IHT Ch 28
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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 pçriod 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
mainthrust 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 thé 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]
kuac...@yahoo.com
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]
kuac...@yahoo.com
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 lUTA 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
(lUTA 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 nô
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 thé 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 (198) 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]
kuac...@yahoo.com
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
prop- erty 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]
kuac...@yahoo.com
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]
kuac...@yahoo.com
33 IHT--settlements with an interest in possession: the old and new
regimes
Updated by Natalie Lee, Senior Lecturer in Law, University of
Southampton and Apania Nathan, LAS Ham, LLM, Barrister, Gray's Inn Tax
Chambers
I Basic principles [33.1]
II When is IHT charged? [33.21]
III The taxation of reversionary interests [33.61]
The Finance Act 2006 introduced substantial changes to the tax
treatment of settlements with beneficial interests in possession.
Broadly speaking, the tax treatment of settlements created after 22
March 2006 is aligned with the tax treatment of discretionary
settlements. Consequently, with limited exceptions, the inter vivos
creation of an interest in possession settlement will give rise to an
immediate chargeable transfer, and property held within the
settlement, which will not be deemed to form part of the life tenant's
estate, will be subject to periodic and exit charges. The result of
the changes is that, in effect, two sets of rules operate for trusts
with interest in possession: one for those where the interest arose
prior to 22 March 2006, and the other for those created on or after
that date.
I BASIC PRINCIPLES
I General
a) Charging method
A person who became entitled to the income of a fund prior to 22 March
2006 (usually the life tenant) and someone who becomes entitled to
particular types of interests in possession on or after 22 March 2006
(see [33.3]) is treated 'as beneficially entitled to the property in
which the interest subsists' (IHTA 1984 s 49(1)). This rule is, of
course, a fiction since a life tenant has no entitlement to capital.
Although the section does not expressly provide for the deduction of
trust liabilities, in practice it is the net value of the trust fund
that is attributed to the relevant beneficiary.
As all the capital is treated as being owned by the life tenant, for
IHT Purposes it forms part of his estate, so that on a chargeable
occasion IHT is charged at his rates. The settlement itself is not a
taxable entity, although Primary liability for IHT falls upon the
trustees. [*806] Interest in possession trusts created on or after 22
March 2006 which do not fall within the limited exceptional categories
will he treated in the same way as trusts with no interest in
possession, which are considered in the next chapter. In short, the
IHT levy on these other settlements operates by treating the
settlement as a separate chargeable entity and by (generally) imposing
a tax charge at regular intervals. Even before the changes made by FA
2006, Carnwath LJ in IRC v Eversden (2003) at para 25, suggested that
there appeared to be no reason why this method, if it achieves tax
'neutrality', should not be applied across the board. It would appear
that FA 2006 sought to do just that, but it is questionable whether
there should exist neutrality between two fundamentally different
concepts. [33.1]
b) Other interests
As the life tenant of a trust with an interest in possession is
treated as owning all the capital in the fund (IHTA 1984 s 49), other
beneficiaries with 'reversionary interests' own nothing. IHTA 1984 s
47 defines reversionary interests widely to cover:
'a future interest under a settlement, whether it is vested or
contingent (including an interest expectant on the termination of an
interest in possession which, by virtue of section 50 ... is treated
as subsisting in part of any property)'.
Generally, reversionary interests are excluded property and can be
transferred without a charge to IHT (see [33.61]). Despite the breadth
of this definition, the term would not appear to catch the interests
of discretionary beneficiaries since such rights as they possess (to
compel due administration; to be considered; and jointly to wind up
the fund) are present rights. Their interests are neither in
possession nor in reversion. 'Settlement powers' (including a power to
revoke the settlement) are not 'property' for IHT purposes and hence
fall out of charge. [33.2]
2 Who is treated as owning the fund?
a) life interests
The beneficiary who:
(i) became entitled to an interest in possession prior to 22 March
2006; or
(ii) becomes entitled on or after 22 March 2006 to:
(a) an immediate post-death interest; or
(b) a disabled person's interest; or
(c) a transitional serial interest (see Chapter 32 for definitions);
where the interest is not a disabled person's interest or one for
bereaved minor
is treated as being beneficially entitled to the trust property, or to
an appropriate part of that property in which the interest subsists
(IHTA 1984, s 49(1); if there is more than one beneficiary, it is
necessary to apportion the, capital in the fund (IHTA 1984 s 50(1)).
EXAMPLE 33.1
Bill and Ben, beneficiaries under a family settlement created prior to
22 March1 2006, jointly occupy 'Snodtands', the ancestral home, which
is worth £150,000. [*807] This capital value most he apportioned to
Bill and Ben in proportion to the annual value of their respective
interests. As their interests are (presumably) equal the apportionment
will he as to £75,000 each.
It can he seen from the above that formerly all beneficiaries entitled
to an interest in possession were treated in this way. One result f
the changes introduced by FA 2006 is that the statutory fiction (that
a person with an interest in possession is deemed to be beneficially
entitled to the underlying property in which his interest subsists) is
disapplied for interests in possession acquired on or after 22 March
2006, with limited exceptions. These exceptions are couched in defined
terms (sec Chapter 32), and are illustrated by the following examples:
(1) Eddie died in September 2006, leaving his entire estate to his
wife, Glarrie, for life, with remainder to his son William absolutely.
Clarrie's interest is an immediate post-death interest and thus
qualifies as an interest in possession for the purposes of IHTA 198,1
s 49. On Eddie's death, the transfer to Clarrie is exempt under the
spouse exemption (IHTA 1984 s 18; see [31.41]); on Clarrie's death,
the value of the capital in which her interest in possession subsists
will he added to her free estate.
(2) In 1992, Phil left his residuary estate to his wife Jill for life,
thereafter to his son David for life with remainder to his grandson
Josh absolutely'. Jill dies in 2007. David's interest is a
transitional serial interest (it arises in immediate succession on or
after 22 March 2006 but before 6 April 2008 to an interest in
possession subsisting before 22 March 2006 tinder a trust created
before then), and thus qualifies as an interest in possession for the
purposes of s 49.
(3) In 1996, Peggy settled her considerable holding of Marks & Spencer
shares on her daughter Jenny for life, thereafter to jenny's husband
Brian for life with remainder to Jenny and Brian's children. jenny
dies on 1 May 2008. Brian's interest is a transitional serial interest
and thus is an interest in possession for the purposes of s 49. If,
rather than dying, jenny surrenders her interest on 1 May 2008, then
Brian's interest would not be a transitional serial interest. If,
instead, Jenny surrenders her interest in December 2007, Brian's
interest will qualify as a transitional serial interest under (2)
above.
Depending upon whether entitlement began before or on or after 22
March 2006, a beneficiary who has the right to the income of the fund
for a period shorter than his lifetime (however short the period may
he) is still treated as owning the entire settled fund. If the
settlement does not produce any income, but instead the beneficiary is
entitled to use the capital assets in the fund, IHTA 1984 s 49(1)
suggests that he is treated as owning those assets. If the use is
enjoyed by more than one beneficiary, the value of the fund is
apportioned under IHTA 1984 s 50(5) in accordance with the 'annual
value' of their respective interests. Annual value is not defined.
For a recent ease on life interests, see Oakley v IRC [2005] STC (SCD)
343. [33.3]-[33.4] [*808]
h) A beneficiary entitled to a fixed amount of income
Difficulties may arise where one beneficiary is entitled to a fixed
amount of income each year (eg an annuity) and any balance is pair! to
another beneficiary. If the amounts of income paid to the two were
compared in the year when a chargeable event occurred, a tax saving
could he engineered. Assume, for instance, that the annuity interest
terminates so that IHT is charged on its value. The proportion of
capital attributable to that interest and, therefore, the IHT would he
reduced if the trustees had switched investments into assets producing
a high income in that year. A relatively small proportion of the total
income would then be payable to the annuitant who would be treated as
owning an equivalently small portion of the capital. When a chargeable
event affects the interest in the residue of the income (eg through
termination) the trustees could switch the assets into low income
producers, thereby achieving a similar reduction in IHT.
IHTA 1984 s 50(3) is designed to counter such schemes by providing
that the Treasury may prescribe higher and lower income yields which
take effect as limits beyond which any fluctuations in the actual
income of the fund are ignored (see SI 2000/174).
EXAMPLE 33.2
The value of the settlement is £100,000; income £15,000 per annum, A
is entitled to an annuity' of £5,000 pa; B to the balance of the
income. If there is a chargeable transfer affecting the annuity, A is
not treated as owning £33,333 of the capital ([£5000 ÷ £15,000] x
£100,000) but instead a proportion of the Treasury higher rate' yield.
Assume that the higher rate is 8% on the relevant day; the calculation
is, therefore:
Notional income = 8% of £100,000 ÷ £8,000.
A's share of capital is, therefore, [£5,000 ÷ £8,000] x £100,000 =
£62,500.
This calculation is used whenever the actual income yield exceeds the
prescribed higher rate. The calculation cannot lead to a charge in
excess of the total value of the fund!
When a chargeable transfer affecting the interest in the balance of
the income occurs, if the actual income produced falls below the
prescribed lower rate, the calculation proceeds as if the fund yielded
that rate. If both interests in the settlement are chargeable on the
same occasion, the prescribed rates do not apply because the entire
fund is chargeable. [33.5]
c) A lease treated as a settlement
When a lease is treated as a settlement (eg a lease for life or lives:
see [32.2]), the lessee is treated as owning the whole of the leased
property save for any part treated as belonging u) the lessor. To
calculate the lessor's portion it is necessary to compare what he
received when the lease was granted with what would have been a full
consideration for the lease at that time (IHTA 1984 ss 50(6), 170).
[33.6]-[33.20]
EXAMPLE 33.3
(1) Land worth £100,000 is let to A for his life. The lessor receives
no consideration so that Πis treated as owning the whole of the
leased property tic £100,000). The granting of the lease is a PET by
the lessor of £100,000. [*809]
(2) As above, save that full consideration is furnished, The lease is
not treated as a settlement (sec [32.2]). No IHT will he charged on
its creation as the lessor's estate does not tall in value.
(3) Partial consideration (equivalent to 40% of hill consideration) is
furnished so that the value of the lessor's interest is 40% of
£100,000 = £40,000. The value of the lessee's interest is £60,000 and
the granting of the lease is a PET of £60,000.
HMRC accepts that if A, the owner of Blackacre, were to sell it for
full consideration arrived at on the basis that he reserves a lease
for life, then that lease has been granted for full consideration and
so does not involve the creation of a settlement. This approach is
questionable.
II WHEN IS IHT CHARGED?
For interests in possession arising on or after 22 March 2006, with
one limited exception, IHT is charged on a transfer of property to the
settlement, on 10 year anniversaries and when property leaves the
settlement (see Chapter 34 below). For settlements created prior to 22
March 2006 and in respect of a disabled person's interest created on
or after that date, the pre-FA 2006 treatment continues, whereby IHT
may he charged on the creation of the settlement and whenever an
interest in possession terminates. This event may occur inter vivos or
on death: whilst there will always be a charge on death (unless the
event is subject to an exemption, such as the spouse exemption (IHTA
1984 s 18)), in the former case the settlor or beneficiary (as
appropriate) will be treated as making a PET provided that the trust
fund is not then held on discretionary trusts. There are arid-
avoidance rules to prevent the indirect creation of discretionary
trusts via short-lived interests in possession (see [33.31]). [33.21]
I Creation of interest in possession trusts
If the trust is set up on death the usual IHT charging regime operated
(see Chapter 30). If created inter vivos, whether there is an
immediate IHT charge will depend upon when the interest in possession
was created. 1f it was prior to 22 March 2006, the settlor would have
made a PET; if it was on or after 22 March 2006, there will be an
immediate IHT charge in all cases except where the interest is a
disabled person's interest (IHTA 1984 s 3A(1A) inserted by FA 2006 Sch
20, para 9). Where there is a PET, under general rules, a charge to
TUT will only occur if the settlor dies within seven years; anti-
avoidance rules may, however, trigger a charge by reference to the
settlor's circumstances when he created the trust if the life interest
ends within seven years, at a time when the settlor is still alive and
the property then becomes held on trusts without an interest in
possession (see [33.31] for a discussion of these rules). [33.22]
EXAMPLE 33.4
(1) Sam settles property on his daughter Sally for life, remainder to
charity. The creation of the trust, if before 22 March 2006, is a PET
by Sam and on Sally's [*810] death the fund will he exempt from
charge (see IHTA 1984 s 23 for the charity exemption). 1f the property
had been settled on 23 March 2006, there would have been an immediate
chargeable transfer (at half the death rates), unless Sally qualified
as a disabled person (see Chapter 32).
(2) Before 22 March 2006, Sid settles property on a stranger, Jake
Straw, for life or until such time as the trustees determine and
thereafter the property is to he held on discretionary trusts for
Sid's family and relatives. The creation of the trust is a PET; a
later termination of Jake's life interest will he a chargeable
transfer and may trigger the anti-avoidance rules. As with (1) above,
had the property been settled on 23 March 2006, there would have been
an immediate IHT charge.
(3) Before 22 March 2006, Sam settles property on Susan, his daughter,
for life, remainder to her twins contingently on attaining 21. Susan
surrenders her life interest before 22 March 2006 when the twins are
(i) 17, (ii) 18, (iii) 21.
The creation of the trust is a PET as is the surrender of Susan's life
interest. If it is surrendered at (i), the fund is then held for A&M
trusts (a PET); if surrendered at (ii), the transfer is to the twins
as interest in possession beneficiaries (a PET); while, if surrendered
at (iii), the twins are absolutely entitled and so it will be an
outright gift which is a PET. (Note the differing CGT results, see
Chapter 25). As with (1) and (2) above, if the property had been
settled on 23 March 2006, there would have been an immediate IHT
charge. Moreover, on the surrender of Susan's life interest
(necessarily after 22 March 2006) at either (i), ii) or (iii), there
would be an exit charge since her interest is treated in the same way
as settlements with no interest in possession (see Chapter 34).
Furthermore, the relief formerly afforded to A&M trusts is no longer
available for trusts created on or after 22 March 2006 (see Chapter
34).
2 The charge on death
Where an interest in possession was created prior to 22 March 2006,
and for a post-22 March disabled person's interest, an immediate post-
death interest and a transitional serial interest, as the assets in
the settlement are treated as part of the estate of the deceased
interest in possession beneficiary at the time of his death, IHT is
charged on the settled fund at the estate rate appropriate to his
estate. The tax attributable to the settled property must be paid by
the trustees. Although the trustees pay this tax, the inclusion of the
value of the fund in the deceased's estate may increase the estate
rate, thereby causing a higher percentage charge on the deceased's
free estate. [33.23]
EXAMPLE 33.5
The settlement consists of securities worth £100,000 and is held for
Albinoni for life with remainder to Busoni. Albinoni has just died and
the value of his free estate is £170,000; he made chargeable lifetime
transfers of £105,000. IHT will be calculated as follows:
(1) Chargeable death estate: £170,000 + £100,000 (the settlement) =
£270,000.
(2) Join table at £105,000 (point reached by lifetime transfers which
cumulate).
(3) Calculate death IHT (£36,000).
(4) Convert to estate rate:
tax 36,000
------- x 100: ie x ---------- x 100 = 13.33% [*811]
estate 270,000
(5) IHT attributable in settled properly is 13.33% of £100,000 =
£3,330.
3 Inter vivos terminations
The termination of an interest in possession occurring during-the life
of the relevant beneficiary is a transfer of value which was, until
the Finance Act 2006 changes, a PET provided that the property was,
after that event, held for one or more beneficiaries absolutely (so
that the settlement was at an end), or for a further interest in
possession or on A&M or disabled trusts. IHT was only payable in such
cases if the former life tenant died within seven years of the
termination. Otherwise (eg where after the termination the fund was
held on discretionary trusts), there was an immediate charge to tax.
