lim-there is no clawback of the APR (see
below)/BPR.
By her
will Mrs X leaves everything to the children (including the farm) and provided
that she has owned the farm for two years 100% relief is again available.
Notes:
(a) In
cases where Mrs X cannot afford the purchase price, consider leaving the sum
outstanding.
(b) To
ensure that Mrs X will acquire the farm, consider granting her an option in the
will.
(c) Stamp
duty land tax will be payable on the sale.
(d) In
cases where the availability of the relief is in doubt (for example, because
there is a mixed business) consider leaving the business in a discretionary
trust so that if relief turns out not to be available the property can be
appointed out to the surviving spouse under IHTA 1984 s 144. Alternatively if
relief is available the trust may continue in being or the property can be
appointed out to the children.
(8)
Business property relief is intended to benefit businesses as opposed to
investments but this objective has not been fully achieved. Investments in
limited partnerships may attract 100% relief and an AIM portfolio, qualifying
for relief at 100%, may be attractive.
(9) In
some cases it may be worth de-listing: je turning the fully quoted company back
into an unquoted company or one dealt in on AIM because of the higher levels of
relief available. [31.61] [*777]
3
Agricultural property relief ('APR': IHTA 1984 ss 115-124)
IHTA 1984
ss 115-124 contains rules, introduced originally in FA 1981, giving relief for
transfers of agricultural property. As with BPR, this relief is given
automatically. The old (pre-1981) regime will not be considered save for a
brief mention of the transitional provisions. [31.62]
a) 'Agricultural
property' (IHTA 1984 s 115(2))
Relief is
given for transfers of value of agricultural property, defined in s 115(2) as
follows:
"Agricultural
property" means agricultural land or pasture (part 1) and includes woodland and any
building used in connection with the intensive rearing of livestock or fish if
the woodland or building is occupied with agricultural land or pasture and the
occupation is ancillary to that of the agricultural land or pasture (part 2); and also includes such
cottages, farm building and farmhouses, together with the land occupied with
them, as are of a character appropriate to the property (part 3).'
(The
italicised division into parts is adopted from the Starke and Rosser cases which are considered below
and is intended to identify the three separate dimensions of the definition.)
This
definition includes habitat land and land used for short rotation coppice (this
being a way of producing renewal fuel for bio-mass-fed power stations-in simple
terms, willow or other cuttings are planted on farmland and, after the first
year, are harvested every three years or so and then made into chips which are
used as fuel).
Farm
cottages included in the definition of 'agricultural property' must have been
occupied for the purposes of agriculture (see s 117(1)); ESC F16 extends relief
in such cases to include a cottage occupied by a retired farm employee or his
surviving spouse provided that either the occupier is a statutorily protected
tenant or the occupation is under a lease granted to the farm employee for his
life and that of any surviving spouse as part of his contract of employment by
the landlord for agricultural purposes.
[31.63]
b) The
Starke and Rosser cases
Starke
v IRC (1995)
concerned the transfer of a 2.5 acre site containing within it a substantial
six-bedroomed farmhouse and an assortment of outbuildings together with several
small areas of enclosed land which was used as part of a medium-sized farm
carrying on mixed farming. The court concluded that the relevant property did
not constitute 'agricultural land' within the above definition of 'agricultural
property'. The decision is hardly surprising but it does point to the dangers
of a farmer giving away the bulk of his farm retaining only the farmhouse and a
relatively small area of land. Such retained property will rarely qualify for
relief as was emphasised in Rosser v IRC (2003) where the deceased having given away 39
acres of land was left owning only a house, barn and two acres of land when she
died. [31.64]
e) The
'character appropriate' test: general principles
When is a
farmhouse of a character appropriate to the property? The question arises
regularly in practice and the following points may be noted. [*778]
(1) The
stakes were dramatically increased in this area as a result of the introduction
of 100% relief coupled with rising house prices.
(2) A
farmhouse will be primarily a 'residential' property-hence CGT roll-over relief
is not available on it (see [22.72]) and nor will business property relief
usually be available (save for any part used 'exclusively' for business
purposes);
(3) The
general approach of the Revenue has most recently been expressed by Twiddy in Taxation, 15 June 2000, p 277.
(4) In
addition to satisfying the character appropriate test, remember that relief is
only given on the 'agricultural value' (see [31.64]) of the property and that
the house must be occupied for purposes of agriculture (see s 117).
(5) the
farmhouse must be of a character appropriate to 'the property': what is meant
in this context by 'the property'? In Rosser the Special Commissioner had no
doubt about the required nexus commenting:
'The
nexus between the farm buildings and the property in section 115(2) is that the
farm buildings and the property must be in the estate of the person at the time
of making the deemed disposition under section 4(1) of the 1984 Act. The
alternative view that the farm buildings are in the estate but the property to
which they refer is not is untenable. This view would seriously undermine the
structure for inheritance tax and create considerable uncertainty about when
tax is chargeable and the amount of the value transferred. I would add,
however, that estate is defined in the 1984 Act as the aggregate of all
property to which the person is beneficially entitled. Property is widely
defined in the 1984 Act to include rights and interests of any description. It
will therefore cover not only tangible property but also equitable rights,
debts and other choses in action, and indeed any right capable of being reduced
to money value. Thus, under the situation covered in section 115(2) if the
person making the deemed disposition at death legally owned the farm buildings
and had a legal interest such as a right of profit in the property to which the
character of the farm buildings is appropriate then the farm buildings and the
property would be part of the estate.'
[31.65]
d) Case
law on the farmhouse and character appropriate test
The cases
(all decided by the Special Commissioners) may be summarised as follows: In Dixon
v IRC (2002) the
property comprised a cottage, garden and orchard totalling 0.6 acres. Although
surplus fruit was sold it was decided that the property was not agricultural
land or pasture: rather there was a residential cottage with land. In Lloyds
TSB (PRs of Antrolius deceased) v IRC (2002) it was agreed that Cookhill Priory (a listed
six-bed country house) was a farmhouse and that the surrounding 125 acres (plus
6.54 acres of tenanted land and buildings including a chapel) were agricultural
property. The Special Commissioner decided that the character appropriate test
was also satisfied. In Higginson's Exors v IRC (2002) Ballywood Lodge, formerly
a nineteenth century hunting lodge of six beds with 63 acres of agricultural
land; three acres of formal gardens and 68 acres of woodland and wetland around
Ballywood Lake, was considered not to be a farmhouse ('not the style of house
in which a typical farmer would live').
[*779]
Of the
three, the most important decision in terms of laying down a guiding principle
is the Antrob'us case in which the Commissioner summed up the factors to be
taken into account in applying the character appropriate test as follows:
'Thus the
principles which have been established for deciding whether a farm-house is of
a character appropriate to the property may be summarised as: first, one should
consider whether the house is appropriate by reference to its size, content and
layout, with the farm buildings and the particular area of farmland being
farmed (Korner) one should consider whether the house is proportionate in size
and nature to the requirements of the farming activities conducted on the
agricultural land or pasture in question (Starke); thirdly, that although one
cannot describe a farmhouse which satisfies the "character
appropriate" test one knows one when one sees it (Dixon); fourthly, one
should ask whether the educated rural layman would regard the property as a
house with land or a farm (Dixon); and, finally, one should consider the
historical dimension and ask how long the house in question has been associated
with the agricultural property and whether there was a history of agricultural
production (Dixon).'
No one
factor is decisive but the factors are considered in the round and the eventual
decision based upon 'the broad picture'. In practice expert evidence (especially
evidence of comparables) is of crucial significance. [31.66]
e) 'Agricultural
value' (IHTA 1984 s 115(3))
It is the
'agricultural value' of such property which is subject to the relief: defined
as the value which the property would have if subject to a perpetual covenant
prohibiting its use otherwise than as agricultural property. Enhanced value
attributable to development potential is not subject to the relief. BPR may
apply to this excess value in the case of farmland although not in the case of
the farmhouse: in practice the agricultural value is often considered to be
around two-thirds of open market value, although in current market conditions a
much smaller discount may be appropriate. This point was made by the Special
Commissioner in the Higginson case when he commented:
'A
property may command a high price in the open market because of potential for
development; and subsection (3) clearly caters for that situation. But it seems
to roe that the notional restrictive covenant would have much less of a
deprecatory effect in a case where the property has a value greater than
ordinary not because of development potential but rather because of what I
might call "vanity value" on account of its site, style or the like.
In the light of my decision the point is academic.'