Following FA 2006, the only post-22 March 2006 termination that will
qualify as a PET is the coming to an end during his lifetime of the
interest of a person whose interest is an immediate post-death
interest when the settled property becomes, at the same time, subject
to a trust for a bereaved minor (see Chapter 32 and Chapter 34) (IHTA
1984 s 3A(3A) inserted by FA 2006 Sch 20, para 9). [33.24]
a) Actual terminations
Any charge will be calculated on the basis that the life tenant had
made a transfer of value of the assets comprised in the trust fund
when the interest terminates (IHTA 1984 s 52(1)). [33.25]
EXAMPLE 33.6
(1) £100,000 is held on trust for Albinoni for life or until
remarriage and thereafter for Busoni. If Albinoni had remarried before
22 March 2006, his life interest would have terminated and he would
have been treated as having made a transfer of value which would have
been a PET. Accordingly, should he die within seven years, IHT will be
charged on the value of the fund at the time when his interest ended.
(The trustees should hear this in mind before making any distribution
to Busoni). If his interest had been created prior to 22 March 2006,
but he remarries on or after that date, there would be an immediate
IHT charge on the termination of his interest. Note, had the interest
been a post 22 March 2006 interest, then it would he treated in the
same way as trusts with no interest in possession, which are discussed
in the next chapter.
If Albinoni never remarried, but consented (before 22 March 2006) to
an advancement of £50,000 to Busoni, his interest in that portion of
the fund would have ended and he would have made a transfer of value
which was a PET of £50,000. Assume that three years later (still prior
to 22 March 2006), Albinoni surrendered his life interest in the fund,
worth at that time £120,000. This is a further transfer of value which
was a PET; IHT may therefore be charged (if he dies in the seven years
following the advancement) on £170,000. Notice that in all eases any
tax charge is levied on a value transferred which is 'equal to the
value of the property in which his interest subsisted' (see s 52(1)).
The principle of calculating loss to donor's estate (see 28.61]) does
not apply. Had the advancement and the surrender
occurred on or after 22 March 2006, there would have been an immediate
IHT charge. [*812]
(2) Claude owns 49% of the shares in his family investment Company,
Money Box Ltd, and is the life tenant under a settlement which owns a
further 12% of those shares. The remainder beneficiary under the trust
is Claude's daughter. No dividends are paid by the company. The tax
position if Claude had surrendered his interest in possession prior to
22 March 2006 is as follows:
(a) The surrender of a beneficial interest in a settlement is
generally tree from CGT (TCGA 1992 s 76(l)). Assuming that the
settlement ends, there will he a deemed disposal under TCGA 1992 s
71(1); see Chapter 25.
(b) For IHT purposes, Claude would have been treated as making a
transfer of value which was a PET, but the value transferred is
limited to the value of the shares in the settlement (IHTA 1984, s
52(1)). Thus only the value of a 12% minority holding will he subject
to tax us the event of Claude's death within seven years.
On Claude's death his estate will then comprise only a 49% minority
shareholding (assuming that Claude acquired his interest in the
settlement before 22 March 2006 or, if later, the interest was an
immediate post-death interest, a disabled person's interest or a
transitional serial interest).
The merit of this arrangement was that the substantial loss to
Claude's estate resulting from his loss of control of the company did
not attract a tax charge; instead, both shareholdings were valued
separately. Surrender of the life interest could have occurred on
Claude's deathbed but the advantages would not, of course, have been
obtained if the life interest had been retained and the 49% holding
given away Had the surrender occurred on or after 22 March 2006, it
would have attracted a charge, and the arrangement would thereby lose
its merit.
b) Deemed terminations
IHTA 1984 s 51(1) provides that if the beneficiary disposes of his
beneficial interest in possession, that disposal 'shall not be a
transfer of value but shall be treated as the coming to an end of the
interest The absence of gratuitous intent does not prevent an IHT
charge on the termination of beneficial interests in possession. As
with actual terminations, the life tenant would normally be treated as
having made a transfer of valise which, before the changes introduced
by FA 2006, would have been a PET so that tax will only be charged if
he dies within seven years. [33.26]
EXAMPLE 33.7
(1) Albinoni assigns by way of gift his life interest to Cortot IHT
will be charged as if that life interest had terminated. Cortot
becomes a tenant pur autre vie and when Aibinoni dies Cortot's
interest in possession terminates so raising the possibility of a
further IHT charge. Assuming that both events occur before 22 March
2006, both Albinoni and Cortot have made PETs (for quick succession
relief, see 33.42]).
(2) If, instead of gifting his interest, Albinoni sold it to Cortot
for £20,000 (full value) on 1 March 2006 and the trust fund was then
worth £100,000, Albinoni's interest would have thereby terminated so
that he made a transfer of value of £100,000. However, as he had
received £20,000, he made a PET equal to the fall in his estate of
£80,000 (£100,000 - £20,000; IHTA 1984 s 52(2)). [*813]
e) Partition
A division of the trust fund between life tenant and remainderman
causes (lie interest in possession to terminate and IHT may be charged
(in the case of a PET, if the life tenant dies within seven years) on
that portion of the fund passing to the remainderman (IHTA 1984 s
53(2)). [33.27]
EXAMPLE 33.8
On 1 March 2006, Albinoni and Busoni agreed to partition the £100,000
trust fund in the proportions 40:60. Albinoni would have been treated
as making a PET of £60,000 (£100,000 - £40,000). Any IHT would have
been payable out of the fund which is divided,
d) Advancements etc to life tenant
If all or part of the capital of the fund is paid to the life tenant,
or if he becomes absolutely entitled to the capital, his interest in
possession will determine pro tanto, but no IHT will he charged since
there will he no fall in the value of his estate (IHTA 1984 s 53(2)).
[33.28]
e) Purchase of a reversionary interest by the life tenant (IHTA 1984
ss 10, 55(1))
As the life tenant who acquired his interest before 22 March 2006 or,
if later, the interest was an immediate post-death interest, a
disabled person's interest or a transitional serial interest is
treated as owning the fund, his tax bill could he reduced were he to
purchase a reversionary interest in that settlement. Assume, for
instance, that B has £60,000 in his bank account and is the life
tenant of a fund with a capital value of £100,000. For IHT purposes he
is treated as owning an estate worth £160,000. 1f B were to purchase
the reversionary interest in the settlement for its market value of
£60,000, the result would be as follows: first, B's estate has not
fallen in value. Originally it included £60,000: after the purchase it
includes a reversionary interest worth £60,000 since, although
excluded property, the reversionary interest must still he valued.
Secondly, B's estate now consists of the settlement fund valued at
£100,000 and has been depleted by the £60,000 paid for the
reversionary interest so that a possible charge to IHT on £60,000 has
been avoided.
To prevent this loss of tax, IHTA 1984 s 55(1) provides that the
reversionary interest is not to he valued as a part of B's estate at
the time of its purchase (thereby ensuring that his estate has fallen
in value) whilst IHTA 1984 s 10 (see [28.21]) is excluded from
applying thereby ensuring that the fall in value may be subject to
charge even though there is no donative intent. Hence, by paying
£60,000 for the reversionary interest B has made a PET which will he
taxed if he dies in the following seven years. [33.29]
f) Transactions reducing the value of the property
When the value of the fund is diminished by a depreciatory transaction
entered into between the trustees and a beneficiary (or persons
connected with him), tax is charged as if the fall in value were a
partial termination of the interest in possession (IHTA 1984 s 52(3)).
A commercial transaction lacking gratuitous intent is not caught by
this provision. [*814] In Macpherson v IRC (1988) the value of
pictures held in a trust fund was diminished by an arrangement with a
person connected with a beneficiary as a result of which, in return
for taking over care, custody and insurance of the pictures, that
person was entitled to keep the pictures for his personal enjoyment
for some 14 years. Although this arrangement was a commercial
transaction, lacking gratuitous intent when looked at in isolation, it
was associated with a subsequent operation (the appointment of a
protected life interest) which did confer a gratuitous benefit so that
the exception in s 10 did not apply and the reduction in value of the
fund was subject to charge. [33.30]
EXAMPLE 33.9
Trustees grant a 50-year lease of a property worth £100,000 at a
peppercorn rent to the brother of a reversionary beneficiary As a
result the property left in the settlement is the freehold reversion
worth only £20,000. The granting of the lease is a depreciatory
transaction which causes the value of the fund to fall by £80,000 and
as it is made with a person connected with a beneficiary, 1HTA 1984 s
52(3) will apply and IHT may, be levied as if the life interest in
£80,000 had ended. (Contrast the position if the lease had been
granted to the brother on fully commercial terms.)
4 Anti-avoidance (IHTA 1984 s 54A and s 54B)
Note that whilst these provisions apply in respect of all interest in
possession trusts created prior to 22 March 2006, where the
beneficiary became entitled to the interest in possession on or after
that date, s 54A applies only where that interest is a disabled
person's interest or a transitional serial interest (IHTA 1984 s
54A(2) inserted by FA 2006 Sch 20, para 16).
a) When do the rules apply?
The three prerequisites are that:
(1) an interest in possession trust is set up by means of a PET;
(2) it terminates either as a result of the life tenant dying or by
his interest ceasing inter vivos; and
(3) at that time a no interest in possession trust (other than an A&M
trust) arises.
If the termination occurs within seven years of the creation of the
original interest in possession trust and at a time when the settlor
is still alive, the anti-avoidance rules then apply. [33.31]
b) Operation of the rules
The IHT charge on the property at the time when the interest in
possession ends is taken to be the higher of two alternative
calculations. First, the IHT that would arise under normal charging
principles, ie by taxing the fund as if the transfer had been made by
the life tenant at the time of termination. The rates of charge will
be either half rates (when there is an inter vivos termination) or
full death rates when termination occurs as a result of the death of
the life tenant. The alternative calculation involves deeming the
[*815] settled property to have been transferred at the time of
termination by a hypothetical transferor who in the preceding seven
years had made charge- able transfers equal in value to those made by
the settlor in the seven years before he created the settlement. For
the purpose of this second calculation half rates are used. [33.32]
EXAMPLE 33.10
In 2003 Sam settled property worth £90,000 on trust for Pam for life
or until remarriage and thereafter on discretionary trusts for Sam's
relatives and friends.
His cumulative total at that time was £200,000 and he had made PETs of
£85,000. Pam remarried one year later at a time when she had made
chargeable transfers of £50,000, PETs of £45,000; and when the settled
property was worth £110,000.
(1) The anti-avoidance provisions are relevant since the conditions
for their operation are satisfied.
(2) Normally IHT would have been calculated at Pam's rates, ie on a
chargeable transfer from £50,000 to £160,000. Alternatively under
these provisions the tax could have been calculated by taking a
hypothetical transferor who had Sam's cumulative total at the time
when he created the trust; ie the £110,000 would have been taxed as a
chargeable transfer from £200,000 to £310,000. In this example the
second calculation would have been adopted since a greater amount of
IHT results. Tax must be paid by the trustees.
(3) Assume that either Sam or Pain died after the termination of the
interest in possession trust. This may result in a recalculation of
the LUT liability (in this example PETs made by that person in the
seven years before death would become chargeable). So far as the anti-
avoidance rules are concerned, however, there is no question of
disturbing the basis on which the IHT calculation was made in the
first place. Hence, as was shown in (2) above, the greater tax was
produced by taking the hypothetical transferor and, therefore, the
subsequent death of Pam is irrelevant since it cannot be used to
switch the basis of computation to Pam's cumulative total. By
contrast, the death of Sam may involve additional IHT liability since
his PETs of £85,000 will now become chargeable and thus included in
the hypothetical transferor's total when the settlement was created.
e) How to avoid the rules
First, if the interest in possession continues for seven years these
rules do not apply.
Secondly, they are not in point if the settlement was created without
an immediate interest in possession (eg there was an A&M trust which
subsequently became an interest in possession trust), or if the
settlement was created by means of an exempt transfer (eg if a life
interest was given to the settlor's spouse and that interest was
subsequently terminated in favour of a discretionary trust).
Thirdly, trustees can prevent the rules from applying if, within six
months of the ending of the interest in possession, they terminate the
discretionary trust either by an absolute appointment or by creating a
further life interest.
Fourthly, it is always possible to channel property into a
discretionary trust by a PET, if an outright gift is made to another
individual (a PET) who then settles the gifted property on the
appropriate discretionary trusts (a chargeable transfer but taxed at
his rates). Of course the transferor will have no legal right to force
the donee to settle the outright gift. [*816]
Finally, the rules are only triggered by a PET. Hence a settlement on
the settlor's spouse is not caught. [33.33]
5 Exemptions and reliefs
a) Reverter to settlor/spouse (IHTA 1984 s 53(3)-(5))
If, on the termination of an interest in possession, property reverts
to the settlor, there is no charge to IHT unless that interest had
been acquired for money or money's worth. This exemption also applies
when the property passes to the settlor's spouse or (if the settlor is
dead) to his widow or widower so long as that reverter occurs within
two years of the settlor's death (for the CGT position, see Chapter
25). [33.34]
EXAMPLE 33.11
(1) In 2004, Janacek created a settlement of £100,000 in favour of K
for life (a PET). When K dies and the property reverts to the settlor
no IHT will be charged.
Contrast the position, if the settlement provided that the fund was to
pass to L on the death of K, hot the settlor's wife had purchased that
remainder interest and given it to her husband as a Christmas present.
On the death of the life tenant, although the property will revert to
the senior, the normal charge to IHT will apply. (For the CGT
position, see Chapter 25.)
(2) Bert and his wife, Bertha, own their house as tenants in common.
On Bert's death in 2004 he left his share to his daughter, Bettina. In
2005, she settled it on trust for her mother (Bertha) for life;
remainder to herself (Bettina) for life with remainders over.
On Bertha's death in February 2006, Bettina was still alive and the
IHT reverter to settlor exception applied. Because Bettina only enjoys
a life interest, the CGT uplift on death was available (which it would
not have been if Bettina had then become absolutely entitled). The
arrangement provides added security for Bertha without forfeiting any
life benefits (contrast IRC v Lloyds Private Banking Ltd (1998) at
[32.3]).
b) Use of the life tenants exemptions
The spouse exemption is available on the termination of the interest
in possession if the person who then becomes entitled, whether
absolutely or to another interest in possession, is the spouse of the
former life tenant. In addition, IHTA 1984 s 57 permits the use of the
life tenant's annual (£3,000 pa) exemption and the exemption for gifts
in consideration of marriage on the inter vivos termination of an
interest in possession if the life tenant so elects (see IHTA 1984 s
57(3), (4)). The exemptions for small gifts (£250) and normal
expenditure out of income cannot be used.
EXAMPLE 33.12
Orff is the life tenant of the fund. His wife and son are entitled
equally in remainder. If he surrenders the life interest, there will
be no tax on the half share passing to his wife (spouse exemption).
The chargeable half share passing to his son is a PET (provided the
surrender March 2006) and, [*817] should it become chargeable
because of his death within seven years, the annual exemption and, if
surrender coincides with the marriage of the son, the £5,000) marriage
gift relief will be available.
Although the making of a PET is no! reported, the appropriate notice
should be givers to the trustees by the life tenant indicating that he
wishes the transfer to he covered by his relevant exemption (the
annual or marriage exemptions) so that it can then be submitted (if
needed) to HMRC as required by s 57(4) (and see SI 2002/1731).
[33.35]
c) The surviving spouse exemption
The carry-over of this estate dusty relief is discussed at [30.158].
The first spouse must have died before 13 November 1974 and the relief
ensures that IHT is not charged on the termination of the surviving
spouse's interest its the property whether that occurs inter vivos or
on death (IHTA 1984 Sch 6 para 2). [33.36]
d) Excluded properly
If the settlement contains excluded property, IHT is not charged on
that portion of the fund (IHTA 1984 ss 5(1), 53(1)). [33.37]
e) IHTA 1984 s 11 dispositions
If the interest in possession is disposed of for the purpose of
maintaining the disponer's child or supporting a dependent relative,
IHT is not charged (see [31.7]). [33.38]
f) Charities
Tax is not charged if on the termination of the interest in possession
the property is held on trust for charitable purposes. [33.39]
g) Protective trusts
The forfeiture of a protected life interest is not normally treated as
the terminations of an interest in possessions (see [34.117]).
[33.40]
h) Variations and disclaimers
Dispositions of the deceased may be altered after his death by means
of an instrument of variation or disclaimer and treated as if they had
been made by the deceased. Disclaimers are possible in the case both
of settlements created by the will or intestacy of the deceased (IHTA
1984 s 142) and pre-existing settlements in which the death has
resulted in a person becoming entitled to an interest in the settled
property (IHTA 1984 s 93). Variations are only permitted for
settlements created on the relevant death, not for settlements in
which the deceased had been the beneficiary. 1f an interest in
possession is created under a variation made on or after 22 March 2006
and is deemed to arise on the deceased's death pre-22 March 2006, it
will be treated as an [*818] interest in possession in existence
before that date, and so will be subject to the pre-22 March 2006
rules, Where the deceased dies on or after 22 March 2006, the new
interest in possession will be an immediate post-death interest and,
accordingly, it should still be possible to obtain the spouse/civil
partnership exemption for interests in possession created by deed of
variation within s 142 whenever the deceased might die. [33.41]
EXAMPLE 33.13
Poulenc, the life tenant of a settlement created by his father, has
just died. His brother Querrus is now the life tenant iii possession
and if he assigns his interest within two years of Poulenc's death,
the normal charging provisions will apply, (Note: (1) he could
disclaim his interest without any IHT charge (IHTA l984 s 93); (2) see
[30.155] for problems caused to trustees when or her property of the
deceased is varied or disclaimed.)
i) Quick succession relief (IHTA 1984 s 141)
This relief is similar to that for unsettled property (see [30.144]).
The first chargeable transfer may he either the creation of the
settlement or any subsequent termination of an interest in possession
(whether that termination occurs inter vivos or on death). Hence, it
can be voluntarily used (by the life tenant surrendering or assigning
his interest) whereas in the case of unsettled property it is only
available on a death. The calculation of the relief in cases where
there is more than one later transfer is dealt with in IHTA 1984 s
141(4). [33.42]
EXAMPLE 33.14
(1) A settlement is created in January 2000; (2) the life interest
ends in half of the fund in March 2002; (3) the life interest ends in
the rest of the fund in February 2003. Assume that both PETs become
chargeable because of the death of the life tenant within seven years.
Quick succession relief is available at a rate of 60% on event (2);
and again at a rate of 40% on event (3). Generally, relief is given in
respect of the earlier transfer first ((2) above). To the extent that
the relief given represents less than the whole of the tax charged on
the original net transfer ((1) above), further relief can then be
given in respect of subsequent transfers ((3) above) until relief
equal to the whole of the tax (in (1) above) has been given.
j) Business reliefs
In a settlement containing business property that relief is available
to the life tenant provided that he fulfils the conditions for relief
(IHTA 1984 ss 103-114). Note that the relief appears to he unaffected
by the changes introduced by FA 2006.
EXAMPLE 33.15
Satie is the life tenant of the settlement. He holds 30% of the shares
in the trading company Teleman Ltd, and the trust holds a further 25%.
Further, the trust owns the factory premises which are leased to the
company. On the death of Satie, IHT business relief is available as
follows: [*819]
(1) On the shores: the relief (assuming that the two-year ownership
condition is satisfied) is at 100% on Satie's shares and on those of
the fund. The life tenant is treated as having controlled the company
since he held 30% (his own) and is treated as owning a further 25% of
the shares.
(2) 0n the land: the relief is at 50% since the asset is used by a
company controlled by the life tenant. (But see Fetherstonehough v IRC
(1984).)
Similar rules operate for agricultural relief. ie the life tenant must
satisfy the conditions of two years' occupation or seven years'
ownership (ownership by the trustees being attributed to the life
tenant). Because the interest in possession beneficiary is treated as
owning the trust fund (rather than it being owned by the trustees)
problems can arise in the case of both APR and BPR when, for instance,
a beneficiary under an A&M trust obtains an interest in possession
(see, in the context of clawback, Example 31.15(4)). [33.43]-[33.60]
III THE TAXATION OF REVERSIONARY INTERESTS
a) General rule: excluded property
Reversionary interests are generally excluded property so that their
assignment or transfer does not lead to an IHT charge. (The purchase
of a reversionary interest by the life tenant has been considered at
[33.29].) [33.61]
EXAMPLE 33.16
A fund is settled on trust for A for life (A is currently aged 88); B
for life (B is 78);
and C absolutely (C, A's son, is 70).
This settlement is likely to be subject to three [HT charges within a
fairly short period. The position would he much improved if B and C
disposed of their reversionary interests:
(1) B should surrender his interest. Taking into account his age it
has little value and is merely an IHT trap.
(2) C should assign his interest to (ideally) a younger person. He
might for instance have minor grandchildren and an A&M trust in their
favour would be an attractive possibility. (Note the changes made by
FA 2006 to such trusts established on or after 22 March 2006: see
Chapter 34.)
The result of this reorganisation is that the fund is now threatened
by only one IHT charge (on A's death) in the immediate future.
b) Exceptions
In four eases reversionary interests are not excluded property. This
is to prevent their use as a tax avoidance device.
First, the sale of a reversionary interest to a beneficiary under the
same trust, who is entitled to a prior interest (see [33.29]).
Secondly, the disposition of a reversionary interest which has at any
time, and by any person, been acquired for a consideration in money or
money's worth. (For special rules where that interest is situated
outside the UK, see [35.85].) [*820]
EXAMPLE 33.17
Umberto sells his reversionary interest to Vidor (a stranger to the
trust) for its market value, £20,000. 1f the general rules operated
the position would he that:
(1) Umberto is disposing of excluded property so that no IHT is
chargeable.
(2) Vidor has replaced chargeable assets (20,0O0) with excluded
property so that were he to die or make an inter vivos gift IHT would
he avoided.
IHTA 1984 s 48(1) (a) and s 48(3) prevent this result. The reversion
ceases to be excluded property once it has been purchased (even for a
small consideration) so that a disposition by Vidor may lead to an IHT
charge.
Thirdly, a disposition of a reversionary interest is chargeable if it
is one to which either the settlor or his spouse is, or has been,
beneficially entitled (IHTA 1984 s 48(1)(b)).
EXAMPLE 33.18
In 2003 Viv settled property worth £100,000 on trust for his father
Will for life (Will is 92). Viv retained the reversionary interest
which he then gave to his daughter Ursula. If the general rules were
not modified the position would be that:
(1) The creation of the settlement would have been a PET by Viv but
the diminution in his estate would have been very small (the
difference between £100,000 and the value of a reversionary interest
in £100,000 subject only to the termination of the interest of a 92-
year-old life tenant!).
(2) The transfer of the reversion by Viv would have escaped IHT since
it is excluded property.
IHTA 1984 s 48(1) (b) ensures that the transfer of the reversion is a
PET so that Viv achieved no tax saving (and, indeed, was left with the
danger of a higher IHT bill than if he had never created the
settlement since the death of Will is a chargeable event).
This may be used to the taxpayer's advantage in a 'Melville type'
scheme: namely, where it is desired to create a discretionary trust in
order to obtain hold-over relief whilst ensuring that any IHT transfer
of value is kept within the nil rate hand (see [32.52]).
Fourthly, the disposition of a reversionary interest is chargeable
where that interest is expectant upon the termination of a lease which
is treated as a settlement (typically one for life or lives; IHTA 1984
s 48(l)(c). The lessor's reversion is treated in the same way as a
reversionary interest purchased for money or money's worth so that on
any disposition of it, IHT may be charged. [33.62] [*821]
kuac...@yahoo.com
possession and those treated as settlements without an interest in
possession
Updated by Aparna Nathan, LLB Hons, LLM, Barrister, Gray's inn Tax
Chambers and Natalie Lee, Barrister, Senior Lecturer in Law,
University of Southampton
I Introduction and terminology [34.1]
Il The method of charge [34.21]
III Exemptions and reliefs [34.51]
IV Discretionary trusts created before 27 March 1974 [34.71]
V Accumulation and maintenance trusts (IHTA 1984 s 71) [34.91]
VI Trusts for bereaved minors and 18-25 trusts [34.101]
VII Other special trusts [34.111]
I INTRODUCTION AND TERMINOLOGY
Prior to the changes introduced by FA 2006, relevant property referred
to property held in a settlement lacking an interest in possession.
The method of charging settlements of this nature is totally different
from that for settlements with an interest in possession (see Chapter
33). Instead of attributing the fund to one of the beneficiaries, the
settlement itself is the taxable entity. Like an individual, a record
of chargeable transfers must he kept although, unlike the individual,
it will never die and so will only be taxed at half rates. Taking into
account the recent changes, this chapter will discuss the rules by
reference to relevant property. Until those changes, the discretionary
trust was the most significant trust with relevant property. In fact
the category is wider than discretionary trusts catching, for
instance, the settlement in the Pilkington case ([32.24]) and trusts
where the beneficiaries' interests are contingent. These rules will
now also apply to a post-22 March 2006 trust with an interest in
possession that is not a transitional serial interest, an immediate
post-death interest or disabled person's interest (see Chapter 33).
[*822]
EXAMPLE 34.1
(1) A fund of £100,000 is betel upon trust for such of A, B, C, D, E
and F as the trustees may in their absolute discretion (which extends
over both income and capital) think appropriate. The trust is one
without an interest in possession.
(2) Dad settles property on trust for Sonny absolutely contingent on
his attaining 30. Sonny is aged 21 at the date of the settlement and
the income is to he accumulated until Sonny attains 30. There is no
interest in possession.
(3) On 1 April 2006, Mum settles property on trust for her daughter
Tamsin for life, with remainder to her grandson Victor absolutely.
Although there is an interest in possession, it arises post-22 March
2006 and, not being a transitional serial interest, an immediate post-
death interest or disabled person's interest (and nor is it a 'special
trust' considered in Sections VI and VII of this Chapter), it will be
subject to the same regime that applies to settlements where there
exists no interest in possession.
IHT is charged on 'relevant property' (IHTA 1984 s 58(1)) defined, for
pre-22 March 2006 trusts, as settled property (other than excluded
property) in which there is no qualifying interest in possession, with
the exception of property settled on the 'special trusts' considered
in Sections V and VI, below.
A 'qualifying interest in possession' was one owned beneficially by an
individual or, in restricted circumstances, by a company. If within
one settlement there existed an interest in possession in a part only
of the settled property, these rules applied to the portion which
lacks such an interest. It has already been mentioned that the term
'relevant property' now applies to property settled on a post-22 March
2006 trust giving rise to an interest in possession that is not a
transitional serial interest, an immediate post-death interest or
disabled person's interest. There continues to be an exception for
property on 'special toasts' considered in Sections VI and VII. [34.1]-
[34.20]
II THE METHOD OF CHARGE
The central feature is the periodic charge imposed upon relevant
property at ten-yearly intervals. The anniversary is calculated from
the date on which the trust was created (IHTA 1984 s 61(1)). In the
case of settlements initially established with a nominal sum (eg £10)
it is from the date when that nominal sum is received by the trustees.
EXAMPLE 34.2
(1) Silas creates a discretionary trust on 1 January 1989. The first
anniversary charge will fall on 1 January 1999; the next on 1 January
2009 and so on. If the trust had been created by will and he had died
on 31 December 1988, that date marks the creation of the trust (IHTA
1984 s 53). A similar principle applies if the trust was established
by an instrument of variation falling within 11-ITA 1984 s 142 (see
[30.153]).
(2) Sebastian creates (in 1988) a settlement in favour of his wife
Selina for life; thereafter for such of his three daughters as the
trustees may in their absolute discretion select, Selina dies in 1989.
For IHT purposes the discretionary trust is created by Selina on her
death (IHTA 1984 s 80) although the ten-year anniversary runs from
1988 (IHTA 1984 s61(2)). [*823]
(3) The first anniversary charge in respect of the trust created by
Mum for Tamsin (Example 34.1(3)) will fall on 1 April 2016.
Apart from the periodic charge, IHT is also levied (the 'exit charge')
on the happening of certain events. In general, the IHT then charged
is a proportion of the last periodic charge. Special charging
provisions operate for chargeable events which occur before the first
ten-year anniversary. No accounts need be filed by trustees of
'excepted settlements': see SI 2002/1732. In general the assets in the
trust must be cash and the value of the settled property at the time
of the chargeable event must not exceed £1,000. [34.21]
1 The creation of the settlement
This will, generally, be a chargeable transfer of value by the settlor
for IHT purposes. The following matters should be noted: first, if the
settlement is created inter vivos, grossing-up applies unless IHT is
paid out of the fund (see Chapter 28).
Secondly, the cumulative total of chargeable transfers made by the
settlor forms part of the cumulative total of the settlement on all
future chargeable occasions (ie his transfers never drop out of the
cumulative total). Therefore, in order to calculate the correct IHT
charge it is essential that the trustees are told the settlor's
cumulative total at the date when he created the trust. When as a
result of the settlor's fraud, wilful default or neglect there is an
underpayment of IHT, HMRC may recover that sum from the trustees
outside the normal six-year time limit. In such cases the time limit
is six years from the date when the impropriety comes to the notice of
HMRC (IHTA 1984 s 240(3)). Obviously a problem would arise for
trustees if at the time when the underpayment came to light they held
insufficient assets to discharge the extra IHT bill since they could
be made personally liable for the tax unpaid. HMRC have, however,
previously stated that where the trustees have acted in good faith and
hold insufficient settlement assets they will not seek to recover any
unpaid tax from them personally (Law Society's Gazette, 1984, p 3517).
Thirdly, a 'related settlement' is one created by the same settlor on
the same day as the trust with relevant property (other than a
charitable trust). Generally such settlements should be avoided (see
[34.27]). The use of 'pilot' settlements is considered at [34.35].
Fourthly, additions of property by the original settlor to his
settlement may create problems although it is standard practice in the
case of 'pilot' trusts (see [34.33]). If property is added by a person
other than the original settlor, the addition will be treated as a
separate settlement (see [32.7]).
Problems may arise for the trustees if the settlor dies within seven
years of creating the trust. PETs made before the settlement was
created and within seven years of his death then become chargeable so
that tax on creation of the settlement and the computation of any exit
charge made during this period may need to be recalculated. If extra
tax becomes payable this is primarily the responsibility of the
settlement trustees and their liability is not limited to settlement
property in their hands at that time. Given this danger it [*824]
will he prudent for trustees who are distributing property from the
trust with relevant property within the first seven years to retain
sufficient funds or take suitable indemnities to cover all contingent
IHT liability. [34.22]
EXAMPLE 34.3
Sumar makes the following transfers of value:
May 1998 -- £200,000 to his sister Sufi (a PET).
May 1999 -- £70,000 to a family discretionary trust.
In May 2000 the trustees distribute the entire fund to the
beneficiaries and in May 2003 Sumar dies.
As a result of his death, the 1998 PET is chargeable (the resultant
1(1) is primarily the responsibility of Sufi) and in addition tax on
the creation of the settlement insist he recalculated.
When it was set up the PET was ignored so that the transfer fell
within Sumar's nil rate hand. With his death, however, IHT must he
calculated, at the rates in force in May 2003, on transfers from
£200,000 to £270,000 (tax is £8,000). In addition it is likely that no
IHT will have been charged on the distribution of the fund in 2000 and
therefore a recomputation is again necessary with the trustees being
liable for the resulting tax.
2 Exit charges before the first ten-year anniversary
a) When will an exit charge arise?
A charge is imposed whenever property in the settlement ceases to be
'relevant property' (IHTA 1984 s 65). For instance, if the trustees of
a discretionary trust appoint property to a beneficiary or if an
interest in possession arises in any portion of the fund, there will
be a charge to the extent of the property ceasing to he held on
discretionary trusts. Note that if an interest in possession arises on
or after 22 March 2006, the property only ceases to he relevant
property to the extent that it is a disabled person's interest (by
definition, it cannot be an immediate post-death interest or a
transitional serial interest). 1f the resultant IHT is paid out of the
property that is left in the discretionary trust, grossing-tip will
apply. A charge is also imposed if the trustees make a disposition as
a result of which the value of relevant property comprised in the
settlement falls (a 'depreciatory transaction'; see [33.30]: notice
that in this case there is no requirement that the transaction must he
made with a beneficiary or with a person connected with him).