The value
of agricultural property may be artificially enhanced for the purposes of the
relief by charging the costs of acquiring the agricultural property against
non-qualifying property (see Example 31.19, below; IHTA 1984 ss 5(5), 162(4)
and cf BPR, [31.44]). Further, it is not necessary to transfer a farming
business or part thereof in order to obtain relief which can be given on a mere
transfer of assets nil [*780]
EXAMPLE
31.19
A farmer
owns a let farm qualifying for 50% agricultural relief and worth Lim, subject
to a mortgage of £500,000. His other main assets are investments
worth £500,000. Were he to die, the value of his estate on death
would be £lm made up of the investments plus the farm after deducting
the mortgage thereon. Agricultural relief at 50% would then be available on the
net value of the farm (ie on £500,000) which would reduce that to
£250,000 leaving a chargeable death estate of £750,000.
Suppose,
however, that before his death the farmer arranged with the appropriate
creditor to switch the mortgage from the agricultural land to the investments.
The result then would be that on death the value of his estate would, as above,
be £Im made up of the value of the farm (1m) since the investments
now, after deducting the mortgage, are valueless. Accordingly, agricultural
relief would be available on the entire value of the farm and amounts to
£500,000 leaving a chargeable death estate of £500,000.
f) The
level of relief (IHTA 1984 s 116)
Section
116 provides (subject to the provisions of s 117 which are considered in
[31.66]) that the level of APR is 100% where:
'The
interest of the transferor in the property immediately before the transfer
carries the right to vacant possession or the right to obtain it within the
next 12 months.'
This is
extended by ESC F17 to cases where the transferor's interest in the property
immediately before the transfer either:
(1)
carried the right to vacant possession within 24 months of the date of
transfer; or
(2) is
notwithstanding the terms of the tenancy valued at an amount broadly equivalent
to vacant possession value.
The
former situation would cover the service of notices under the terms of the
Agricultural Holdings Act 1986 and so-called 'Gladstone v Bower arrangements' while the second
situation would be relevant in cases akin to that of Lady Fox (discussed below
at [31.71]).
With the
passage of the Agricultural Tenancies Act 1995 100% relief was extended to
landlords in cases where property was let on tenancies beginning on or after 1
September 1995. This applies to all tenancies: je the relevant tenancy does not
have to be a new style business tenancy under the 1995 legislation but
includes, for instance, statutory succession rights arising on the death of a
tenant (see Private Client Business (1996) p 2).
Otherwise
the level of relief is at 50%.
[31.68]
g) Ownership
and occupation requirements (IHTA 1984 s 117)
However,
relief is not available unless the further requirements of s 117 are satisfied:
s 116
does not apply to any agricultural property unless:
(a) it
was occupied by the transferor for the purposes of agriculture throughout the
period of two years ending with the date of the transfer, or [*781]
(b) it
was owned by him throughout the period of seven years ending with that date and
was throughout that period occupied (by him or another) for the purposes of
agriculture.' (See Harrold v IRC (1996) for when a farmhouse is 'occupied'.) [31.69]
EXAMPLE
31.20
(1) Dan
started farming in 1985 and died in April 2003. As an owner-occupier he was
entitled to APR at 100%.
(2)
Bill's farm was tenanted when he acquired it in 1989 but in 2002 the lease was
surrendered. In August 2003 Bill died. He was the owner-occupier at death but
did not satisfy the requirements of s 117(a); assuming that he has owned the
farm for seven years, however, s 117(b) will be satisfied so that he will be
entitled to 100% APR.
(3) Jack
acquired his farm as an investment in 1997 and died in 2003. No APR available.
(4) Tom
has owned agricultural land for ten years and has farmed it himself. He wishes
to cease the farming operations himself and enters into a share farming
arrangement with a neighbouring farmer under which Tom provides the land and
the neighbouring farmer provides labour, live and dead stock etc. Tom dies.
100% relief will not be available unless the terms of the share farming
agreement are such that Tom could, immediately before his death, serve notice
to terminate the arrangements within 12 months.
(5) Wilf
died owning a meadow which had for more than seven years been let under a
grazing agreement with a neighbour who had used the land to graze his horses.
Relief was not available because the horses had no connection with agriculture
and hence the meadow had not been occupied for the purposes of agriculture (Wheatley
Executors of Wheatley) v IRC (1998)). Contrast, however, the position if the grazing
agreement had related to cattle or sheep, when it is accepted that a farming
operation (the sale of grass) is being carried on, provided that it can be
shown that the taxpayer is doing something (replanting, maintaining fences,
etc) other than just receiving rent. It is not thought that the Wheatley
decision is correct.
h) Trusts
and companies
The
relief (at 100% or 50% as appropriate) is available in three further cases:
first, where agricultural property is held on discretionary trusts (100%
relief, if the trustees have been farming the land themselves); secondly, where
agricultural property is held on trust for a life tenant under an interest in
possession trust; and finally, where agricultural property is held by a company
in which the transferor of the shares has control. 'Control' has the same
meaning as for BPR (see [31.54]). To claim the relief the appropriate two- or
seven-year period of ownership must be satisfied by the company
(vis-à-vis the agricultural property) and by the
shareholder/transferor (vis-à-vis the shares transferred). [31.70]
EXAMPLE
31.21
Muckspreader
dies owning shares in a company owning agricultural land in circumstances when
APR is available in respect of the shares. He leaves the shares to his widow.
She dies within two years.
On the
widow's death no APR is available because she does not get the benefit of
Muckspreader's period of ownership of the shares. This is anomalous
(compare [*782] the position for
BPR) The position would have been different if Muckspreader had owned the
agricultural land itself and left it to his widow; see IHTA 1984 s 120; cf s
123(1)(b).
i) Technical
provisions
As with
BPR there are technical provisions relating to replacement property and
clawback (see [31.58]), transfers between spouses, and succession from a donor
(see [31.46]). Similarly, a binding contract for the sale of the property
results in APR not being available (see [31.52]). [31.71]
j) Agricultural
tenancies
The grant
of a tenancy of agricultural property is not a transfer of value provided that
the grant is for full consideration in money or money's worth (IHTA 1984 s 16).
Hence, it is not necessary for the lessor to show (particularly in the case of
transfers within the family) that he had no gratuitous intent and that the
transaction was such as might be made with a stranger (see IHTA 1984 s 10(1)).
For difficulties that may arise in ascertaining the market value of
agricultural tenancies, see Law Society's Gazette, 1984, p 2749, Law
Society's Gazette,
1985, pp 420 and 484, Baird's Executors v IRC (1991) and Walton v IRC (1996) (considered at
[28.73]). [31.72]
k) Clawback
The
availability of the relief when extra IHT is payable, or a PET becomes
chargeable, because of a death within seven years is subject to the same
restrictions as apply for BPR (see [31.58]). [31.73]
1)
Lotting and the Fox decision
In
valuing an estate at death, 'lotting' requires a valuation on the basis that
the vendor must be supposed to have' taken the course which would get the
largest price for the combined holding 'subject to the caveat ... that it does
not entail undue expenditure of time and effort' (see further [30.4]). In IRC
v Gray (1994) the
deceased had farmed the Croxton Park Estate in partnership with two others and
the land was subject to tenancies which Lady Fox, as freeholder, had granted to
the partnership. The Revenue sought to aggregate or lot together the freehold
in the land with her partnership share as a single unit of property. It may be
noted that under the partnership deed she was entitled to 921/2% of profits
(and bore all the losses). The Court of Appeal reversed the Lands Tribunal
holding that lotting was appropriate since that was the course which a prudent
hypothetical vendor would take to obtain the best price. The fact that the
interests could not be described as forming a 'natural unit of property' was
irrelevant. The arrangement employed in this case was commonly undertaken
(before the introduction of 100% APR) in order to reduce the tax charge on
agricultural property. An alternative involved leases being granted to a family
farming company and the Revenue seeks to apply this decision to those
arrangements. As a result of ESC F17 noted in [31.65] transfers in Fox-type cases now attract 100%
relief. [31.74] [*783]
m) Transitional
relief, double discounting
Under the
rules which prevailed up to 1981 APR was available where L let Whiteacre to a
partnership consisting of himself and his children M and N. On a transfer of
the freehold reversion (valued on a tenanted, not a vacant possession, basis)
50% relief was available. The ingredient of 'double discounting' consisted of
first reducing the value of the property by granting the lease and then
applying the full (50%) relief to that discojinted value. As a quid pro quo the
Revenue argued that the grant of the lease could he a transfer of value even if
for a full commercial rent.