The exit charge does not apply to a payment of costs or expenses (so
long as it is 'fairly attributable' to the relevant property), nor
does it catch a payment which is income of any person for the purposes
of income tax (IHTA 1984 s 65(5)). [34.23]
h) Calculation of the settlement rate
The calculation of the rate of IHT is based upon half the full IHT
rates, even if the trust was set up under the will of the settlor. The
rate of tax actually payable is then 30% of those rates applicable to
a hypothetical chargeable transfer.
Step 1 This hypothetical transfer is made up of the sum of the
following:
(1) the value of the property in the settlement immediately after it
commenced;
(2) the value (at the date of the addition) of any added property; and
(3) the value of property in a related settlement (valued immediately
after it commenced (IHTA 1984 s 68(5)).
No account is taken of any rise or fall in the value of the settled
fund and the value comprised in the settlement and in any related
settlement can include property subject to an interest in possession.
Step 2 Tax at half rates on this hypothetical transfer is calculated
by joining the table at the point reached by the cumulative total of
previous chargeable transfers made by the settlor in the seven years
before he created the settlement. Other chargeable transfers made on
the same day as the settlement are ignored and, therefore, if the
settlement was created on death, other gifts made in the will or on
intestacy are ignored (IHTA 1984 s 68(4) (b)).
Step 3 The resultant tax is converted to an average rate (the
equivalent of an estate rate) and 30% of that rate is then taken. The
resultant rate (the 'settlement rate') is used as the basis for
calculating the exit charge. [34.24]
EXAMPLE 34.4
Justinian settles £100,000 on discretionary trusts on 6 April 2003.
His total chargeable transfers immediately before that date stood at
£165,000. He pays the IHT. If an exit charge arises before the first
ten-year anniversary of the fund (6 April 2013) the settlement rate
would be calculated as follows:
Step I Calculate the hypothetical chargeable transfer. As there is no
added property and no related settlement it comprises only the value
of the property in the settlement immediately after its creation (ie
£100,000).
Step 2 Cumulate the £100,000 with the previous chargeable transfers of
Justinian
(ie £165,000). Taking the IHT rates in force in April 2003, tax on
transfers between £165,000 and £265,000 is £2,000.
Step 3 The tax converted to a percentage rate is 2%; 30% of that rate
produces a 'settlement rate' of 0.6%.
e) The tax charged
The charge is on the fall in value of the fund. To establish the rate
of charge, a further proportion of the settlement rate must be
calculated equal to one-fortieth of the settlement rate for each
complete successive quarter that has elapsed from the creation of the
settlement to the date of the exit charge. That proportion of the
settlement rate is applied to the chargeable transfer (the 'effective
rate').
EXAMPLE 34.5
Assume in Example 34.4 that on 25 March 2005 there was an exit charge
on £20,000 ceasing to he relevant property. The 'effective rate' of
IHT is calculated as follows:
Step 1 Take completed quarters since the settlement was created, ie
seven.
Step 2 Take 7/40ths of the 'settlement rate' (0.6%) to discover the
'effective rate' = 0.105%.
Step 3 The effective rate is applied to the fall in value of the
relevant property.
The IHT will, therefore, be 21 if the tax is borne by the beneficiary;
or 21.02 if borne by the remaining fund. [*826] There is 110 charge
on events that occur in the first three months after the settlement is
created (IHTA 1984 s 65(4)) nor, in certain circumstances when the
trust was set up by the settior on his death, on events occurring
within two years of that death (see [30.145]). [34.25]
3 The charge on the first ten-year anniversary
a) What property is charged?
The charge is levied on the value of the relevant property comprised
in the settlement immediately before the anniversary (ITHA 1984 s 64).
Income only becomes relevant property, and thus subject to charge,
when it has been accumulated (see SP 8/86). Pending accumulation it is
not subject to the anniversary charge and can be distributed free from
any exit charge (see [34.23]). Note that the income arising in a
post-22 March 2006 interest in possession trust that now falls within
the definition of relevant property will, by definition, not be
accumulated; it will be paid to the beneficiary with an interest in
possession. At what moment is income accumulated? Accumulation occurs
once an irrevocable decision to that effect has been taken by
trustees, and it may also occur after a reasonable time for
distribution has passed (but see Re Locker (1977) in which income
arising between 1965 arid 1968 was still available for distribution in
1977). The legislation gives no guidance on what property is treated
as being distributed first; ie if an appointment is made by the
trustees out of property comprised in the settlement, does it come out
of the original capital or out of accumulations of income? As a
reduced charge may apply to property which has been added to the trust
(such as accumulated income: see [34.33]) this is an important
omission (for the approach adopted in practice by the Revenue, see
Capital Taxes News, vol 8, May 1989).
The assets in the fund are valued according to general principles and,
if they include business or agricultural property, the reliefs
appropriate to that property will apply, subject to satisfaction of
the relevant conditions. Any IHT charged on such property may be
payable in instalments. [34.26]
b) Calculation of the rate of IHT
Half rates will be used and, as with the exit charge, the calculation
depends upon a hypothetical chargeable transfer.
Step 1 Calculate the hypothetical chargeable transfer which is made up
of the sum of the following:
(1) the value of relevant property comprised in the settlement
immediately before the anniversary;
(2) the value, immediately after it was created, of property comprised
in a 'related settlement'; and
(3) the value, at the date when the settlement was created, of any non-
relevant property then in the settlement which has not subsequently
become relevant property.
Normally the hypothetical chargeable transfer will be made up
exclusively of property falling within (1) above. (2) and (3), which
affect the rate of IHT to be charged without themselves being taxed,
are anti-avoidance measures. [*827] Related settlements are included
because transfers made on the same day as the creation of the
settlement are normally ignored and, therefore, advantage could be
achieved if the settlor were to set up a series small funds rather
than one large fund. Non-relevant property in the settler is included
because the trustees could switch the values between the two portions
of the fund.
Step 2 Calculate tax at half rates on the hypothetical chargeable
transfer by joining the table at the point reached by:
(1) the chargeable transfers of the settlor made in the seven years
before he created the settlement; and
(2) chargeable transfers made by the settlement in the first ten
years. Where a settlement was created after 26 March 1974 and before 9
March 1982, distribution payments (as defined by the IHT charging
regime in force between those dates) must also be cumulated (IHTA 1984
s 66(6).
Settlements with relevant property will, therefore, have their own
total of chargeable transfers with transfers over a ten-year period
being cumulated (contrast the seven-year period used for individuals).
The unique feature of a settlement's cumulation lies in the inclusion
(and it never drops out) of chargeable transfers of the settlor in the
seven years before the settlement is created.
Step 3 The IHT is converted to a percentage and 30% of that rate is
then taken and charged on the relevant property in the settlement.
The highest rate of IHT is 20% (half of 40%). The highest effective
rate (anniversary rate) is, therefore, 30% of 20%, ie 6%. Where the
settlement comprises business property qualifying for 50% relief, this
effective rate falls to 3% and assuming that the option to pay in
instalments is exercised, the annual charge over the ten-year period
becomes a mere 0.3%. 1f the property qualities for 100% business or
agricultural relief there is no charge. [34.27]
EXAMPLE 34.6
Take the facts of Example 34.5 (namely, original fund £100,000, exit
charge on £20,000; previous transfers of settlor £165,000). In
addition, assume Justinian had created a second settlement of £35,000
on 6 April 2003.
The fund is worth £105,000 at the first ten-year anniversary.
(1) Relevant property to be taxed is £105,000
(2) Calculate hypothetical chargeable transfer: £
Relevant property, as above 105,000
Property in related settlement 35,000
. -------
. 140,000
. =======
(3) Settlement's cumulative IHT total £
Settlor's earlier transfers 165,000
Chargeable transfers of trustees in preceding
ten years 20,000
(4) Tax from the IHT table (at half rates) on transfers from £185,000
to £325,000 (1140,000 + £185,000) = £10,000 so that, as a percentage
rate IHT is 7.14%. [*828]
(5) the 'effective rate' is 30% of 7.14% 2.14%.
Tax payable is £105,000 x 2.14% = £2,250
4 Exit charges after the first anniversary charge and between
anniversaries
The same events will trigger an exit charge after the first ten-year
anniversary as before it. The IT-IT charge will be levied on the fall
in value of the hind with grossing-up, if necessary The rate of charge
is a proportion of the effective rate charged at the first ten-year
anniversary. That proportion is one-fortieth for each complete quarter
from the date of the first anniversary charge to the date of the exit
charge (IHTA 1984 s 69).
EXAMPLE 34.7
Continuing Example 34.6, exactly 15 months later the trustees appoint
£25.000 to a beneficiary. The IHT (assuming no grossing-up) will be:
£25,000 s 2.14%. x 5/40 (five quarters since last ten-year
anniversary) = £66.88.
If the rates of IHT have been reduced (including the raising of the
rate hands) between the anniversary and exit charges, the lower rates
will apply to the exit charge and, therefore, the rate of charge on
the first anniversary will have to be recalculated at those rates
(IHTA 1984 Sch 2 pant 3). So long as the IHT rate bands remain linked
to rises in the retail prices index (IHTA 1984 s 8) recalculation will
be the norm.
No exit charge is levied if the chargeable event occurs within the
first quarter following the anniversary charge. [34.28]
5 Later periodic charges
The principles that applied on the first ten-year anniversary operate
on subsequent ten-year anniversaries. So far as the hypothetical
chargeable transfer is concerned the same items will he included (so
that the value of property in a related settlement and of non-relevant
property in the settlement is always included). The cumulative total
of the fund will, as before, include the chargeable transfers of the
settlor made in the seven years before he created the settlement and
the transfers out of the settlement in the ten years immediately
preceding the anniversary (earlier transfers by the settlement fall
out of the cumulative total). The remaining stages of the calculation
are unaltered. [34.29]
6 Technical problems
The basic structure of the charging provisions in IHTA 1984 ss 58-69
is
relatively straightforward. The charge to IHT is built on a series of
periodic charges with interim charges (where appropriate) which are
levied at a fraction of the full periodic charge. [34.30]
a) Reduction in the rate of the anniversary charge
If property has not been in the settlement for the entire preceding
ten years (as will be the case when income is accumulated during that
period) there is [*829] a proportionate reduction in the charge IHTA
1984 s 66(2)). The reduction in the periodic rate is calculated by
reference to the number of completed quarters that expired before the
property became relevant property in the settlement.
EXAMPLE 34.8
Assume in Example 34.6 that £15,000 had become relevant property on 30
April 2009.
The IHT charge on the first ten-year anniversary (on 6 April 2013)
would now be calculated as follows:
(1) £90,000 (£105,000 - £15,000) at 2.14% = fl,926.
(2) The £15,000 will be charged at a proportion of the periodic charge
rate: namely 2.14% reduced by 24/40 since 24 complete quarters elapsed
since the creation of the settlement (on 1 April 2003) to the date
whew the £15,000 became relevant property. As a result the IHT charged
is £15,000 x 0.85% (ie 2.14% s 16/40) = £128.40.
This proportionate reduction in the effective rate of the periodic
charge will not affect the calculation of IHT on events occurring
after the anniversary, ie any exit charge is at the full effective
rate.
The legislation does rot contain provisions which enable specific
property to be identified. Thus, the reduction mentioned above applies
to the value of the relevant property in the fund at the ten-year
anniversary 'attributable' to property which was not relevant property
throughout the preceding ten years. Presumably a proportionate
calculation will he necessary where the value of the fund has shown an
increase. Furthermore, if accumulated income is caught by the
anniversary charge, a separate calculation will have to be made with
regard to each separate accumulation (see SP 8/S6: [34.26]). [34.31]
b) Transfers between settlements
IHTA 1984 s 81 prevents a tax advantage front switching property
between settlements of relevant property, by providing that such
property remains comprised in the first settlement. Accordingly,
property cannot be moved out of a discretionary trust to avoid an
anniversary charge; property cannot be switched from a fund with a
high cumulative total to one with a lower total; and the transfer of
property from one discretionary fund to another will not he
chargeable. [34.32)
e) Added property
Special rules operate if, after the settlement commenced (and after 8
March 1982), the settlor made a chargeable transfer as a result of
which the value of the property comprised in the settlement was
increased (IHTA 1984 s K)7(1é. Note that it is only additions by the
settlor that trigger these provisions and that it is the value of the
fund which must be increased and not necessarily the amount of
property in that fund. Transfers which have the effect of increasing
the value of the fund are ignored if they are not primarily intended
to have that effect and do not in fact increase the value hit more
than 5%. [*830]
EXAMPLE 34.9
Sam, the settlor, creates in 2003 a discretionary trust of stocks and
shares in Sham Ltd and the benefit of a life insurance policy on Sam's
life.
(1) Each year Sam adds property to the settlement, equal to his annual
LUT exemption.
(2) Sam continues to pay the premiums on the life policy each year.
(3) Sam transfers further shares in Sham Ltd.
The special rules for added property will not apply in either case (1)
or (2), since Sam is not making a chargeable transfer; the first
transfer is covered by his annual exemption and the second by the
exemption for normal expenditure out of income. The transfer of
further shares to the fund, however, is caught by the provisions of
IHTA 1984 s 67.
If the added property provisions apply the calculation of the periodic
charge which immediately follows the addition will be modified. For
the purposes of the hypothetical chargeable transfer, the cumulative
total of the settlor's chargeable transfers will be the higher of the
totals (1) immediately before creating the settlement plus transfers
made by the settlement before the addition; and (2) immediately before
transferring the added property, deducting from this latter total the
transfer made on creation of the settlement and a transfer to any
related settlement. The settlor should normally avoid additions, since
they may cause more IHT to be charged at the next anniversary and it
will be preferable to create a separate settlement. [34.33]
d) The timing of the exit charge
Assume, for example, that a discretionary trust has been in existence
for nearly ten years and that the trustees now wish to distribute all
or part of the fund to the beneficiaries. Are they better off doing so
just before the ten-year anniversary or should they wait until just
after that anniversary? Generally, it will be advantageous to
distribute before an anniversary because IHT payable will be
calculated at rates then in force but on historic values, le on the
value of the fund when it was settled or at the last ten-year
anniversary. By contrast, if the trustees delay until after the
anniversary, IHT (still at current rates) will then be assessed on the
present value of the fund. To this general proposition one major
exception exists which may well be the result of defective drafting in
the legislation. It relates to a fund consisting of property
qualifying for either business relief or agricultural relief at 50%.
In this situation trustees should not break up the fund immediately
before the first anniversary. [34.34]
EXAMPLE 34.10
A discretionary settlement was created on 1 January 1992. At all times
it has consisted of agricultural property which will qualify for 50%
relief. Assume no earlier transfers by settlor and that the value of
the property is £500,000 throughout. Consider the effect of
agricultural property relief if:
(1) the trustees distribute the entire fund on 25 December 2001. The
distribution occurs before the first ten-year anniversary. The entire
value of the property in the settlement immediately after it commenced
must be included in the hypothetical transfer of value since there is
no agricultural property relief reduction. Therefore £500,000 must be
included (IHTA 1984 s 111(5) (a)).
The rate thus calculated is then applied to the fund as reduced by
business relief Hence, although the amount subject to the charge is
only £250,000 (£500,000 minus 50% relief), a higher rate of IHT will
apply. (Notice that if 100% relief were to be available in 2001 this
trap would not arise.)
(2) the trustees distribute the entire fund on 3 January 2002. As the
first ten-year anniversary fell on January there will he no exit
charge because the distribution is within three months of that
anniversary. So far as the anniversary charge is concerned the
property subject to the charge will be reduced by 50% relief to
£250,000; and for the purpose of calculating the hypothetical
chargeable transfer the value of the property is similarly reduced by
the relief.
7 Using discretionary trusts
Discretionary trusts are likely to remain attractive in the following
situations:
(1) Small inter vivos discretionary settlements. Notice that Mo
discretionary settlements can be used to create two nil rate band
trusts when the transferor is transferring one and a half times his
nil rate band.
EXAMPLE 34.11
A taxpayer transfers agricultural property (qualifying for 50% relief)
into two discretionary trusts as follows:
Into Discretionary Trust I property which reduces his estate by
£125,000 after 50% agricultural property relief.
Into Discretionary Trust 2 property which reduces his estate by
£62,500 after 50% agricultural property relief.
In both cases, assume that the agricultural property is sold by the
trustees. The result is that the first discretionary trust is worth
£250,000 and, in working out any IHT charges, the settlor's cumulative
total when the trust was created was nil. The second discretionary
trust is worth £125,000 and was set up at a time when the cumulative
total of the settlor was £125,000. Accordingly, the two trusts are nil
rate hand trusts, but remember that, to avoid the related settlement
rules, they should be created on separate days.
In appropriate cases a settlor can create a number of pilot
settlements each with a full nil rate band.
EXAMPLE 34.12
S wishes to put £400,000 into discretionary trusts. He therefore
creates four pilot trusts of £10 each on different days (so that they
are not 'related settlements') and subsequently but on the same day
pays £99,990 into each trust thus created. The trusts are not related
since they are created on different days and each comprises £100,000.
As transfers made on the same day are ignored in computing the
settlors cumulative total, that total is either £10 or £20 or £30 when
the relevant addition is made. Notice that although each settlement
will enjoy a full nil rate band, the transfer of £400,000 into
settlement will attract an immediate IHT charge at half rates. (Note
Ensure that each settlement is independent of the others, eg different
trustees, beneficial class and see the Rysaffe case, [32.4].)
(2) In will drafting, the use of the mini (£275,000) discretionary
trust remains attractive for the smaller estate and, for flexibility
the 'two-year' trust (see [30.145]). [*832]
(3) Until the FA 2006 changes, it was possible to set tip
discretionary trusts by channelling property through an A&M trust (ie
taking advantage of 'children of straw'). This will not he possible
for inter vivos trusts created on or after 22 March 2006. [34.35]-
[34.50]
III EXEMPTIONS AND RELIEFS
Many of the exemptions from IHT do not apply to trusts with relevant
property, eg the annual exemption, the marriage exemption, and the
exemption for normal expenditure out of income. There is no exemption
if the settled fund reverts to either the settlor or his spouse (and
note that if the settlor is a beneficiary, the reservation of benefit
provisions apply, see Chapter 29). Business and agricultural property
relief may, however, be available, provided that the necessary
conditions for the relief are met by the trustees. There is no
question of any aggregation with similar property owned by a
discretionary or other beneficiary.
Exit charges are not levied in certain cases when property leaves the
settlement, eg:
(1) Property ceasing to be relevant property within three months of
the creation of the trust or of an anniversary charge or within two
years of creation (if the trust was set up on death and the conditions
in IHTA 1984 s 144(1) are satisfied) is not subject to an exit charge
([30.145]),
(2) Property may pass, without attracting an exit charge, to such
privileged trusts as employee trusts (IHTA 1984 s 75); maintenance
funds for historic buildings (IHTA 1984 Sch 4 para 16); permanent
charities (IHTA 1984 s 76(1)); and political parties in accordance
with the exemption in IHTA 1984 s 24 (IHTA 1984 s 76(1)(b); and see
Chapter 31).
If a discretionary fund contains excluded property (arid property
qualifying for 100% business or agricultural relief) the periodic and
exit charges will not apply to that part of the fund. [34.51]-[34.70]
IV DISCRETIONARY TRUSTS CREATED BEFORE 27 MARCH 1974
Discretionary settlements created before 27 March 1974 are subject to
special rules for the calculation of tax which generally result in
less tax being charged (see generally IHTA 1984 ss 66-68). [34.71]
1 Chargeable events occurring before the first ten-year anniversary
The rate of IHT is set out in IHTA 1984 s 68(6). As the settlement is
treated as a separate taxable entity only transfers made by the
settlement are cumulated. Such chargeable transfers will either be
distribution payments (if made under the regime in force from 1974 to
1982) or chargeable events under IHTA 1984 s 65. Once the cumulative
total is known, the rate of tax will be calculated at half rate and
the charge will be at 30% of that rate. [34.72] [*833]
2 The first anniversary charge
No anniversary charge applied before 1 April 1983. Thus, the first
trust to suffer this charge was one created on 1 April 1973 (or 1963;
1953; 1943 and soon.).
The amount subject to the charge is calculated in the normal way. In
calculating the rate of charge, however, it is only chargeable
transfers of the settlement in the preceding ten years that are
cumulated. (as the settlement predates CTT/IHT the senior has no
chargeable transfers to cumulate). Property in a related settlement
and non-relevant property in the settlement are ignored. As before,
the rate of charge is reduced if property has not been relevant
property throughout the decade preceding the first anniversary. The
danger of increasing an IHT bill by an addition of property by the
senior (sec [34.33]) is even greater with these old trusts. If such an
addition has been made, the settlor's chargeable transfers in the
seven-year period before the addition must be cumulated in calculating
the rate of tax on the anniversary charge (IHTA 1984 s 67(4)). The
effective rate of charge for the anniversary charge is (as for new
trusts) 30% of the rate calculated according to half the table rates.
[34.73]
3 Chargeable events after the first anniversary charge
The position is the same as for new trusts. The charge is based upon
the rate charged at the last anniversary. [34.74]-[34.90]
EXAMPLE 34.13
In November 1975 Maggie settled £400,000 on discretionary trusts for
her family. The following events have since occurred:
In May 1981: a distribution payment of £100,000.
In May 1984: trustees distribute a further sum of £85,000 (tax borne
by
beneficiary).
In November 1985: the first ten-year anniversary. The value of
relevant property then in the fund is £300,000.
IHT will be charged as follows:
(1) May 1984: The distribution is a chargeable event occurring before
the first ten-year anniversary. IHT is calculated by cumulating the
chargeable transfer of £85,000 with the earlier transfer made by the
settlement (the distribution payment of £100,000). (Notice that there
is no proportionate reduction in the effective rate for exit charges
levied on old discretionary trusts before the first anniversary)
(2) November 1985: The anniversary charge will be calculated on the
relevant property in the settlement (£100,000). The cumulative total
of transfers made by the settlement is £185,000 (£100,000 plus
£85,000).
V ACCUMULATION AND MAINTENANCE TRUSTS (IHTA 1984 s 71)
Finance Act 2006
FA 2006 has made significant changes in the area of A&M trusts. It has
effectively put a stop to the creation of new A&M trusts after 22
March 2006, [*834] providing that IHTA 1984 s 71 does not apply to
any property settled on or after that date. The result is that for A&M
trusts subsisting on 22 March 2006 which do not come within the
conditions for trusts for bereaved minors (see [34.102]), transitional
relief is available so that they will continue to be exempt from the
relevant property regime if first, the trust provides that the
beneficiary will become absolutely entitled to the trust property at
18, or the terms are varied before 6 April 2008 to provide for this.
If they do not so provide, the trust assets will become relevant
property on 6 April 2008, from which time the periodic and exit
charges will apply; or secondly, the trusts arise under the will of a
deceased parent or step-parent in favour of his or her child and,
before 6 April 2008, the child will become entitled to an interest in
possession (for example, under the Trustee Act 1925, s 31 on attaining
the age of 18), and the property is then held for the bereaved minor
absolutely on attaining an age no greater than 25, with income and
capital being applied only for his benefit in the meantime. What
follows is therefore an analysis of the tax treatment of A&M trusts
created before 22 March 2006.
1 Tax treatment for A&M trusts created pre-22 March 2006
a) inheritance tax
Rather than make outright gifts to minor children, it has been fairly
common to settle the property in trust (often subject to the
satisfaction of a contingency, eg 'attaining the age of 21') for their
benefit. The reason for this special treatment was to avoid
discriminating between gifts to adults and settled gifts to infants
for IHT purposes.
EXAMPLE 34.14
Simon makes two gifts: one to his brother, Enrico, and one to his two-
month-old granddaughter, Frederica.
(1) The gift to Enrico: The gift is a PET and therefore only subject
to IHT if Simon dies within seven years.
(2) The gift to Frederica: In view of her age, it is felt necessary to
settle the property on trusts which give the trustees the power to
maintain Frederica, but which give her no interest in possession.
Under general principles, the creation of that settlement will be a
chargeable transfer of value and the discretionary trust charging
regime will operate. As a result there would he anniversary charges
and, when Frederica obtains either an interest in possession or an
absolute interest in the settled fund, an 'exit' charge.
The object of the special provisions was to prevent this double
charge. The inter vivos creation of an accumulation and maintenance
(A&M) settlement was accordingly a PET and thereafter, so long as the
property continues to be held on A&M trusts, the ten-year anniversary
charge would not apply and there would be no proportionate periodic
charge when the property left the trust. As a result, the taxation of
gifts to minors was treated in the same way as gifts to adults. For
all inter vivos trusts created on or after 22 March 2006 and for
trusts for minors created by the will of someone other than a parent
of the minor (in this case, see [34.102]) alter that date,
discrimination now exists with the removal of these advantages.
[34.91] [*835]
b) Other taxes
The privileged status of the A&M trust only applies for IHT purposes.
So far as the other taxes are concerned, general principles operate.
Unless the property settled comprises business assets, CGT hold-over
relief is not available on the inter vivos creation of the trust and
will only be available on its termination if a beneficiary becomes
absolutely entitled to the assets on the ending of the accumulation
period ([24.91]). For income tax, the creation of an A&M trust by a
parent on behalf of his own infant unmarried children will result in
any income which is distributed being taxed as his under the income
tax settlement provisions (see ITTOIA 2005 s 629). The trustees will
(generally) suffer income tax at the rate of 40% (TA 1988 s 686).
[34.92]
2 The requirements of IHTA 1984 s 71
To qualify for privileged IUT treatment, an A&M trust has to satisfy
the three requirements considered below. Failure to do so means that
the normal charging system (either discretionary trust or interest in
possession) applies. When the requirements cease to be satisfied IHT
will not be charged save in exceptional cases (see [34.98]). [34.93]
3 Requirement 1
'One or more persons (... beneficiaries) will, on or before attaining
a specified age not exceeding 25, become entitled to, or to an
interest in possession in, the settled property or part of it' (IHTA
1984 s 71).
This is concerned with the age at which a beneficiary becomes entitled
either to the income from the fund or to the fund itself. The age of
25 is specified as a maximum age limit and this is generously late
when one considers that the justification for these rules is to deal
with settlements for infant children.
EXAMPLE 34.15
(1) Property is settled (prior to 22 March 2006) upon trust 'for A
absolutely, contingent on attaining the age of 18'. A (currently aged
10) will become entitled to both income and capital at that age so
that Requirement 1 is satisfied. (2) Property is settled in 1982 upon
trust 'for B absolutely, contingent upon attaining the age of 30'. At
first sight Requirement 1 is broken since B (aged 8) will not acquire
the capital in the fund until after the age of 25. However, it will be
satisfied if the beneficiary acquires an interest in possession before
25; B will do so, because Trustee Act 1925 s 31 (if not expressly
excluded) provides that when a beneficiary with a contingent interest
attains 18, that beneficiary shall thereupon be entitled to the income
produced by the fund even though he has not yet satisfied the
contingency.
The requirement that a beneficiary 'will' become entitled does not
require absolute certainty; death, for instance, can always prevent
entitlement. The [*836] word causes particular problems when
trustees possess overriding powers of advancement and appointment
(dispositive powers) which, if exercised, could result in entitlement
being postponed beyond 25. So long as the dispositive power can only
be exercised amongst the existing beneficiaries (or other persons
under the age of 25) and cannot postpone entitlement beyond the age of
25, Requirement l is satisfied. Accordingly, a power to vary or
determine the respective shares of members of the class, even to the
extent of excluding some members altogether, is permissible.
EXAMPLE 34.16
Property is held on trust for the three children of A contingent upon
their attaining the age of 25 and, if more than one, in equal shares.
The trustees are given overriding powers of appointment, exercisable
until a beneficiary attains 25, to appoint the fund to one or more of
the beneficiaries as they see fit. Requirement 1 is satisfied since
the property will vest absolutely in the beneficiaries no later than
the age of 25. The existence of the overriding power of appointment is
irrelevant since it cannot be exercised other than in favour of the
class of beneficiaries and cannot be used to postpone the vesting of
the fund until after a beneficiary has attained 25.
The existence of a common form of power of advancement will not
prevent Requirement 1 from being satisfied (see Lord Inglewood v IRC
(1983)). However, such powers can be exercised so as to postpone the
vesting of property in a beneficiary beyond the age stated in the
trust document and, hence, beyond the age of 25 (see Pilkington v IRC
(1962)) and they can, in exceptional cases, result in property being
paid to a non-beneficiary (as in & Clore's Settlement Trusts (1966)
where the payment was to the beneficiary's favourite charity). 1f the
power is so exercised a charge to IHT will result.
The effect of powers of appointment which, if exercised, would break
Requirement l is illustrated by the following example (and see SP El):
EXAMPLE 34.17
Property is settled in 1983 'for the children of E contingent on their
attaining 25'.
The trustees are given the following (alternative) overriding powers
of appointment.
(1) To appoint income and capital to F's sister F: The mere existence
of this power causes the settlement to break Requirement 1. There is
no certainty that the fund will pass to E's children since the power
might be exercised in favour of F.
(2) To appoint income to F's brother G: The same consequence will
follow since the mere existence of this power means that the income
could be used for the benefit of G and, hence, break Requirement 2
(for details of this Requirement see below).
(3) To appoint capital and income to E's relatives so tong as those
relatives are no older than 25: This power does not break Requirement
1 since whoever receives the settled fund, whether E's children or his
relatives, will be no older than 25.
It may be difficult to decide whether or not the settlement contains a
power of revocation or appointment which will break Requirement 1. In
Lord Inglewood v IRC (1981), Vinelott J distinguished between events
provided for in the trust instrument and events wholly outside the
settlor's control: [*837]
'the terms of the settlement must be such that one or more of the
beneficiaries, if they or one of them survive to the specified age,
will he hound to take a vested interest on or before attaining that
age ... Of course, a beneficiary may assign his interest, or he
deprived of it, by an arrangement, or by bankruptcy, before he attains
a vested interest. But he is not then deprived of it under the terms
of the settlement, so these possible events, unlike the exercise of a
power of revocation or appointment, must he disregarded ...' [1981]
STC 318 at 322 (see also Fox LJ, in the Court of Appeal, [1983] STC
133 at 138).
EXAMPLE 34.18
Sebag creates a settlement (prior to 22 March 2006) in favour of his
second daughter, Juno, under which she will obtain the property if she
attains the age of 18. If she marries before that age, however, the
property is to pass to Sebag's brother, Sebastian.
This provision in the settlement could operate to deprive Juno of the
property in circumstances when, as a matter of general law, she would
not he so deprived. The settlement does not satisfy Requirement 1 and
so does not qualify for privileged treatment.
Two other matters should be noted in relation to Requirement I. First,
even if a trust instrument fails to specify an age at which the
beneficiary will become entitled to either the income or capital, so
long as it is clear from the terms of that instrument and the known
ages of the beneficiaries that one or more persons will in fact become
entitled before the age of 25, Requirement 1 will be satisfied (ESC
F8).
Secondly, for an A&M trust to be created there had to be a living
beneficiary at that time. It was possible to set up a trust for a
class of persons including some who were unborn ('the grandchildren of
the settlor' for instance), but there had to be at least one member of
the class in existence at the date of creation (IHTA 1984 s 71(7)). If
the single living beneficiary dies, the trust (assuming that it was
set up for a class of beneficiaries) will remain an A&M trust until a
further member of that class is born. If a further class member is
never born, it will eventually pass elsewhere and at that stage an IHT
charge may arise. [34.94]
4 Requirement 2
'No interest in possession subsists in the settled property (or part)
and the income from it is to be accumulated so far as a is not applied
for the maintenance, education or benefit of such a person' (IHTA 1984
s 71).
There must be no interest in possession and once such an interest
arises, the settlement breaks Requirement 2 and ceases to be an A&M
trust.