Double
discount is not available under the present system of agricultural relief and
the grant of the tenancy will not be a chargeable transfer of value if for full consideration (IHTA 1984 s
16). On a transitional basis, however, where land was let, as in the above
example, on 10 March 1981 so that any transfer by L immediately before that
date would have qualified for relief, on the
next transfer of value, that relief will still apply but at the current level
of 100%. (Note that the relief was limited to £250,000 of
agricultural value (before giving relief) or to £1,000 acres, at the
option of the taxpayer.) The transitional relief will not apply in cases where
the pre-10 March 1981 tenancy has been surrendered and regranted but similar
transitional relief applies where before 10 March 1981 the land was let to a
company which the transferor controlled (IHTA 1984 s 116(2)-(5)). [31.75]
EXAMPLE
31.22
For many
years Mary has owned agricultural land which has been let to a family farming
company in which she owns 100% of the shares. On her death 50% relief only will
be available on the land since she is not entitled to obtain vacant possession
(the company being a separate legal entity). If, however, the arrangement had
been in place before 10 March 1981, Mary may be entitled to 100% relief under
the 'Double Discount Rule' (for instance, if she was a director of the company
immediately before 10 March 1981). Relief will only be available up to a maximum
of 1,000 acres or land which at 10 March 1981 was worth up to
£250,000.
n) Milk
quota
Following
Coule v Coldicott
(1995) the Capital Taxes Office now considers that milk quota comprises a
separate asset distinct from the land. Accordingly it will not qualify for APR
but 'with an owner occupied dairy farm, business relief at the same rate will
normally be available in the alternative' (see Inheritance Tax Manual IHTM
24506). This treatment appears at odds with the BPR provisions (see Taxation, 3 June 1999, p 244). [31.76]
o) Inter-relation
of agricultural and business property reliefs
Although
the two reliefs are similar and overlap, the following distinctions are worthy
of note:
(1) APR
is given in priority to BPR (IHTA 1984 s 114(1)).
(2) Differences
exist in the treatment of woodlands, crops, livestock, dead-stock, plant and
machinery, and farmhouses etc. When APR does not apply, consider whether BPR is
available. [*784]
(3) APR
is only available on property situated in the UK, Channel Islands and Isle of Man whereas BPR is not
so restricted.
(4) In
the Tax Bulletin,
1994, p 182, the Inland Revenue commented that:
Where
agricultural property which is a farming business is replaced by a
non-agricultural business property, the period of ownership of the original
property will be relevant for applying the minimum ownership condition to the
replacement property. Business property relief will be available on the
replacement if all the conditions for that relief were satisfied. Where non-agricultural
business property is replaced by a farming business and the latter is not
eligible for agricultural property relief, s 114(1) does not exclude business
property relief if the conditions for that relief are satisfied.'
'Where
the donee of the PET of a farming business sells the business and replaces it
with a non-agricultural business the effect of s 124A(1) is to deny
agricultural property relief on the value transferred by the PET. Consequently,
s 114(1) does not exclude business property relief if the conditions for that
relief are satisfied: and, in the reverse situation, the farming business
acquired by the donee can be "relevant business property" for the
purposes of s 113B(3) (e).' [31.77]
p) Relief
at 100%
Many of
the comments made at [31.60] in the context of BPR apply equally to
agricultural property. In addition:
(1) there
is no longer any attraction in the type of fragmentation arrangements
illustrated in the Fox case (see [31.71]). Maximum relief is available for in-hand land;
(2) in-hand
land need not be farmed by the owner himself. He can enter into contract
farming arrangements without jeopardising 100% relief provided that these are
correctly structured;
(3) the
grant of new tenancies after August 1995 will not jeopardise 100% relief:
thought should be given to terminating or amending (eg by adding a small area
of extra land) existing tenancies so that a new tenancy resulting in 100%
relief for the landlord arises;
(4)
complex structures should no longer be set up but what should be done with
existing structures? The costs of unscrambling may be considerable and it is
worth reflecting that, assuming that the value of tenanted land is one half of
the vacant possession value, the effect of 50% APR is to reduce the tax rate to
10% of vacant possession value and as that tax can be paid in ten instalments,
the annual tax charge is a mere 1%. [31.78]
4 Relief
for heritage property (IHTA 1984 ss 30-35 as amended)
In
certain circumstances an application can be made to postpone the payment of IHT
on transfers of value of heritage property. Such claims now have to be made
within two years of the transfer of value or relevant death or within such
longer period as the Board may allow (IHTA 1984 s 30(3BA) inserted by FA 1998).
As tax can be postponed on any number of such transfers, the result is that a
liability to IHT can be deferred indefinitely (similar deferral provisions
operate for CGT: TCGA 1992 s 258(3)). Tax postponed under these provisions may
subsequently become chargeable
[*785] under IHTA 1984 s 32
on the happening of a 'chargeable event'. If the ransfer is potentially exempt,
an application for conditional exemption can only be made (and is only
necessary) if the PET is rendered chargeable by the donor's death within seven
years. HMRC provides a now somewhat out-of-date guide, Capital Taxation and
the National Heritage.
(IR 67), and a Guide to the 1998 changes, Capital Taxes Relief for Heritage
Assets (January
1999). [31.79]
a) Conditions
to be satisfied if IHT is to be deferred
In order
to obtain this relief, first, the property must fall into one of the categories set
out in IHTA 1984 s 31(1):
Category
1: any relevant
object which appears to the Board to be preeminent for its national,
scientific, historic or artistic interest (this category was restricted by FA
1998 by the inclusion of the requirement that the object must be pre-eminent):
see IHTA 1984 s 31(1)(a).
Category
2: land of
outstanding scenic, historic, or scientific interest (IHTA 1984 s 31(1)(b)).
Category
3: buildings of
outstanding or architectural interest and their amenity land (s 3l(1)(c), (d))
and chattels historically associated with such buildings (s 3l(1)(e)).
Secondly, undertakings have to be given
with respect to that property to take reasonable steps for its preservation; to
secure reasonable access to the public (see Works of Art: A Basic Guide published by the Central Office
of Information); and (in the case of Category 1 property) to keep the property
in the UK.
In
appropriate cases of Category 1 property, it had been sufficient for details of
the object and its location to be entered on an official list of such assets
and concern had been expressed that proper access for the public was not always
available. FA 1998 accordingly provided that the public must have extended
access (ie access not confined to access when a prior appointment is made) and
for greater disclosure of information about designated items (IHTA 1984 s 31
(4FA) (4FB) inserted by FA 1998, see also [31.78]).
The
undertaking must be given by 'such person as the Treasury think appropriate in
the circumstances of the case'. In practice, this will mean a PR, trustee,
legatee or donee.
A third requirement exists in the case of
lifetime transfers of value. The transferor must have owned the asset for the
six years immediately preceding the transfer if relief is to be given. Notice,
however, that the six-year requirement can be satisfied by aggregating periods
of ownership of a husband and wife and that it does not apply in cases where the
property has been inherited on a death and the exemption has then been
successfully
claimed.
It is surprising that the six-year requirement is limited to inter vivos transfers thereby permitting
deathbed schemes. [31.80]
b) Reopening
existing undertakings
With the
aim of securing greater public access, FA 1998 provided that in the case of
claims for conditional exemption made on or after 31 July 1998 open access (je
other than merely by prior appointment) must be given (s 31 (4FA)). Further,
the terms of any undertakings must be published. In [*786] addition, a procedure was introduced as a result of
which existing undertakings (given from 1976 onwards) can be varied by
agreement or, in certain circumstances, a variation in their terms might be
imposed (s 35A). [31.81]
c) Effect
of deferring IHT
Where
relief is given the transfer is a 'conditionally exempt transfer'. So long as
the undertakings are observed and the property is not further transferred IHT
liability will be postponed. If there is a subsequent transfer, the existing
exemption may be renewed and a further exemption claimed.
Three
'chargeable events' cause the deferred IHT to become payable: first, a breach
of the undertakings; secondly, a sale of the asset; and thirdly, a further
transfer (inter vivos or on death) without a new undertaking. [31.82]
d) Calculation
of the deferred IHT charge
Calculation
of the deferred IHT charge will depend upon what triggers the charge. If there
is a breach of undertakings, the tax is charged upon the person who would be
entitled to the proceeds of sale were the asset then sold. The value of the
property at that date will be taxed according to the transferor's rates of IHT.
When he is alive, this is by reference to his cumulative total at the time of the
triggering event (any PETs that he has made are ignored for these purposes even
if they subsequently become chargeable); when he is dead, the property is added
to his death estate and charged at the highest rate applicable to that estate
but at half the IHT table rates unless the conditionally exempt transfer was
made on his death.
EXAMPLE
31.23
In 2000
Aloysius settled a Rousseau painting (valued at £500,000) on
discretionary trusts. The transfer was conditionally exempt, but, six years
later (when the picture is worth £650,000), the trustee breaks the
undertakings by refusing to allow the painting to be exhibited in the Primitive
Exhibition in London. If Aloysius is still alive in 2006, IHT is calculated on
£650,000 at Aloysius' rates according to his cumulative total of
chargeable transfers in 2006. Had Aloysius died in 2006 with a death estate of
£1,000,000, £650,000 would be charged at half the rates
appropriate to the highest part of an estate of £1,650,000. As can be
seen from this example, considerable care should be exercised in deciding
whether the election should be made. If the relevant asset is likely to
increase in value, it may be better to pay off the IHT earlier assuming that
sufficient funds are available.
1f the
deferred charge is triggered by a sale, the above principles operate, save that
it is the net sale proceeds that will be subject to the deferred charge.
Expenses of sale, including CGT, are deductible. If there is a disposal of part
of a property which is conditionally exempt the designation of the whole is
reviewed: if the disposal has not materially affected the heritage entity then
the designation for the remainder stays in force and the IHT charge is limited
to the part disposal. However, if the part disposal results solely from the
leasehold enfranchisement under the Leasehold Reform, Housing and Urban
Development Act 1993 (or Leasehold Reform Act 1967) these rules do not apply:
instead there is no review of the retained property and the charge is limited
to the part sold. [*787]
Calculation
of the deferred charge is more complex where it is triggered by a gift since
two chargeable transfers could occur; the first on the gift and the second by
the triggering of the deferred charge. If the gift is a chargeable event
(excluding PETs) the tax payable on that gift is credited against the triggered
deferred charge. Where the gift is a chargeable transfer, but not a chargeable
event, as the triggering charge does not arise the credit will be available
against the next chargeable event affecting that property.
EXAMPLE
31.24
Eric
makes a conditionally exempt transfer to Ernie on his death in 2002. Ernie in
turn settles the asset on discretionary trusts in 2006 and (although the asset
is pre-eminent) the trustees do not give any undertaking.
The
creation of the settlement is a chargeable transfer by Ernie. IHT will be
calculated at half rates in 2006.
The
triggered charge the value of the asset in 2006 will be subject to IHT at
Eric's death rates. A tax credit for IHT paid on the 2006 gift which is
attributable to the value of the asset is available.
If the
trustees had given an appropriate undertaking in 2006 (since Ernie inherited
the property on Eric's death, the six-year ownership requirement does not need
to be satisfied by Ernie), the trust would be taxed as above. The transfer is
not a chargeable event so that no triggering of the conditionally exempt
transfer occurs. The tax credit is available if this charge is triggered at a
later stage, cg by the trustees selling the asset.
If a
conditionally exempt transfer is followed by a PET which is a chargeable event
with regard to the property, IUT triggered is allowed as a credit against IHT
payable if the PET becomes chargeable.
Where
there has been more than one conditionally exempt transfer of the same
property, and a chargeable event occurs, HMRC has the right to choose which of
the earlier transferors (within 30 years before the chargeable event) shall be
used for calculating the sum payable.
[31.83]
EXAMPLE
31.25
Z gives a
picture to Y who gives it to X who sells it. There have been two conditionally
exempt transfers (by Z and V) and HMRC can choose (subject to the 30-year time
limit) whether to levy the deferred IHT charge according to Z or V's rates.
e) Settled
property
Where
heritage property is subject to an interest in possession trust created prior
to 22 March 2006, or to one of the limited exceptional interest in possession
trusts (that is not a trust for a bereaved minor or a disabled person's trust)
created on or after that date (see [33. 4]), it is treated as belonging to the
life tenant and the above rules are applied. The exemption may also be
available for heritage property held in a discretionary trust (IHTA 1984 ss 78,
79) and for interest in possession trusts created on or after 22 March 2006
that do not fall within one of the exceptional categories, which are treated in
the same way as discretionary trusts.
[31.84] [*788]
f) Maintenance
funds
IHTA 1984
ss 27, 57(5) and Sch 4 paras 1-7 provide for no IHT to be charged when property
(whether or not heritage property) is settled on trusts to secure the
maintenance, repair etc of historic buildings. Such trusts also receive special
income tax treatment (TA 1988 ss 690 ff) and, for CGT, the hold-over election
under TCGA 1992 s 260 is available.
These
funds can be set up with a small sum of money so long as there is an intention
to put in further sums later. The introduction of the PET in 1986 has, however,
produced a dilemma for an estate owner. He could give away property to his
successor as a PET and rely upon living for seven years in order to avoid IHT.
Alternatively, he could transfer that property by a conditionally exempt
transfer into a maintenance fund. It is not possible to make a gift of the
property and then, if the donor dies within seven years, for the donee at that
point to avoid the IHT charge by transferring the property into a maintenance
fund.
Settled
property will be free of IHT on the death of the life tenant if within two
years after his death (three years if an application to court is necessary) the
terms of the settlement are altered so that the property goes into a heritage
maintenance fund (IHTA 1984 s 57A).
[31.85]
g) Private
treaty sales and acceptance in lieu
Heritage
property can be given for national purposes or for the public benefit without
any IHT or CGT charge arising (IHTA 1984 s 23: see [31.85]). Alternatively, the
property can be sold by private treaty (not at an auction) to heritage bodies
listed in IHTA 1984 s 25(1) and Sch 3. Such a sale can offer substantial
financial advantages for the owner. For instance, if conditionally exempt
property is sold on the open market, conditional exemption is lost and
furthermore a CGT charge may arise. By contrast, a sale by private treaty does
not lead to a withdrawal of the exemption or IHT charge, nor is there a
liability to CGT. Not surprisingly, because of these fiscal benefits the vendor
will have to accept a lower price than if he sold on the open market. The
relevant arrangement involves a 'douceur': broadly, the price that he will
receive is the net value of the asset (ie market price less prospective tax
liability) plus 25% of the tax saved in the case of chattels (10% for land).
EXAMPLE
31.26
(taken
from Capital Taxation and the National Heritage (IR 67))
Calculation
of the price, with 'douceur' (usually 25% but subject to negotiation), at which
a previously conditionally exempted object can be sold to a public body by
private treaty.
Agreed
current market value (say) £100,000
Tax
applicable thereto:
CGT at
(say) 30% on gain element, assumed to be £40,000 . . .
£12,000
[*789]
ED, CTT
or IHT exemption granted on a previous conditionally exempt transfer now
recoverable at (say) 60% on £88,000 (ie market value less CGT) . . .
£52,800
Total tax
. . . £64,800 . . .
£64,800
Net after
full tax . . . . . . £35,200
Add back
25% of tax (the 'douceur') . . . .
. . £16,200
Price
payable by a purchaser, all retained by vendor . . . . . . £51,400
HMRC
writes off the total tax of £64,800 (£12,000 +
£52,800).
The
vendor has £16,200 more than if he had sold the object for
£100,000 in the open market and paid the tax. The public body
acquires the object for £48,600 less than its open market value.
An asset
can be offered to HMRC in lieu of tax (see IHTA 1984 s 230(1)).
Acceptance
in lieu of tax has similar financial advantages for the vendor to a private
treaty sale. The Secretary of State has to agree to accept such assets and it
should be noted that the standard of objects which can be so accepted is very
much higher than that required for the conditional exemption.
Under
these arrangements the offeror obtains the benefit of any rise in the value of
property between the date of the offer and its acceptance by HMRC, but he has
to pay interest on the unpaid IHT until his offer is accepted. As an
alternative, therefore, taxpayers can elect for the value of the property to be
taken at the date of the offer (thereby avoiding the payment of any interest
but forgoing the benefit of any subsequent rise in the value of the property:
F(No 2)A 1987 s 97 and see SP 6/87).
131.86]
5 Gifts
to political parties (IHTA 1984 s 24)
Such
gifts are exempt without limit from IHT, whether made during life or on death.
There are detailed provisions which deny relief where the gift is delayed,
conditional, made for a limited period, or could be used for other purposes (IHTA
1984 s 24(3) (4)). Any capital gain that would otherwise arise can be held over
under TCGA 1992 s 260. [31.87]
6 Gifts
to charities (IHTA 1984 s 23)
Gifts to
charities are exempt without limit. As with gifts to political parties detailed
provisions deny the exemption if the vesting of the gift is postponed; if it is
conditional; if it is made for a limited period; or if it could be used for
non-charitable purposes (on charitable gifts, generally, see chapter 53). Note
that relief is not given if the gift is to a foreign charity: for relief to be
available the gift must be to a UK charity which carries on its charitable work
abroad, or to a UK charity which can then pass the benefit of that gift to a
foreign charity. [31.88] [*790] [*791]
32 IHT--settlements: definition and
classification
Updated
by Natalie Lee, Senior Lecturer in Law, University of Southampton and Aparna
Nathan, LLB Mons, LLM, Barrister, Gray's Inn Tax Chambers
I Introductory and definitions [32.1]
II Classification of settlements [32.21]
III Creation of settlements [32.51]
IV Payment of IHT [32.71]
V Reservation of benefit [32.91]
I
INTRODUCTORY AND DEFINITIONS
In
framing the original IHT rules taxing settled property the objective was to
ensure (1) that it is the capital of the settlement which is subject to tax and
not just the value of the various beneficial interests and (2) that settled
property is taxed neither more nor less heavily than unsettled property. The
changes introduced by FA 2006 are a blatant attempt at preventing the wealthy
from using trusts to minimise IHT. The measures are, however, unclear and
incoherent, and seem to be founded on a misconception of the many and varying
reasons for establishing a trust.