If there is no interest in possession in the income, what is to be
done with it? Two possibilities are envisaged; it can either be used
for the benefit of a beneficiary (eg under a power of maintenance), or
it can be accumulated. There must be a valid power to accumulate:
accordingly once the accumulation period ends Requirement 2 will cease
to be satisfied and the settlement will no longer be an A&M trust.
[*838]
EXAMPLE 34.19
A trust is set up for Loeb, the child of the senior, contingent on his
attaining the age of 25. So long as he is a minor the trustees will
have a power to maintain him out of the income of the fond and a power
to accumulate any surplus income (Trustee Act 1925 s 31). When Loch
becomes 18 he will he entitled to the income of the fund so that an
interest in possession will arise and the settlement will cease to be
an A&M trust. The ending of the trust will not lead to any [HT charge.
Care should he taken in choosing the appropriate period if the
intention is to accumulate income beyond the minorities of the
beneficiaries. Various periods are permitted under LPA 1925 ss 164 and
165 and under Trustee Act 1925 s 31, but some of them may cause the
trust to fall outside the definition of an A&M settlement. In the case
of an inter vivos trust, for instance, a direction to accumulate
'during the lifetime of the settlor' would mean that an interest in
possession might not arise until after the beneficiaries had attained
the age of 25; likewise, a provision to accumulate for 21 years when
the beneficiaries are over the age of four would be fatal. [34.95]
5 Requirement 3
'Either
(i) not more than 25 years have elapsed since the day on which the
settlement was made or (if later) since the time when the settled
property (or part) began to satisfy Requirements 1 and 2, or
(ii) all the persons who are, or have been beneficiaries are, or were,
either grandchildren of a common grandparent, or children, widows or
widowers of such grandchildren who were themselves beneficiaries but
died before becoming entitled as mentioned in [Requirement 1]' (IHTA
1984 s 71).
Requirement 3 was introduced to stop the A&M trust from being used to
benefit more than one generation. There are two ways in which it can
be satisfied. First, the trust must not last for more than 25 years
from the date when the fund became settled on A&M trusts. The second
(alternative) limb is satisfied if all the beneficiaries have a common
grandparent.
EXAMPLE 34.20
(1) Property is settled for the children and grandchildren of the
senior. As there is no grandparent common to all the beneficiaries,
the trust must not last for longer than 25 years if an exit charge to
IHT is to he avoided.
(2) Property is settled for the children of brothers Bill and Ben. As
there is a common grandparent the duration of the settlement does not
need to be limited to 25 years.
Two generations can be benefited tinder an A&M trust without the 25-
year time limit applying in one case, namely substitution per stirpes
is permitted where the original beneficiaries had a common grandparent
and one of those beneficiaries has died. [34.96] [*839]
6 Advantages of accumulation and maintenance trusts
An A&M trust created prior to 22 March 2006 and still in existence may
continue to enjoy the advantages outlined provided that it falls
within one of the two categories discussed in [34.91]. For trusts
created after 22 March 2006, these advantages will no longer apply. No
IHT is charged when property from an A&M trust becomes subject to an
interest in possession in favour of one or more of the beneficiaries,
nor when any part of the fund is appointed absolutely to such a
beneficiary (IHTA 1984 s 71(3), (4)). This exemption, together with
the exclusion of the anniversary charge (IHTA 1984 s 58(l) (bé, means
that once the property is settled on these trusts there should be no
IHT liability whilst the settlement continues in that form and on its
termination. Furthermore the inter vivos creation of the trust is a
PET.
EXAMPLE 34.21
'... to A absolutely contingent on attaining 25'. This straightforward
trust, created in 1990, will satisfy the Requirements so long as A is
an infant. Consider, however,
the position:
(1) When A attains 18: he will he entitled to the income from the fund
(Trustee Act 1925 s 31) and, therefore, Requirement 2 is broken. No
IHT is charged on the arising of the interest in possession.
(2) When A attains 25: ordinary principles for interest in possession
settlements apply; A's life interest comes to an end, but no IHT is
payable since the life tenant is entitled to ail the property (see
IHTA 1984 s 53(2)). Note that adverse CGT consequences may occur at
this time: see [24.91].
(3) If A dies aged 19: II-IT will be assessed on the termination of an
interest in possession.
As already discussed, there is nothing to prevent an A&M trust from
being created for an open class of beneficiaries, eg 'for all my
grandchildren both horn and yet to be horn'. If such a trust is to be
created, it is important to consider whether the class of
beneficiaries should close when the eldest obtains a vested interest
in either the income or capital. Failure to do so will result in a
partial divesting of the beneficiary with the vested interest when a
further beneficiary is born, and, as a result, a PET. Class-closing
rules may be implied at common law (see Andrews v Partington (1791)),
but it is safer to insert an express provision to that effect.
IHTA 1984 s 71(4) (b) provides that 'tax shall not be charged ... on
the death of a beneficiary before attaining the specified age'. It
follows that, if the entire class of beneficiaries is wiped out, an
A&M trust will cease on the death of the final member, but, whoever
then becomes entitled to the fund, no IHT will be payable. When it is
necessary to wait and see if a further beneficiary is born, however,
this provision will not operate, since it is not the death of the
beneficiary which ends the A&M trust in such a case, but the failure
of a further beneficiary to be born within the trust period. [*840]
EXAMPLE 34.22
(1) Property is settled upon trust for Zed's grandchild, Yvonne,
contingent upon her attaining 18. If she were to die aged 16, the
property would (in the absence of any provision to the contrary)
revert to Zed and no IHT would be payable.
(2) Property was settled upon trust for Victor's children contingent
upon their attaining 21. and, if more than one, in equal shares
absolutely. Victor's one child, Daphne, died in 2000 aged 12 and
Victor himself has just died.
No charge to IHT arose on Daphne's death but the property continued to
he held on A&M trusts until Victor died when the trust ended with a
charge to IHT
The A&M trust could be drafted to achieve a considerable degree of
flexibility. It was common for such a trust to contain the following
provisions:
(1) Primary beneficiaries are present and future grandchildren with a
class-closing provision.
(2) The trustees are given a revocable power of appointment among the
beneficiaries (inapplicable once a beneficiary has attained 25).
(3) The A&M trust will end with beneficiaries being entitled to
interests in possession (not absolute interests) and thereafter such a
beneficiary is given power to appoint a life interest to his surviving
spouse and divide up the capital as he sees fit between his children.
However:
(4) The trustees retain an overriding power to determine the life
interest of any beneficiary who has attained (say) 26 and appoint the
property in favour of one or more secondary beneficiaries, often
called discretionary beneficiaries.
As a result, this kind of settlement includes more than one generation
of beneficiaries; has great flexibility; but still qualifies as an A&M
trust when set
up. [34.97]
7 Occasions when an 'exit charge' IHT arise
It is rare for property to leave an A&M trust otherwise than by
vesting in a qualifying beneficiary and so long as this happens no IHT
is chargeable. Provision is, however, made for calculating an 'exit
charge' in the following four circumstances (IHTA 1984 ss 70(6),
71(5)):
(1) When depreciatory transactions entered into by the trustees reduce
the value of the fund (IHTA 1984 s71(3)(b)).
(2) When the 25-year period provided for in Requirement 3 is exceeded
and the beneficiaries do not have a common grandparent.
(3) When property is advanced to a non-beneficiary or resettled on
trusts which do not comply with the three Requirements.
(4) If the trust ends some time after the final surviving beneficiary
has died (see Example 34.22(2)).
IHT is calculated in these cases on the value of the fund according to
how long the property has been held on the A&M trusts:
0.25% for each of the first 40 complete successive quarters in the
relevant period;
0.20% for each of the next 40;
0.15% for each of the next 40; [*841]
0.10% for each of the next 40; and
0.05% for each of the next 40.
Hence, on expiry of the permitted 25 years IHT at a rate of 21% will
apply to the fund. Thereafter, normal discretionary trust rules will
apply, so that five years later there will be an anniversary charge.
[34.981-[34.100]
VI TRUSTS FOR BEREAVED MINORS AND 18-25 TRUSTS
In place of A&M settlements, FA 2006 has introduced two new trust
regimes -- the 'trust for bereaved minors' and '18-25 Trusts'. The
rules governing these trusts are contained in IHTA 1984 s 71A-G
(introduced by FA 2006). [34.101]
I Trusts for bereaved minors
Broadly, a trust is a 'trust for bereaved minors' if property is held
on statutory trusts for minors that arise on intestacy or on trusts
established under the will of a deceased parent of the bereaved minor
or on trusts established under the Criminal Injuries Compensation
Scheme. Trusts of the last two types must fulfil additional
conditions. First, the bereaved minor must, on attaining 18 years of
age (if not earlier), become absolutely entitled to the settled
property, any income arising from such property and any income from
such property that has been accumulated before the bereaved minor
turned 18. Secondly, while the bereaved minor is under the age of 18,
any income or capital payment out of the settled property is provided
for the benefit of the bereaved minor. Thirdly, while the bereaved
minor is under 18 years of age, either the bereaved minor is entitled
to all the income arising from any settled property or no such income
may be used to benefit any other person. Where IHTA 1984 s 71A applies
(ie there is a trust for bereaved minors) the general rule is that
there is a charge to tax where settled property ceases to he property
to which s 71A applies ('the exit charge' -- the authors'
terminology), and where trustees enter into a depreciatory
transaction. The exceptions to the general rule are that no charge
arises:
- first, when the bereaved minor turns 18 or, if earlier, becomes
absolutely entitled to the settled property and any arising or
accumulated income;
- secondly, if the bereaved minor dies under the age of 18; or
- thirdly, when the settled property is paid or applied for the
benefit of the bereaved minor. [34.102]
2 Age 18-25 trusts
18-25 trusts are established under IHTA 1984 s 71D, which applies to
settled property (including property settled before 22 March 2006) if
the property
- is held on trusts for the benefit of a person who is under 25 years
of age;
- at least one of the person's parents has died;
- the trusts were established under the will of the deceased parent or
under the Criminal Injuries Compensation Scheme; and
- the terms of the trusts satisfy the further conditions that first,
the bereaved minor must on attaining 25 years of age (if not
earlier), [*842]
become absolutely entitled to the settled property, any income arising
from such property and any income arising from such property which has
been accumulated before the bereaved turned 18; secondly, while the
bereaved minor is under the age of 25, any benefit provided out of the
settled property is provided to the bereaved minor; and finally, while
the bereaved minor is under 25 years of age, either the bereaved minor
is entitled to all the income arising from any settled property or no
such income may be used to benefit any other person.
It should be noted that s 71D does not apply to any property to which
ss 71 and 71A apply or where, if a person has an interest in
possession in the settled property, that person became beneficially
entitled to the interest in possession before 22 March 2006 or that
interest in possession is an immediate post-death interest or a
transitional serial interest and the person became entitled to it on
or after 22 March 2006.
A charge to tax arises when settled property ceases to be property to
which s 71D applies ('the exit charge' -- the authors' terminology),
or where the trustees enter into depreciatory transactions (IHTA 1984
s 71E (1)). Exceptions from this charge seek broadly to tie in the
charge under s 71D with the charge under s 71A (trusts for bereaved
minors) (s 71E (2)-(4)). For instance, tax is not charged under s 71E
on property ceasing to be property to which s 711) applies where this
is the result of the bereaved minor becoming absolutely entitled to
the settled property income arising and accumulated income at or under
the age of 18, or where the bereaved minor dies under the age of 18.
Property subject to these trusts will be exempt from the relevant
property regime, except that there will be a charge when the bereaved
minor becomes absolutely entitled to the property on attaining the age
of 18 (or if, after attaining the age of 18, the property is applied
for his benefit or is by advancement, or if he dies between the ages
of 18 and 25), with the maximum rate of charge being 4.2% if absolute
entitlement is on attaining the age of 25 (IHTA 1984 s71G). [34.103]-
[34.110]
VII OTHER SPECIAL TRUSTS
1 Charitable trusts
If a trust is perpetually dedicated to charitable purposes, there is
no charge to IHT and the fund is not 'relevant property' (IHTA 1984 s
58). Transfers to charities are exempt, whether made by individuals or
by trustees of discretionary trusts (IHTA 1984 s 76).
IHTA 1984 s 70 is concerned with temporary charitable trusts defined
as 'settled property held for charitable purposes only until the end
of a period (whether defined by a date or in some other way)' and
ensures that when the fund ceases to be held for such purposes an exit
charge will arise. That charge (which is calculated in the same way as
for A&M trusts; see above) will never exceed a 30% rate which is
reached after 50 years. [34.111]
2 Trusts for the benefit of mentally disabled persons and persons in
receipt of an attendance allowance (IHTA 1984 s 89)
These trusts continue to enjoy their tax advantages even after the
changes made by FA 2006.
A qualifying trust for a disabled person is treated as giving that
person an interest in possession. As a result, the IHT regime for no
interest in possession trusts does not apply. The inter vivos creation
of this trust by a person other than the relevant beneficiary is a
PET. There are no restrictions on the application of income which can
therefore be used for the benefit of other members of the class of
beneficiaries. This can he particularly useful where the application
of income to the 'principal' disabled beneficiary could jeopardise his
entitlement to state benefits. At least one half of any capital
benefits must be paid to the 'principal' beneficiary. A charge to IHT
will arise on the death of the disabled person whose deemed interest
in possession will aggregate with his free estate in the normal way.
Although disabled trusts can also obtain CGT advantages (eg a full
annual exemption for the trustees), to qualify the disabled
beneficiary must be entitled to at least one half of the income or be
the sole income beneficiary (see TCGA 1992 Sch 1 para 1 and Private
Client Business (1993) p 161). [34.112]
3 Pension funds IHTA 1984 s 151)
A superannuation scheme or fund approved by HMRC for income tax
purposes is not subject to the rules for no interest in possession
trusts. This exemption from IHT extends to payments out of the fund
within two years of the member's death. It is common practice for the
member to settle the 'death benefit' on discretionary trusts: this
trust will be subject to normal charging rules although HMRC consider
that IHTA 1984 s 81 applies to deem the property to remain comprised
in the original fund: eg for the purpose of ten-year anniversary dates
(see [34.23]). [34.113]
4 Employee trusts (IHTA 1984 s 86)
These trusts will not in law be charitable unless they are directed to
the relief of poverty amongst employees (see Oppenheim v Tobacco
Securities Trust Co Ltd (1951)). They may, however, enjoy IHT
privileges. Their creation will not involve a transfer of value,
whether made by an individual (IHTA 1984 s 28) or by a discretionary
trust (IHTA 1984 s 75). Once created, the fund is largely exempted
from the IHT provisions governing discretionary trusts, especially
from the anniversary charge. To qualify for this treatment, the fund
must be held for the benefit of persons employed in a particular trade
or profession together with their dependants. These provisions are
extended to cover newspaper trusts (see IHTA 198,1 s 87); approved
profit sharing schemes and the FA 2000 employee share ownership plan.
[34.114]
5 Compensation funds (IHTA 1984 ss 58, 63)
Trusts set up by professional bodies and trade associations for the
purpose of indemnifying clients and customers against loss incurred
through the default of their members are exempt from the rules for no
interest in possession trusts. [34.115] [*844]
6 Maintenance funds for historic buildings (IHTA 1984 s 77, Sch 4)
IHT exemptions are available for maintenance funds where property is
settled and the Treasury give a direction under IHTA 1984 Sch 4 para
1. Once the trust ceases, for any reason, to carry out its specialised
function, an exit charge, calculated in the same way as for A&M
trusts, occurs. [34.116]
7 Protective trusts (IHTA 1984 ss 73, 88)
A protective trust may he set up either by using the statutory model
provided for by the Trustee Act 1925 (TA) s 33, or by express
provisions.
These trusts have always been subject to special IHT rules and, as
originally enacted, The rules offered scope for tax avoidance (see
IHTA 1984 s 73 and Thomas v IRC (1981)). Accordingly, the rules were
changed with effect from 11 April 1978 by providing that the life
tenant is deemed to continue to have an interest in possession for IHT
purposes despite the forfeiture of his interest (IHTA 1984 s 88). It
follows that the discretionary trust regime is not applicable to the
trust that arises upon such forfeiture. Should the capital be advanced
to a person other than the life tenant, a charge to IHT will arise and
on the death of the beneficiary the fund will be treated as part of
his estate for IHT purposes (Cholmondeley v IRC (1986)). As a result
of these rules there is the curious anomaly that, after a forfeiture
of the life interest, the interest in possession rules apply to a
discretionary trust although it should be borne in mind that ordinary
rules apply for other taxes. Thus for income tax a 40% rate applies
once the life interest is forfeited and there is no CGT uplift on the
death of the principal beneficiary.