[32.1]
1 What is
a settlement?
a) Definition
'Settlement'
is defined in IHTA 1984 s 43:
'(2)
"Settlement" means any disposition or dispositions of property,
whether effected by instrument, by parole or by operation of law, or partly in
one way and partly in another, whereby the property is for the time being--
(a) held
in trust for persons in succession or for any person subject to a contingency;
or
(b) held
by trustees on trust to accumulate the whole or part of any income of the
property or with power to make payments out of that income at the discretion of
the trustees or some other person, with or without power to accumulate surplus
income; or [*792]
(c)
charged or burdened (otherwise than for full consideration in money or money's
worth paid for his own use or benefit to the person making the disposition),
with the payment of any annuity or other periodical payment payable for a life
or any other limited or terminable period;
(3) A lease of property which is for life or
lives, or for a period ascertainable only by
reference to a death, or which is terminable on, or at a date ascertainable
only by reference to, a death, shall be treated as a settlement and the
property as settled property, unless the lease was granted for full
consideration in money or money's worth, and where a lease not granted as a
lease at a rack rent is at any time to become a lease at an increased rent it
shall be treated as terminable at that time.' [32.2]
EXAMPLE
32.1
(1)
Property is settled on X for life remainder to Y and Z absolutely (a fixed
trust; see sub-s (2) (a), above).
(2)
Property is held on trust for 'such of A, B, C, D, E and F as my trustees in
their absolute discretion may select' (a discretionary trust; see sub-s (2)
(b), above).
(3)
Property is held on trust 'for A contingent on attaining 18' (a contingency. settlement; see sub-s (2) (a), above).
(4)
Property is held on trust by A and B as trustees for Z absolutely (a bare
trust, although for lUT purposes there is no settlement and the property is
treated as belonging to Z).
(5) A and
B jointly purchase Blackacre. Under LPA 1925 ss 34 and 36 (as amended) there is
a statutory trust of land with A and B holding the laud on trust (as joint
tenants) for themselves as either joint tenants or tenants in common in equity.
For lUT purposes there is no settlement and the property belongs to A and B
equally.
(6) A
grants B a lease of Blackaere for his (B's) life at a peppercorn rent. This is
a settlement for lUT purposes and A is the trustee of the property (IHTA 1984 s
45). Under LPA 1925 s 149 the lease is treated as being for a term of 90 years
that is determinable on the death of B.
b) The
Lloyds Bank case
Mr and
Mrs E owned their house as beneficial tenants in common. On her death, Mrs E
left her half share on trust providing that:
'While my
husband ... remains alive and desires to reside in the property and
keeps the
same in good repair and insured comprehensively to its full value ... and pays
and indemnifies my Trustees against all rates taxes and other outgoings in
respect of the property my Trustee shall not make any objection to such
residence and shall not disturb or restrict it in any way and shall not take
any steps to enforce the trust for sale on which the property is held or to
obtain any rent or profit from the property.'
Subject
to the above, the property was held on trust for her daughter absolutely. In IRC
v Lloyds Private Banking Ltd (1998) it was held that the above clause gave Mr E a life
interest in the property since it elevated him to the status of a sole occupier
of the entirety free from any obligation to pay compensation for excluding the
daughter from occupation and free from the [*793] risk
that an application would be made to court for sale. See also Woodhall
(Woodhall's Personal Representative) v IRC (2000), Faulkner (Adams Trustee) v IRC (2001) and the comments by
Lightman J and the Court of Appeal in IRC v Eversden (2002), (2003). [32.3]
c) Associated
operations
In Rysaffe
Trustee Co (CI) Ltd v IRC (2003) Park J and the Court of Appeal decided that for the purposes
of s 43 'dispositions' had its ordinary meaning and was not extended to include
a disposition by associated operations. In simple terms therefore provided that
a trust lawyer would say that five separate trusts had been established with
identical property (in Rysaffe it was private company shares) then the IHT legislation
must be applied on that basis. The use of the plural 'dispositions' in s 43(2)
deals with the situation where property is added to an existing settlement
whether by the settlor or by some other person. [32.4]
d) The
contrast with income tax: 'bounty'
Although
'settlement' has a wide definition for income tax purposes it has been
restricted to eases where there is an element of bounty (see [16.61]): for IHT
purposes there is no such restriction and hence commercial arrangements (eg
landlord sinking funds) may have LUT ramifications. [32.5]
e)
Resettlements
As
discussed in [25.82] difficulties have arisen in identifying, for CGT purposes,
when property has been resettled (ie when a new settlement has been created out
of an existing settlement). Difficulties may also occur when it is necessary to
determine whether the settlor has created one or more settlements. There are
similar problems in IHT.
In Minden
Trust (Cayman) Ltd v IRC (1984) an appointment of settled property in favour of overseas
beneficiaries was held to amend the terms of the original settlement so that
the terms of that appointment read with the original settlement were
dispositions of property and, therefore, a settlement. [32.6]
EXAMPLE
32.2
Each year
Sam creates a discretionary trust of £3,000 (thereby utilising his
annual exemption) and his wife does likewise. At the end of five years there
are ten mini discretionary trusts. As a matter of trust law, and assuming that
each settlement is correctly documented, there is no reason why this series
should be treated as our settlement. So far as the IHT legislation is concerned
the settlements are not made on the same day (see IHTA 1984 s 62); the
associated operations provisions (IHTA 1984 s 268) would seem inapplicable (the
facts are quite different from those in Hatton v IRC (1992) and in no sense is this a
series of operations affecting the same property: see the Rysaffe case considered above. The Ramsay principle, although of uncertain
ambit, could only be applied with difficulty to a series of gifts. The separate
trusts should be kept apart (there should be no pooling of property) and each
settlement should be fully documented.
[*794]
2
Settiors
In the majority
of cases it is not difficult to identify the settlor, since there will usually
he one settlor who will create a settlement by a 'disposition' of property
(which may include a disposition by associated operations; see IHTA 1984 s
272). If that settlor adds further property, this creates no problems in the
interest in possession settlement, but difficulties arise if the settlement is
discretionary (see [34.33]) with further complications if the original property
was excluded property and the additional property was not, or vice versa (see
Chapter 35 and Tax Bulletin, February 1997). A settlement may have more than
one settlor:
EXAMPLE
32.3
(1) Bill
and Ben create a settlement in favour of their neighbour Barum.
(2) Bill
adds property to a settlement that had been created two years ago by Ben in
favour of neighbour Barum.
IHTA 1984
s 44(2) states that:
'Where
more than one person is a settlor in relation to a settlement and the
circumstances so require, this Part of this Act (excepts 48(4)-(6)) shall have
effect in relation to it as if the settled property were comprised in separate
settlements.'
Thomas
v IRC (1981)
indicates that this provision only applies where an identifiable capital fund
has been provided by each settlor. The fund will be treated as two separate
settlements in the case of discretionary trusts where both the incidence of the
periodic charge and the amount of IHT chargeable may be affected. IHTA 1984 s
44(1) defines settlor (in terms similar to those for income tax purposes) thus:
'In this
Act "settlor", in relation to a settlement, includes any person by
whom the settlement was made directly or indirectly, and ... includes any
person who has provided funds directly or indirectly for the purpose of or in
connection with the settlements or has made with any other person a reciprocal
arrangement for that other person to make the settlement.' [32.7]
3
Additions of property
A further
problem arises where there is only one settlor who adds property to his
settlement; is this for IHT purposes one settlement or two? This question is
significant in relation to discretionary trusts (especially with regard to
timing and rate of the periodic and inter-periodic charges) and where excluded
property is involved in a settlement. As a matter of trust law, there will be a
single settlement where funds are held and managed by one set of trustees for
one set of beneficiaries, so that such additions will usually not lead to the
creation of separate settlements. An article in the Tax Bulletin, February 1997
('Excluded Property Settlements by People Domiciled Overseas') presented a
somewhat different view:
'In the
light of the definitions of "settlement" and "settled
property" in s 43, our view is that a settlement in relation to any
particular asset is made at the time when
[*795] that asset is
transferred to the settlement trustees to hold on the declared trusts. Thus,
assets added to a settlor's own settlement made at an earlier time when the
senIor was domiciled abroad will not be "excluded", wherever they may
be situated, if the settlor has a UK domicile at the time of making the
addition.'