One cautionary note should be added; this system of charging only
applies to protective trusts set up under the TA 1925 s 33 or to
trusts 'to the like effect'. Minor variations to the statutory norm
are, therefore, allowed; but not the inclusion of different
beneficiaries under the discretionary trust (such as the brothers and
sisters of the principal beneficiary) nor a provision that enables a
forfeited life interest to revive after the lapse of a period of time.
In such cases, the normal rules applicable to interest in possession
and discretionary trusts apply (see Law Society's Gazette, 3 March
1976 and SP F7). [34.117] [*844]
kuac...@yahoo.com
Updated by Aparna Nathan, LLB Hons, LLM, Barrister Gray's Inn Tax
Chambers
I Domicile and situs [135.3]
II What is excluded property? [35.201
III Double taxation relief for non-excluded property [35.41]
IV Miscellaneous points [35.61]
V Foreign settlements, reversionary interests and excluded property
[35.81]
1 Ambit of IHT
As a general rule, IHT is chargeable on all property situated within
the UK regardless of its owner's domicile and on property, wheresoever
situate, which is beneficially owned by an individual domiciled in the
UK. [35.1]
2 Excluded property
Any transfer of 'excluded property' is not chargeable to IHT (IHTA
1984 ss 3(2) and 5(1)). The main example of excluded property is
'property situated outside the UK ... if the person beneficially
entitled to it is an individual domiciled outside the UK' (IHTA 1984 s
6(1)). In determining whether property is excluded property relevant
factors include not only the domicile of the transferor who is the
beneficial owner of the property and the situation of the property
(situs), but also the nature of the transferred property, since
certain property is excluded regardless of its situs or the domicile
of its owner. [35.2]
I DOMICILE AND SITUS
1 Domicile
a) General rules
An individual cannot, under English law, be without a domicile which
connotes a legal relationship between an individual and a territory.
There are three kinds of domicile: domicile of origin, domicile of
choice and domicile of dependence. [*846]
A person acquires a domicile of origin at the moment when he is born.
He will usually take the domicile of his father unless he is
illegitimate or born after his father's death in which case he takes
the domicile of his mother. A domicile of origin is never completely
lost, but may be superseded by a domicile of dependence or choice; it
will revive if the other type of domicile lapses.
A person cannot acquire a domicile of choice until he is 16 or marries
under that age. Whether someone has replaced his domicile of origin
(or dependence) by a domicile of choice is a question of fact which
involves physical presence in the country concerned and evidence of a
settled intention to remain there permanently or indefinitely (animus
manendi).
Unmarried infants under the age of 16 (in England and Wales, younger
in
Scotland) acquire their father's domicile of dependence and women who
married before 1 January 1974 acquired their husband's domicile by
dependence. [35.3]
b) Deemed domicile
If a person's domicile under the general law is outside the UK, he may
he deemed to he domiciled in the UK, for IHT purposes only, in two
circumstances (IHTA 1984 s 267).
First, if a person was domiciled in the UK on or after 10 December
1974 and within the three years immediately preceding the transfer in
question, he will be deemed to be domiciled in the UK at the time of
making the transfer (IHTA 1984 s 267(1)(a)). This provision is aimed
at the taxpayer who moves his property out of the UK and then
emigrates to avoid future IHT liability on transfers of that property.
In such a ease he will have to wait three years from the acquisition
of a new domicile of choice for his property to become excluded
property under IHTA 1984 s 6(1) (see Re Clore (No 2,) (1984)).
Secondly, a person will be deemed domiciled in the UK if he was
resident for income tax purposes in the UK on or after 10 December
1974 and in not less than 17 out of the 20 income tax years ending
with the income tax year in which he made the relevant transfer (IHTA
1984 s 267(1)(b)). This catches the person who has lived in the UK for
a long time even though he never became domiciled here under the
general law. Residence is used in the income tax sense (see Chapter
18), and does not require residence for a period of 17 complete years.
This is because the Act is concerned with a person who is resident in
a tax year and such residence may be acquired if the individual
concerned comes to the UK at the very end of that year (eg on 1 April)
with the intention of remaining indefinitely in the UK In such a case,
the individual will be resident for the tax year in which he arrived-
albeit that it is about to end-and that will count as the first year
of residence for the purpose of the 17-year test. Similarly, were he
to leave the UK immediately after the commencement of a tax year, he
would be treated as resident in the UK in that final tax year.
Accordingly, in an extreme case, an individual could arrive in the UK
on 1 April in one year, remain for the next 15 years and make a
transfer on 10 April in year 17 and yet be caught by the 17-year test,
even though only being resident in the UK for a little over 15 years.
[35.4] [*845]
EXAMPLE 35.1
(1) Jack who was domiciled in England moved to New Zealand on 1 July
2001 intending to settle there permanently. 11e died on 1 January
200,3 when according to the general law he had acquired a domicile of
choice in New Zealand. However, because Jack had a UK domicile and
died within three years of losing it, he is deemed under s 267(1) (a)
to have died domiciled in the UK Accordingly, all his property
wherever situated (excluding gifts; see below) is potentially
chargeable to IHT. Jack would have had to survive until 1 July 2004 to
avoid being caught by this provision.
(2) On 5 June 2003, Jim who is domiciled under the general law in
Ruritania and who is a director of BB Ltd (the UK subsidiary of a
Ruritanian company) gives a house that he owns in Ruritania to his
son. By virtue of his job Jim has been resident for income tax
purposes in England since 1 January 1976, but he intends to return to
Ruritania when he retires. For IHT purposes Jim is deemed to he
domiciled in England under s 267(1) (h); the gift will, therefore, be
subject to IHT if Jim dies within seven years.
(3) Boer, resident in the UK but domiciled in South Africa, forms an
overseas company to which he transfers the ownership of all his UK
property. He has exchanged chargeable assets (UK property) for
excluded property (shares in the overseas company). (For the purposes
of income tax, this arrangement would fall within the transfer of
assets legislation: see [18.111].)
(4) François, a non-UK domiciliary, owns all the shares in a UK
property dealing company. He converts that share capital into bearer
shares holding the relevant certificates offshore. On his death the
assets are not UK sites (note the stamp duty charge on an issue of
bearer shares: see Chapter 49).
2 Situs
Subject to contrary provisions in double taxation treaties (and
special rules for certain property) the situs of property is governed
by common law rules and depends on the type of property involved. For
instance:
(1) An interest in land (including a leasehold estate or rent charge)
is situated where the land is physically located.
(2) Chattels (other than ships and aircraft) are situated at the place
where they are kept at the relevant time.
(3) Registered shares and securities are situated where they are
registered or, if transferable upon more than one register, where they
would normally be dealt with in the ordinary course of business.
(4) Bearer shares and securities, transferable by delivery, are
situated where the certificate or other document of title is kept.
(5) A bank account (ie the debt owed by the bank) is situated at the
branch that maintains the account. (Special rules apply to non-
residents' foreign currency bank accounts: [35.26].) [35.5]-[35.19]
II WHAT IS EXCLUDED PROPERTY?
1 Property situated outside the UK and owned beneficially by a non-UK
domiciliary (IHTA 1984 s 6(1))
Property falling into this category is excluded regardless of its
nature. [*848]
Settled property situated abroad will be excluded property only if the
settlor was domiciled outside the UK at the time when he made the
settlement (IHTA 1984 s 48(3): note that the position of the interest
in possession beneficiary is irrelevant in this case). If the settlor
retains an interest in possession either for himself or his spouse,
and a discretionary trust arises on the termination of that interest,
an additional test is imposed in determining whether property is
excluded property. This test looks at where the senior or the spouse
(if the interest was reserved for him) was domiciled when that
interest in possession ended (IHTA 1984 s 82). As this provision only
applies where the property is initially settled with a life interest
on the settlor or his spouse, it may be circumvented if the trust
commences in discretionary form and is then converted into a life
interest. [35.20]
EXAMPLE 35.2
(1) Franc, domiciled in Belgium, intends to buy a house in East Anglia
costing £500,000. If he buys it in his own name it will he subject to
IHT on his death. If he buys it through an overseas company, however,
he will then own overseas assets (the company shares) that fall
outside the IHT net. Note that if he occupies the house and is a
director of the overseas company, HMRC will tax him on an emolument
equal to the value of the property each year under the provisions of
ITEPA 2003 s 102 (see [8.116]). This charge will also arise if Franc
is a shadow director of the company: see R v Allen; R v Dimsey (2001).
As an alternative:
(a) the company could he owned by an offshore trust (a two-tier'
structure) or;
(b) he could buy the property in his own name with a substantial
mortgage charged on the house which will have the effect of reducing
its IHT value.
The Revenue has confirmed that where a UK-resident individual is
provided with rent-free accommodation by an overseas resident company
and that company is for the purposes of the transfer pricing
legislation (TA 1988 Sch 28AA: see [41.44]) under the control of the
UK-resident individual, it will not be Revenue practice to impute
rental income to the overseas resident company (see Tax Bulletin,
April 2000, p 742).
(2) Erik, domiciled in Sweden, settles Swedish property on
discretionary trusts for himself and his family. He subsequently
acquires an English domicile of choice. The settlement is of excluded
property for LUT purposes (IHTA 1984 s 48(3)), although the assets
would appear to form part of the settlor's estate when he dies.
Because of the reservation of benefit rules in FA 1986 s 102(3), IHRC
currently accepts that the property remains excluded so that it will
not be subject to any charge (Law Society's Gazette, 10 December
1986). The position is, however, different if Erik is excluded from
all benefit during his life when a deemed PET occurs under s 102(4).
(3) Boris, domiciled in France, died in February 2003 and left his
villa in Tuscany and moneys in his Swiss bank account to his son
Gaspard, a UK resident and domiciliary. 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 of
excluded property. Far CGT however, although the variation is not
itself a disposal, Gaspard is treated as the senior of the trust and
hence the provisions in TCGA 1992 s 86 will apply (see [27.91] and
Marshall v Kerr (1994)).
2 Property that is exempt despite being situated in the UK
a) Government securities
Certain Government securities (gilts) owned by a person ordinarily
resident outside the UK are exempt from IHT (IHTA 1984 s 6(2): see
[18.77] -- FOTRA securities). The domicile of the taxpayer is
irrelevant (see Advanced Instruction Manual at G33). If these
securities are settled they will be excluded property if either the
person beneficially entitled to an interest in possession (eg a life
tenant) is not ordinarily resident in the UK, or, in the case of a
discretionary trust, if none of the beneficiaries are ordinarily
resident in the UK (IHTA 1984s48(4)).
IHTA 1984 s 48(5) contains anti-avoidance provisions:
(J) If gilts are transferred from one settlement to another they will
only be excluded property if the beneficiaries of both settlements are
non-UK ordinarily resident This prevents guts from being channelled
from a discretionary trust where they were not excluded property
(because some of the beneficiaries were UK ordinarily resident) to a
new settlement with non-ordinarily resident beneficiaries only, where
they would be excluded property (as was done in Minden Trust (Cayman)
Ltd v IRC (1984)).
(2) When a close company is a beneficiary of a trust, any gifts owned
by the trust will be excluded property only if all participators in
the company are non-UK ordinarily resident, irrespective of the
company's residence. This aims to prevent individuals from using a
company to avoid IHT. [35.21]
b) Holdings in an authorised unit trust and shares in an open ended
investment company
These securities are excluded property if the person beneficially
entitled is an individual domiciled outside the UK (IHTA 1984 s 6(1A)
inserted by FA 2003). If held in a settlement these assets will be
excluded property unless the senior was domiciled in the UK at the
time when the settlement was made (IHTA 1984 s 48(3A) inserted by FA
2003). [35.22]
e) Certain property owned by persons domiciled in the Channel Islands
or Isle of Man
Certain savings (eg national savings certificates) are excluded
property if they are in the beneficial ownership of a person domiciled
and resident in the Channel Islands or the Isle of Man (IHTA 1984 ss
6(3), 267(4)). [35.23]
d) Visiting forces
Certain property owned in the UK by visiting forces and staff of
allied
headquarters is excluded property (IHTA 1984 s 155). [35.24]
e) Overseas pensions
Certain overseas pensions (usually payable by ex-colonial governments)
are exempt from IHT on the pensioner's death regardless of his
domicile (IHTA 1984 s 153). [35.25] [*850]
f) Non-sterling bank accounts
On the death of an individual domiciled resident and ordinarily
resident outside the UK there is no IHT charge on the balance in any
'qualifying foreign currency account' (IHTA 1984 s &57). This
exemption does not apply to inter vivos gifts of the money in such an
accountant.
For the inter-relationship of excluded property and settlements, see
[35.81]. [35.26]-[35.40]
III DOUBLE TAXATION RELIEF FOR NON-EXCLUDED PROPERTY
Non-excluded property may he exposed to a double charge to tax
(especially on the death of the owner); once to IHT in the UK and
again to a similar tax imposed by a foreign country. Relief against
such double charge may be afforded in one of two ways.
First, the UK may have a double taxation treaty with the relevant
country when the position is governed by IHTA 1984 s 158. The
provisions of the treaty will override all the relevant IHT
legislation (e.g. the deemed domicile rule) and common law rules
regarding the situs of property.
Under these treaties, the country in which the transferor is domiciled
is generally entitled to tax all property of which he was the
beneficial owner. The other country involved usually has the right to
tax some of that property, eg land situated there. In such cases the
country of domicile will give relief against the resulting double
taxation. Most of these treaties also contain provisions to catch the
individual who changes his domicile shortly before death to avoid tax.
Secondly, where no double tax treaty exists, unilateral relief is
given in the form of a credit for the foreign tax liability against
IHT payable in the UK (IHTA 1984 s 159). The amount of the credit
depends on where the relevant property is situated; in some cases no
credit is available if the overseas tax is not similar to IHT,
although some relief is, effectively, given since, in calculating the
reduction in the transferor's estate for calculating IHT, the amount
of overseas tax paid will be disregarded (IHTA 1984 s 5(3)). This
relief is less beneficial than a tax credit. [35.41]-[35.60]
IV MISCELLANEOUS POINTS
I Valuation of the estate-allowable deductions
Certain liabilities of a transferor are deductible when calculating
the value of his estate for IHT purposes (see [30.13]). However, any
liability to a non-UK resident is deductible as far as possible from a
transferor's foreign estate before his UK estate. As a result, a
foreign domiciliary who is chargeable to IT-IT on his UK assets cannot
usually deduct his foreign liabilities from his UK estate. There are
two exceptions to this rule. First, if a liability of a non-UK
resident has to be discharged in the UK, it is deductible from the UK
estate; secondly, any liability that encumbers property in the UK,
reduces the value of that property. [35.61] [*851]
EXAMPLE 35-3
Adolphus dies domiciled in Ethiopia. His estate includes cash in a
London bank account, shares in UK companies and a stud farm in
Weybridge that is mortgaged to an Ethiopian glue factory. He owes a UK
travel company £500 for a ticket bought to enable his daughter to
travel around Texas and £200,000 to a Dallas horse dealer. TUT is
chargeable on his UK assets. However, the mortgage debt is deductible
from the value of his stud farm and £500 is deductible from the UK
estate generally. There is no reduction for the debt of £200,000
assuming that he has sufficient foreign property
2 Expenses of administering property abroad (IHTA 1984 s 173)
Administration expenses are not generally deductible from the value of
the deceased's estate. However, the expense of administering or
realising property situated abroad on death is deductible from the
value of the relevant property up to a limit of 5% of its value.