At first
glance it would appear to suggest that in these circumstances each addition of
property involves the creation of a separate settlement. This is not, apparently,
the Revenue's view, however, and it has subsequently confirmed that there
remains a single settlement, but in testing whether that constitutes (in whole)
an excluded property settlement, each addition (and the settlor's domicile at
that time) needs to be considered. More recently the Revenue has indicated that
it is reconsidering the relationship between the reservation of benefit rules
and excluded property settlements: at present if X (a non UK domiciliary)
establishes a discretionary trust under which he can benefit and subsequently
acquires a UK domicile the property remains excluded and the reservation of
benefit rules are inapplicable.
[32.8]
4
Trustees
The
ordinary meaning is given to the term 'a trustee', although by IHTA 1984 s 45
it includes any person in whom the settled property or its management is for
the time being vested. In cases where a lease for lives is treated as a
settlement the lessor is the trustee.
[32.9]-[32.20]
II
CLASSIFICATION OF SETTLEMENTS
The
Finance Act 2006 brought about a substantive change in the categorisation of
trusts for IHT purposes. Because trusts in existence on 22 March 2006 (Budget
day) will, on the whole, continue to be governed by the 'old' regime, both the
old and the 'new' regime will be considered in this chapter. Moreover, the term
'interest in possession' continues to be of importance to both regimes, and is
considered at some length.
1 The
categories
(i) The
old regime
Under the
former regime, settlements for IHT purposes were divided into two main
categories with one sub-category.
Category
1 A settlement
with an interest in possession, eg where the property is held for an adult
tenant for life who, by virtue of his interest, is entitled to the income as it
arises or, typically in the case of a trust of a residential property, is
entitled to the use or occupation of the trust property.
Category
2 A settlement
lacking an interest in possession, eg where trustees are given a discretion
over the distribution of the income. At most, beneficiaries have the right to
be considered by the trustees; the right to ensure that the fund is properly
administered; and the right to join with all the other beneficiaries to bring
the settlement to an end.
This
category also includes settlements where the property is held on trust for a
minor, contingent on his attaining a specified aue. As long as the [*796] beneficiary is a minor there will be no interest in possession
and the settlement will fall into Category 2, unless the trust satisfies the
requirements for a 'privileged' settlement.
Sub-category
Into this category fall special or privileged trusts. They lack an interest in
possession, but are not subject to the Category 2 regime. The main example
considered in this book is the A&M trust.
To place
a particular trust into its correct category is important for two reasons.
First, because the IHT treatment of each is totally different both as to
incidence of tax and as to the amount of tax charged; and secondly, because a
change from one category to another will normally give rise to an IHT charge.
For example, if a life interest ceases, whereupon the fund is held on
discretionary trusts, the settlement moves from Category 1 to Category 2, and a
chargeable occasion (the ending of a life interest) has occurred. [32.21]
(ii) The
new regime
The new
regime for the inheritance taxation of trusts introduced by FA 2006 abandons,
in effect, the classification of trusts into those with, and those without, an
interest in possession and creates a number of new categorisations.
Category
1 A disabled
person's interest. This is an interest in possession to which a disabled person
is treated as beneficially entitled (IHTA 1984 s 89B, inserted by FA 2006 Sch
20 para 6). Generally, a disabled person is someone who is either mentally
incapable of managing their affairs, or in receipt of an attendance allowance
or disability living allowance (IHTA 1984 s 89(4)-(6)).
Category
2 A settlement
with an interest in possession where the settled property forms part of the
beneficiary's estate. This category comprises (j) an immediate post-death
interest. This is an interest in possession arising immediately on a death on
or after 22 March 2006 (for example, on the death of a husband, the wife of
whom becomes entitled to a life interest in his property under his will) (IHTA
1984 s 49A inserted by FA 2006 Sch 20 para 5); (ii) a disabled person's
interest (see category 1, above); (iii) a transitional serial interest. This
includes (a) an interest in possession arising on or after 22 March 2006 but
before 6 April 2008 in immediate succession to an interest in possession that
was subsisting prior to 22 March 2006 under a trust created before then; and
(b) an interest in possession to which a surviving spouse or civil partner
becomes entitled on the death on or after 6 April 2008 of his or her late
spouse or civil partner, where that late spouse or civil partner's interest in
possession had been subsisting prior to 22 March 2006 under a trust created
before then.
Category
3 A settlement
with no interest in possession or treated as having no interest in possession.
This category comprises not only discretionary trusts (see [32.21], but also
trusts with an interest in possession, with the exception of immediate
post-death interests, transitional serial interests, and trusts in favour of
disabled persons. While trusts for bereaved minors and age 18-25 trusts lack an
interest in possession, they are not subject to the Category 3 regime (see
Category 4, below).
Category
4 A settlement
for a bereaved minor and age 18-25 trusts. These trusts which, in effect,
replace A&M trusts, enjoy similar privileges to those formerly enjoyed by
A&M trusts. [32.22] [*797]
2 The
meaning of an 'interest in possession'
Whilst
the term 'interest in possession' is not, in itself, as significant under the
new regime as it was under the former regime (which continues to apply to those
trusts created prior to 22 March 2006), it remains important as the categories
in [32.22] above demonstrate. Normally trusts can easily be slotted into their
correct category. Trusts falling within the sub-category of the old regime were
carefully defined so that any trust not specifically falling into one of those
special cases must fall into Category 2. Problems were principally caused by
the borderline between Categories I and 2 where the division was drawn
according to whether the settlement had an interest in possession or not. In
the majority of cases no problems arose: at one extreme stood the life interest
settlement; at the other the discretionary trust. However, what of a settlement
which provides for the income to be paid to Albert, unless the trustees decide
to pay it to Bertram, or to accumulate it; or where the property in the trust
is enjoyed in specie by one beneficiary as the result of the exercise of a
discretion (eg a beneficiary living in a dwelling house which was part of a
discretionary fund)? To resolve these difficulties, the phrase an 'interest in
possession' needs definition. The legislation did not, and still does not,
assist; instead, its meaning must be gleaned from a Press Notice of the Revenue
and Re Pilkington (Pearson v IRC) (1981) which largely endorses the statements in that
Press Notice. [32.23]
IR
Press Notice (12 February 1976) This provides as follows:
'an
interest in settled property exists where the person having the interest has
the immediate entitlement (subject to any prior claims by the trustees for
expenses or other outgoings properly payable out of income) to any income
produced by that property as the income arises; but ... a discretion or power,
in whatever form, which can he exercised after incarne arises so as to withhold
it from that person negatives the existence of an interest in possession. For
this purpose a power to accumulate income is regarded as a power to withhold
it, unless any accumulation must he held solely for the person having the
interest or his personal representatives.
On the
other hand the existence of a mere power of revocation or appointment, the
exercise of which would determine the interest wholly or in part (but which, so
long as it remains unexercised, does not affect the beneficiary's immediate
entitlement to income) does not ... prevent the interest from being an interest
in possession.'
The first
paragraph is concerned with the existence of discretions or powers which might
affect the destination of the income after it has arisen and which prevent the
existence of any interest in possession (cg a provision enabling the trustees
to accumulate income or to divert it for the benefit of other beneficiaries)
The second paragraph concerns overriding powers which, if exercised, would
terminate the entire interest of the beneficiary, but which do not prevent the
existence of an interest in possession (eg the statutory power of advancement).
Administrative expenses charged on the income can be ignored in deciding
whether there is an interest in possession, so long as such payments are for
'outgoings properly payable out of income'. A clause in the settlement
permitting expenses of a capital nature to be so [*798] charged
is, therefore, not covered and the Revenue has argued that the mere presence of
such a clause is fatal to the existence of any interest in possession (see
[32.27]). [32.24]
Re
Pilkington (Pearson v IRC) (1981) The facts of the case were simple. Both capital and income of
the fund were held for the settlor's three adult daughters in equal shares
subject to three overriding powers exercisable by the trustees: (1) to appoint
capital and income amongst the daughters, their spouses and issue; (2) to
accumulate so much of the income as they should think fit; and (3) to apply any
income towards the payment or discharge of j any taxes, costs or other
outgoings which would otherwise be payable out of capital. The trustees had
regularly exercised their powers to accumulate the income. What caused the
disputed IHT assessment (for a mere 444.73) was the irrevocable appointment of
some £16,000 from the fund to one of the daughters. There was no
doubt that, as a result of the appointment, she obtained an interest in
possession in that appointed sum; but did she already have an interest in
possession in the fund? If so, no IHT would be chargeable on the appointment
(see [33.28]); if not, there would be a charge because the appointed funds had
passed from a 'no interest in possession' to an 'interest in possession'
settlement (Category 2 to Category 1).
The
Revenue contended that the existence of the overriding power to accumulate and
the provision enabling all expenses to be charged to income deprived the
settlement of any interest in possession. It was common ground that whether
such powers had been exercised or not was irrelevant in deciding the case. The
overriding power of appointment over capital and income did not prevent there
from being an interest in possession (see the second paragraph of the Press
Notice at [32.24] above).
For the
bare majority of the House of Lords the presence of the overriding discretion
to accumulate the income was fatal to the existence of any interest in
possession. 'A present right to present enjoyment' was how an interest in
possession was defined and the beneficiary did not have a present right. 'Their
enjoyment of any income from the trust fund depended on the trustees' decision
as to accumulation of income' (per Viscount Dilhorne). No distinction is to be
drawn between a trust to pay income to a beneficiary, but with an overriding
power to accumulate, and a trust to accumulate, but with a power to pay. Hence,
in the following examples there is no interest in possession:
(1) to A
for life but trustees may accumulate the income; and
(2) on
trust to accumulate the income but with a power to make
payments
to A.
For a
recent application of the principles in Re Pilkington (Pearson v IRC), see Oakley (as Personal
Representatives of Jossaume) v IRC [2005] STC (SCD) 343. [32.25]
3
Problems remaining after Pilkington
The test
laid down by the majority in the House of Lords established some certainty in a
difficult area of law and it is possible to say that the borderline between
trusts with and without an interest in possession (under the old [*799] regime) is reasonably easy to draw; where there is
uncertainty about the entitlement of a beneficiary to income, it is likely that
the settlement will fall into the 'no interest in possession' regime. [32.26]
The
following are some of the difficulties that may affect trusts created prior to
22 March 2006 left in the wake of Pilkington:
Dispositive
and administrative powers For there to be an interest in possession the
beneficiary must be entitled to the income as it arises. Were this test to be
applied strictly, however, even a trust with a life tenant receiving the income
might fail to satisfy the requirement because trustees may deduct management
expenses from that income, so that few beneficiaries are entitled to all the
income as it arises. This problem was considered by Viscount Dilhorne as
follows:
'Parliament
distinguished between the administration of a trust and the dispositive powers
of trustees ... A life tenant has an interest in possession but his interest
only extends to the net income of the property, that is to say, after deduction
from the gross income of expenses etc properly incurred in the management of
the trust by the trustees in the exercise of their powers. A dispositive power
is a power to dispose of the net income. Sometimes the line between an
administrative and a dispositive power may be difficult to draw but that does
not mean that there is not a valid distinction.'
In Pilkington the trustees had an overriding
discretion to apply income towards the payment of any taxes, costs, or other
outgoings which would otherwise be payable out of capital and the Revenue took
the view that the existence of this overriding power was a further reason for
the settlement lacking an interest in possession. Was this power administrative
(in which case its presence did not affect the existence of any interest in
possession) or dispositive (fatal to the existence of such an interest)?
Viscount Diihorne decided that the power was administrative. Acceptable though
this argument may be for management expenses, is it convincing when applied to
other expenses and taxes (eg CGT and IHT) which would normally be payable out
of the capital of the fund? In Miller v IRC (1987) the Court of Session held
that a power to employ income to make good depreciation in the capital value of
assets in the fund was administrative. It must be stressed that the House of
Lords did not have to decide whether the Revenue's contention was correct or
not and that Viscount Dilhorne's observations were obiter dicta. [32.27]
Power to
allow beneficiaries to occupy a dwelling house This power may exist both in
settlements which otherwise have an interest in possession and in those
without. The mere existence of such a power is to be ignored; problems will
only arise if and when it is exercised. SP 10/79 indicates that if such a power
is exercised so as to allow, for a definite or indefinite period, someone other
than the life tenant to have exclusive or joint right of residence in a
dwelling house as a permanent home, there would be an IHT charge on the partial
ending of a life interest. In the case of a fund otherwise lacking an interest
in possession, the exercise of the power would result in the creation of such
an interest and therefore, an IHT charge would arise. (These consequences do
not arise if the trusts grant non-exclusive occupation or a contractual tenancy
for full consideration.) Whether this view is correct is arguable; in Swales
v [*800] IRC (1984), for instance, the
taxpayer's argument that the mandating of trust
income to
a beneficiary was equivalent to providing a residence for permanent occupation
(and accordingly created an interest in possession) was rejected by the court.
In practice, any challenge could prove costly to the taxpayer, and trustees who
possess such powers should think carefully before exercising them. In recent
years the issue which has arisen is whether on the facts of the case trustees
are to deemed to have exercised their powers. A particular problem area is
where the trustees own a beneficial interest (say 50%) in a residential
property occupied by the other co-owner who is also a beneficiary of the trust
(see [32.32]. [32.28]
Interest-free
loans to beneftciauies It has been suggested that a free loan to a beneficiary
would create an interest in possession in the fund. This is thought to be
wrong: as the beneficiary becomes a debtor (to the extent of the loan), one
wonders in what assets his interest subsists; the moneys loaned would appear to
belong absolutely to him and he would not seem to enjoy any such rights in the
IOU. [32.29]
Position
of the last surviving member of a discretionary class If the class of
beneficiaries has closed, the sole survivor is entitled to the income as it
arises so that there is an interest in possession. When the class has not
closd, however, trustees have a reasonable time to decide how the accrued
income is to be distributed and, if a further beneficiary could come into
existence before that period has elapsed, the current beneficiary is not
automatically entitled to the income as it arises so that there is no interest
in possession (Moore and Osborne v IRC (1984)). Likewise, if the class has not closed and
the trustees have a power to accumulate income. [32.30]
Trusts of
Land and Appointment of Trustees Act 1996 Under s 12 of this Act a beneficiary
with an interest in possession is given a right to occupy trust land (provided
that various conditions are satisfied). In circumstances where there is more
than one such beneficiary the position is regulated by s 13 under which the
trustees have power to permit one of the beneficiaries to occupy the land
whilst providing for the others to be compensated. [32.31]
EXAMPLE
32.4
Under the
Titmarsh A&M trust the twins Tom and Tim became entitled to interests in
possession in 2001 whilst at university. The trust owns a substantial London
property (worth Lim) which Tom will now occupy; Tim who plans to travel is
happy with the arrangement and does not expect to be paid 'compensation'. In
these circumstances the IHT position is far from clear:
(1) Prior
to the 'arrangement' Tom and Tim enjoyed concurrent interests in possession and
each would be treated for IHT purposes as entitled to half the value of the
property (IHTA 1984 s 50).
(2) As a
result of the arrangement reached, Tom alone is now entitled to occupy and
given that Tim has waived any right to compensation it may be that he has made
a PET of the value of his half share to Tom who is now treated as entitled to
an interest in possession in the entirety (see Law Society's Gazette, 22 January 1997, p 30). The
alternative view is that his rights under the settlement are not affected: see Woodhall
(Woodhall's Personal Representative) v IRC (2000).
[*801]
Can an
interest in possession be implied? The question arises in a number of situations:
Case 1: Trustees of a discretionary
trust exercise their powers to allow a beneficiary to occupy a dwelling house
forming part of the trust fund. Occupation is rent free although the
beneficiary is responsible for all outgoings and for insuring the property. SP
10/79 indicates that the Revenue would normally consider that an interest in
possession has been created (for the CGT main residence relief, see Sansom v
Peay (1976) at
[23.62]).
Case 2:
Trustees of a discretionary trust mandate the income to one of the
beneficiaries. This is thought to be an exercise of the trustee's discretionary
powers and not to involve the creation of an interest in possession.
Case 3:
On the death of Mr A his half share in the matrimonial home is settled on
discretionary trusts for a class of beneficiaries including Mrs A and the
children. Mrs A continues in sole occupation of the house until her death. Has
she become entitled to an interest in possession in the beneficial share in the
house which was settled on Mr A's death? In this connection, note that:
(1) Mrs A
is the sole legal owner of the property;
(2) s 12
of the 1996 Act (see [32.31]) may apply to give her a protected right of
occupation;
(3) she
is entitled to occupy by virtue of her 50% beneficial share.
In these
circumstances unless the discretionary trustees exercise their powers to create
an interest in possession in favour of Mrs A it is not thought that one will be
implied from the simple fact of Mrs A's occupation of the property (see the
cases considered at [32.3]).
Case 4: A slightly different problem is
whether a short-lived interest in possession can be treated as a nullity (see
the Hatton case considered at [28.103]). Cautious draftsmen often provide that
overriding powers can only he exercised to terminate an interest in possession
once it has subsisted for at least (say) 12 months. [32.32]-[32.50]
III
CREATION OF SETTLEMENTS
1 IHT on
creation
Whereas
the creation of a settlement prior to 22 March 2006 may have constituted a
chargeable transfer of value by the settlor (for instance if the settlement was
discretionary or was established by will), a settlement created on or after
that date will constitute a chargeable transfer unless it is an inter vivos
trust in favour of a disabled person (IHTA 1984 s 3A as amended by FA 2006 Sch
20 para 9), If the burden of paying the IHT is put upon the trustees of the
settlement, HMRC accepts that the settlor of an inter vivos trust will not
thereby retain an interest in the settlement under the income tax settlement
provisions in ITTOIA 2005 s 619 et seq (SP 1/82) (see [16.91]).