[35.62]
3 Enforcement of tax abroad
On the death of a foreign domiciliary with UK assets, the deceased's
PRs cannot administer his property until they have paid any IHT and
obtained a grant of probate. However, the collection of IHT on
lifetime transfers by a foreign domiciliary presents a problem if both
the transferor and transferee are resident outside the UK and there is
no available property in the UK that can be impounded. [35.63]
4 Foreign assets
If a foreign Government imposes restrictions as a result of which UK
executors cannot immediately transfer to this country sufficient of
the deceased's foreign assets for the payment of IHT attributable to
them, they are given the option of deferring payment until that
transfer can be made. If the amount that is finally brought into the
UK is less than the IHT, any balance will be waived (see ESC F6).
[35.64]-[35.80]
V FOREIGN SETTLEMENTS, REVERSIONARY INTERESTS AND EXCLUDED PROPERTY
I Foreign settlements
As a general rule, settled property which is situated abroad is
excluded property if the settlor was domiciled outside the UK when the
settlement was made (IHTA 1984 s 48(3) and see Tax Bulletin, February
1997). Therefore, the domicile of the individual beneficiaries in such
cases is irrelevant, so that even if the beneficiary is domiciled in
the UK, there will be no charge to IHT on the termination of his
interest in possession nor on any payment made to him from a
discretionary trust. [35.81] [*852]
EXAMPLE 35.4
Generous, domiciled in the USA, settles shares in US companies on his
nephew, Tom, for life. Tom is domiciled and resident in the UK The
property is excluded property, being property situated abroad settled
by a senior domiciled at that time outside the UK, so that there will
be no charge to IHT on the ending of Tom's life interest.
If, however, those shares were exchanged for shares in UK companies,
the property would no longer be excluded and there would be a charge
to IHT on the termination of Tom's life interest.
If Generous had settled those same US shares on discretionary trusts
for his nephews, all of whom were UK domiciled, the property would be,
for the same reason, excluded property, so that the normal
discretionary trust charges would not apply'. (Note the CGT treatment
of IHT excluded property settlements as a result of FA 1998 changes:
see [27.111].)
2 Reversionary interests
a) Definition
For HIT purposes any future interest in settled property is classified
as a reversionary interest (IHTA 1984 s 47). The term, therefore,
includes an interest dependent on the termination of an interest in
possession, whether that interest is vested or contingent. A
contingent interest where the settlement does not have a interest in
possession is also a reversionary interest for IHT purposes.
EXAMPLE 35.5
Property is settled on the following trusts:
(1) A for life, remainder to B for life, remainder to C. B and C both
have reversionary interests for IHT purposes.
(2) A for life, remainder to B for life, remainder to C if he survives
B. C's contingent remainder is a reversionary interest for IHT
purposes.
(3) To A absolutely contingent upon his attaining the age of 21. A is
currently aged six and has a reversionary interest for IHT
purposes.
The interest of a discretionary beneficiary is not, however, a
'reversionary interest', being in no sense a future interest. Such a
beneficiary has certain present rights, particularly the right to be
considered by the trustees when they exercise their discretion and the
right to compel due administration of the fund. The value of such an
interest is likely to he nil, however, since the beneficiary has no
right to any of the income or capital of the settlement. He has merely
a hope (spes). [35.82]
b) 'Situs' of a reversionary interest
A reversionary interest under a trust for sale is a chose in action
rather than an interest in the specific settled assets be they land or
personalty (Re Smyth, Leach v Leach (1898)). In other cases the
position is unclear; but by analogy with estate duty principles it
will be a chose in action if the settled assets are personally; but an
interest in the settled assets themselves if they are land. [*853]
Since a chose in action is normally situated in the country in which
i1 is recoverable (New York Life Insurance Co v Public Trustee
(1924)), in some cases the reversionary interest will not be situated
in the same place as the settled assets. [35.83]
c) Reversionary interests--the general rule
A reversionary interest is excluded property for IHT (IHTA 1984 s
48(1); see [33.61]) with three exceptions designed to counter tax
avoidance:
(1) Where it was purchased for money or money's worth.
EXAMPLE 35.6
There is a settlement on A for life, remainder to B. B sells his
interest to who gives it to his brother Y. X has made a transfer of
value (a PET) of a reversionary interest (which can be valued by
taking into account the value of the settled fund and the life
expectancy of A).
(2) Where it is an interest to which the settlor or his spouse is
beneficially entitled.
(3) Where a lease for life or lives is granted for no or partial
consideration, there is a settlement for IHT (IHTA 1984 s 43(3)) and
the lessor's interest is a reversionary interest (IHTA 1984 s 47).
Such a reversionary interest is only excluded property to the extent
that the lessor did Not receive full consideration on the grant (see
IHTA 1984 s 48(1)(c)for valuation of the lessee's interest in
possession and IHTA 1984 s 170 for the valuation of the lessor's
interest). [35.84]
EXAMPLE 35.7
L grants a lease of property worth £30,000 to T for £10,000 for T's
life. T is treated for IHT purposes, as having an interest in
possession and, therefore, as absolute owner of two-thirds of the
property (£30,000 - £10,000). L is treated as the owner of one-third
of the property (because he received £10,000). Therefore, one-third of
his reversionary interest is not excluded property.
d) Reversionary interests--the foreign element
Under IHTA 198,1 s 48(1) a reversionary interest (with the three
exceptions above) is excluded property regardless of the domicile of
the settlor or reversioner or the situs of the interest. Where the
settled property is in the UK, but the reversionary interest is
situated abroad (see [34.83]) and beneficially owned by a foreign
domiciliary the interest probably is excluded property in all eases
under the general rule of IHTA 1984 s 6(1).
However, the status of a reversionary interest in settled property
situated Outside the UK is cast into some doubt by virtue of IHTA 1984
s 48(3) to which s 6(1) is expressly made subject (IHTA 1984 s 48(3)
(b)). Section 48 (3) States:
'where property comprised in a settlement is situated outside the UK
(a) the property (but not a reversionary interest in the property) is
excluded property unless the settlor was domiciled in the UK at the
time the settlement was made; and [*854]
(b) section 6(1) above applies to a reversionary interest in the
property, but does not otherwise apply in relation to the property'
This provision appears 10 exclude the operation of s 48(11) by saying
that a reversionary interest in settled property situated abroad is
only excluded property (under the general rule in s 6(1)) if it is
itself situated abroad and owned by a foreign domiciliary.
However, it is thought that s 48(3) only prevails over s 48(1) in
eases of conflict and that there is no conflict here since the words
'but not a reversionary interest' in s 48(3)(a) mean that whether a
reversionary interest is excluded property depends not on the situs of
the settled property nor on the settlor's domicile, but on the general
rule in s 48(1).
In summary, therefore, a reversionary interest is always excluded
property regardless of situs or domicile with three exceptions (see
[33.61]). Even if the interest falls within one of the exceptions, it
will still be excluded property if the interest (regardless of the
whereabouts of the settled property) is situated outside the UK and
beneficially owned by a foreign domiciliary (IHTA 1984 s 6(1)); or if
the reversionary interest is itself settled property, is situated
abroad and was settled by a foreign domiciliary (IHTA 1984 s 6(1) and
s 48(3). [35.85] [*855]
kuac...@yahoo.com
Updated by Aparna Nathan, LLB Hons, LLM, Barrister Gray's Inn Tax
Chambers and Natalie Lee, Barrister Senior Lecturer in Law, University
of Southampton
I Case 1--PETs and death [36.2]
II Case 2--Gifts with a reservation and subsequent death [36.3]
III Case 3--Artificial debts and death [36.41
IV Case 4--Chargeable transfers and death 36.5]
The risk of a double charge to IHT arises in a number of situations
and FA 1986 s 104 enabled the Board to make regulations to give relief
to taxpayers in certain cases. The Regulations were made on 30 June
1987 and carne into force on 22 July 1987, although the relief is
given for transfers of value made, and other events occurring on or
after 18 March 1986 (Inheritance Tax (Double Charges Relief)
Regulations 1987, SI 1987/1130). [36.1]
I CASE 1-PETS AND DEATH
The first case is concerned with the area of mutual transfers, ie
where property is transferred (by a PET which becomes chargeable) but
at the death of the donor he has received back property from his donee
(either the original property or property which represents it) which
is included in the donor's death estate. The position is illustrated
in the following example: all the examples in this Appendix are based
on illustrations given in the Regulations themselves. It is assumed
that current IHT rates apply throughout; grossing-up does not apply to
lifetime transfers; and that no exemptions or reliefs are available.
EXAMPLE 36.1
July 2000 -- A makes a gift of a Matthew Smith oil painting (value
£100,000) to B (a PET)
July 2001 -- A makes a gift into a discretionary trust of £335,000 --
IHT paid £10,000 Jan 2002 A makes a further gift into the same trust
of £30,000 IHT paid £6,000
Jan 2003 -- B dies and the Smith picture returns to A Apr 2004 A dies.
His death estate of £400,000 includes the picture returned to him in
2003 which is still worth £100,000 [*856] If no relief were
available, A in Example 36.1 would be subject to IHT on the value of
the picture twice: once when it was given away in 2000 (the chargeable
PET) and a second time on its value in 2004 (as part of his death
estate). In addition A's cumulative total would be increased by the
2000 PET, thereby necessitating a recalculation of the tax charged on
the 2001 and 2002 transfers and resulting in a higher charge on his
death estate.
Regulation 4 affords relief in this situation and provides for two
alternative IHT calculations to be made and for the higher amount of
tax produced by those calculations to be payable. The alternative
calculations may be illustrated as follows:
EXAMPLE 36.1 CONTINUED
First calculation:
Charge the picture as part of A's death estate and ignore the 2000
PET:
July 2000 -- PET £100,000 ignored -- Tax nil
July 2001 -- Gift £335,000: tax £20,000 -- Tax payable = £10.000
Less: £10,000 already paid
Jan 2002 -- Gift £30,000: tax £12,000
Tax payable = £6,000
Less: £6,000 already paid
Apr 2004 -- Death estate £400,000 -- Tax payable = £160,000
Total tax due as result of A's death £176,000
(Note because the 2000 PET is ignored A's cumulative total is
unaltered and a recalculation of tax on the 2001 and 2002 transfers is
unnecessary.)
Second calculation:
Charge the 2000 PET and ignore the value of the picture on A's death
July 2000 -- PET £100,000: tax £nil July 2001 Gift £335,000:
tax £60,000 £50,000
Less: £10,000 already paid
Jan 2001 -- Gift £30,000: tax £12,000 £6,000
Less: £6,000 already paid
Apr 2003 -- Death estate £300,000 £120,000
Total tax due as result of A's death £176,000
Tax payable: The tax payable is equal in amount tinder the two
calculations: see Example 36.3 below.
It may be that reg 4 is capable of being exploited to the benefit of
the taxpayer as can be seen from the following illustration. Assume
that Adam gives property worth £100,000 to his daughter Berta in 2002
and buys the property hack for £75,000 (which represents less than
full consideration) in 2003. He then dies in 2004. Under reg 4 the
value of the property (flOO,000) will remain subject to IHT but Adam's
estate has been reduced by the £75,000 paid for the property (see
especially reg 4(3)(a)). [36.2]
II CASE 2--GIFTS WITH A RESERVATION AND SUBSEQUENT DEATH
This case covers the situation where a gift with a reservation (either
immediately chargeable or a chargeable PET) is followed by the death
of the donor at a time when he still enjoys a reserved benefit or
within seven years of that benefit ceasing (ie within seven years of
the deemed PET). The situation is illustrated in Example 36.2.
EXAMPLE 36.2
Jan 2000 -- A makes a PET of £150,000 to B
Mar 2004 -- A makes a gift of a house worth £335,000 into a IHT paid
discretionary trust but continues to live in the £10,000 property. The
gift is of property subject to a reservation
Feb 2007 -- A dies still living in the house. His death estate is
valued at £485,000 including the house which is then worth £340,000
Regulation 5 prevents double taxation of the house in this example by
providing for two separate IHT calculations to be made as follows:
[36.3]
EXAMPLE 36.2 CONTINUED
First calculation:
Charge the house as part of A's death estate and ignore the gift with
reservation:
. Tax
Jan 2000 -- PET Nil
Mar 2004 -- Gift with reservation ignored Nil
Feb 2007 -- Death estate £485,000: tax £80,000
. Less £10,000 already paid £70,000
. -------
. Total tax due as a result of A's death £70,000
(Note: credit for tax already paid on the gift with reservation cannot
exceed the amount of death tax attributable to that property. In this
example the tax so attributable is £56,082 (ie £80,000 x
£340,000/£485,000) -- hence credit is given for the full amount of
£10,000.)
Second calculation:
The gift with reservation is charged arid the value of the gifted
property is ignored in taxing the death estate:
. Tax
Jan 2000 -- PET Nil
Mar 2004 -- Gift of house £335,000: tax £20,000 £10,000
. Less: £10,000 already paid
Feb 2007 -- Death state £145,000 (ignoring house) £58,000
. -------
Total tax due as result of A's death: £68,000
[*858]
Tax payable: the first calculation yields a higher amount of tax.
Therefore the gift of the house in 2004 is ignored and tax on death is
charged as in the first calculation giving credit for IHT already
paid.
III CASE 3--ARTIFICIAL DEBTS AND DEATH
Relief is afforded under reg 6 when a chargeable transfer (or
chargeable PET) is followed by the transferor incurring a liability to
his transferee which falls within FA 1986 s 103 (the artificial debt
rules).
EXAMPLE 36.3
Nov 1998 -- X makes a PET of cash (£95,000) to Y
Dec 1998 -- Y makes a loan to X of £95,000
May 1999 -- X makes a gift into a discretionary trust of £20,000
Apr 2004 -- X dies. His death estate is worth £305,000 but the loan
from Y remains outstanding
Under s 103 the deduction of £95,000 would be disallowed so that the
1997 PET and the disallowed debt would both attract an IHT charge.
Relief is provided, however, under reg 6 on the basis of the following
alternative calculations: [36.4]
EXAMPLE 36.3 CONTINUED
First calculation:
Ignore the 1998 gift but do not allow the debt to he deducted in the
death estate:
. Tax
Nov 1998 -- PET ignored Nil
May 1999 -- £20,000 Nil
Apr 2004 -- Death estate £295,000 £16,000
Total tax due as result of X's death £16,000
Second calculation:
Charge the 1998 gift but allow the debt to he deducted from the estate
at death.
. Tax
Nov 1998 -- PET £95,000 Nil
May 1999 -- Gift £20,000 Nil
Apr 2004 -- Death estate (£305,000 - loan of £95,000) £16,000
Total tax due as result of X's death £16,000
Tax payable: The total tax chargeable is equal in amount under the two
calculations and reg 8 provides that in such cases the first
calculation shall be treated as producing a higher amount: accordingly
the debt is disallowed against the death estate and the PET of £95,000
is not charged.
IV CASE 4--CHARGEABLE TRANSFERS AND DEATH
Under FA 1986 s 104(1)(d) regulations can be made to prevent a double
charge to IHT in circumstances 'similar' to those dealt with in the
first three cases above.
Regulation 7, made in pursuance of this power, applies when an
individual makes a chargeable transfer of value to a person after 17
March 1986, arid dies within seven years of that transfer, at a time
when lie was beneficially entitled to property which either directly
or indirectly represented the property which had been transferred by
the original chargeable transfer.
For relief to be given under this regulation it is important to
realise that the lifetime transfer must have been chargeable when
made. Prior to the changes made by FA 2006, the majority of transfers
to individuals would not have fallen within its ambit since they would
have been PETs. Since that is no longer the case, the regulation may
now be of increased significance and will be of importance in the
following cases:
(1) When the chargeable transfer is to a discretionary trust which
subsequently returns all or part of the property to settlor.
(2) When the chargeable transfer creates a beneficial interest in
favour of the settlor.
(3) When the chargeable transfer is to a company with, again, that
property being returned to the transferor.
As with the other cases, relief under reg 7 is given on the basis of
two alternative calculations. The first includes the returned property
in the death estate but ignores the original chargeable transfer
(although there is no question of any refund of tax paid at that
time). The second calculation taxes the original chargeable transfer
(ie it may be subject to a supplementary charge on death and remains
in the taxpayer's cumulative total) but ignores the returned property
in taxing the transferor's death estate. [36.5]