Further,
beneficiaries with life interests in trusts created on or after 22 March 2006
will no longer be treated as owning the capital of the fund itself unless the
interest is a disabled person's interest, an immediate post-death interest or a
transitional serial interest (see [32.22]). The result of this change is
illustrated by the following examples, which compare the difference in
treatment of pre- and post-22 March 2006 settlements. [*802]
EXAMPLE
32.5
(1) In
November 2005, S settled £100,000 on trust for himself for life with
remainder to his children. The old regime applies. As S, the life tenant, is
deemed to own the entire fund (and not simply a life interest in it) his estate
has not fallen in value, and no IHT would have been charged. If, instead, this
settlement had been made on 22 March 2006, S would no longer he treated as
owning the entire fund, just the life interest in it and, to the extent that
his estate had fallen in value by an amount representing the difference between
the value of the entire fund and the life interest, not being a disabled
person's interest and thus not a PET, it would have amounted to a chargeable
transfer.
(2) In
December 2005, S settled £100,000 on trust for his wife for life,
remainder to his children. S's wife was treated as owning the fund so that S's
transfer was an exempt transfer to a spouse (for the position if after the
wife's interest the property was held on discretionary trusts under which the
settlor could benefit, see the IRC v Eversden). Had S settled the property in
April, 2006, S's wife would no longer be treated as owning the fund and,
accordingly, it would have amounted to a chargeable transfer.
The inter
vivos creation of a settlement before 22 March 2006 would have been a PET in
the following cases:
(1) If it
had created an interest in possession trust.
(2) If
the trust had satisfied the definition of an A&M or disabled trust.
In other
cases before 22 March 2006 (and notably when a discretionary trust was
created), there was an immediately chargeable transfer. For settlements created
before 22 March 2006, even if the settlement as created had contained an
interest in possession, the termination of that interest during the lifetime of
the settlor and within seven years of the setting up of the trust would have
triggered the anti-avoidance rules in IHTA 1984 s 54A if a discretionary trust
then arose (see [33.31]). The new regime applies for settlements created after
22 March 2006. As a result, the inter-vivos creation of any settlement will
trigger an inheritance tax charge. Further, there will be periodic and exit
charges to inheritance tax.
No inter
vivos settlement
created on or after 22 March 2006 will qualify as a PET unless it is made in
favour of a disabled person. The anti-avoidance rules in s 54A mentioned above
will apply in the same fashion on the termination of a disabled person's
interest. [32.51]
2 CGT
tie-in and Melville
Whilst
general CGT hold-over relief is no longer available it remains possible to
defer the payment of tax if the settior makes a chargeable transfer (eg if he
creates a discretionary trust: see TCGA 1992 s 260 and [24.61]). [32.52]-[32.70]
EXAMPLE
32.6
(1) Sid
puts assets worth £285,000 into a discretionary trust. For IHT
purposes, the transfer, although chargeable, falls within his nil rate band so
that no tax is payable. For CGT, hold-over relief is available.
(2)
Hopeful puts assets worth £lm and showing a substantial gain into a
discretionary trust which he retains a power to revoke. For IHT purposes,
a [*803] vexed question was whether he had made a transfer of value
at all and, if so, of how much. If he could have revoked the trust as soon as
it was created it was argued that he had lost nothing so that he had made no
transfer of value and CGT hold-over relief was accordingly unavailable. In Melville
v IRC (2001) a
discretionary settlement included the settlor as a potential beneficiary and
gave him (90 days after creation of the trust) the right to direct the trustees
to exercise their discretionary powers (for instance by appointing the property
to himself). The Court of Appeal held that the right possessed by the settlor
was property for IHT purposes which could be exercised to (in effect) revoke
the settlement. Therefore, there was a transfer of value (given the 90-day period)
but of a relatively small amount. The result of that decision was reversed by
FA 2002 which inserted a new provision into IHTA 1984 s 272 restricting the
definition of property' by excluding settlement powers. Accordingly if Hopeful
were to create his settlement today his estate would fall in value by the
£lm of assets settled and the power reserved would be ignored. Hence
he would suffer a substantial IHT charge. The 2002 legislation was, however,
restrictively drafted and Hopeful should consider the following (Melville Mark
Il) variant.
(3)
Hopeful puts assets worth Lim into a discretionary trust as above. The
difference is that after (say) 100 days he becomes absolutely, entitled to the
property if he is then alive. This contingent remainder interest is property
for IHT purposes and, given that it has a substantial value, restricts the fall
in value of his estate. An interest under a settlement is not a 'settlement
power' within the 2002 legislation.
IV
PAYMENT OF IHT
Primary
liability for IHT arising during the course of the settlement rests upon the
settlement's trustees. Their liability is limited to the property which they
have received or disposed of or become liable to account for to a beneficiary
and such other property which they would have received but for their own
neglect or default.
If
trustees fail to pay, HMRC can collect tax from any of the following (IHTA 1984
s 201(1)):
(1) Any
person entitled to an interest in possession in the settled property. His
liability is limited to the value of the trust property, out of which he can
claim an indemnity for the tax he has paid.
(2) Any
beneficiary under a discretionary trust up to the value of the property that he
receives (after paying income tax on it) and with no right to an indemnity for
the tax he is called upon to pay.
(3) The
settlor, where the trustees are resident outside the UK, since, should the
trustees not pay, the Revenue cannot enforce payment abroad. 1f the settlor
pays, he has a right to recover the tax from the trust. [32.71]-[32.90]
V
RESERVATION OF BENEFIT
The
creation of inter vivos settlements can cause problems in the reservation of
benefit area and the following matters are especially worthy of note:
(1) If
the settior appoints hi mself a trustee of the settlement, that appointment
will not by itself amount to a reserved benefit. If the terms of the
settlement [*804] provide for his remuneration, however,
there may then be a reservation in the settled property (Oakes v Stamp
Duties Comr
(1954): it appears that this point is not taken by the Capital Taxes Office
provided the remuneration is not excessive: see Inheritance Tax Manual IHTM
14394). Alternatively, the settlor/trustee could be paid an annuity, since such
an arrangement will not constitute a reserved benefit and the ending of that
annuity will not lead to any IHT charge (IHTA 1984 s 90). Particular
difficulties are caused if the settlor/trustee is a director of a company whose
shares are held in the trust fund. The general rule of equity is that a trustee
may not profit from his position and this means that he will generally have to
account for any director's fees that he may receive. It is standard practice,
however, for the trust deed to provide that a trustee need not in such cases
account for those fees. When the senIor/trustee is allowed to retain fees under
the deed it is arguable that he has reserved a benefit in the trust assets
within the ruling in the Oakes case. The Revenue has, however, indicated that it will
not take this point so long as the director's remuneration is on reasonable
commercial terms.
(2) If
the settlor reserves an interest for himself under his settlement, whether he
does so expressly or whether his interest arises by operation of law, there is
no reservation of benefit and he is treated as making a partial gift (see
Chapter 29).
EXAMPLE
32.7
S created
a settlement for his infant son, absolutely on attaining 21. No provision was
made for what should happen if the son were to die before that age, and
therefore there was a resulting trust to the settlor. The settlor died whilst
the son was still an infant and was held to have reserved no benefit. Instead,
he was treated as making a partial gift: ie a gift of the settled property less
the retained remainder interest therein (Stamp Duties Comr v Perpetual
Trustee Co
(1943); and see Re Cochrane (1906) where the settlor expressly reserved surplus
income).
The
position with regard to discretionary trusts in which the settlor is included
in the class of beneficiaries has been more problematic. In view of the limited
nature of a discretionary beneficiary's rights (see Gartside v IRC (1968)) it is unlikely that he
can be treated as making a partial gift. HMRC's view is that in all cases where
a settlor is a discretionary beneficiary he will be treated as having reserved
a benefit in the entire settled fund despite the fact that he may receive no
payments or other benefits under the trust. This has now been accepted by the
High Court in IRC v Eversden (2002) and was agreed between the parties on the appeal.
The inclusion of the settlor's spouse as a discretionary beneficiary does not
by itself result in a reserved benefit. Were that spouse to receive property
from the settlement, however, and that property was then shared with or used
for the benefit of the settlor, HMRC may then argue that there is a reserved
benefit. Finally, the reservation rules do not apply to an outright exempt gift
to a spouse although the FA 2003 amendments mean that reserved benefits can no
longer be channelled through a spouse: see Chapter 29. [32.91]
Continued:
Chapters 33-36