For Inheritance Tax (IHT) purposes, it would be useful if individuals could give assets away but continue to use them afterwards. Unfortunately, as the following query illustrates, there are anti-avoidance rules, which can result in an IHT charge in many such situations.  

Mark McLaughlin

Introduction

'Having your cake and eating it' is an expression that many will be familiar with. And it is also a fairly good way of explaining the rationale behind the inheritance tax (IHT) anti-avoidance rules regarding gifts with reservation of benefit (GWR). The law is contained in Finance Act 1986, ss 102-102C and Schedule 20. In broad terms, without the GWR rules an individual could make a potentially exempt gift of an asset, but continue to have the use and enjoyment of that asset; after seven years, the property would be exempt from IHT.

An example of a GWR would be where a married couple gift the matrimonial home to their adult children, with the parents continuing to live at the property as before; the children no longer live with their parents, who do not pay a full market rent for their continued occupation of the property. There are potential 'let-outs' from the GWR rules, but they do not apply in such circumstances. The result is therefore that the parents' respective interests in the property are deemed to form part of their death estate for IHT purposes. In addition, the normal capital gains tax uplift to market value upon death is not avaialable, because they no longer own the property on death.

The following query ('tugsni07') concerns the application of the GWR rules in practice.      

Query from TaxationWeb visitor ('tugsni07')

Husband (H) and wife (W) owned their home as joint tenants. In 2001, they gift their home to their adult children who live elsewhere, but they both continue to live in the property without paying a full market rent to the children - so a plain gift with reservation. In 2002, H permanently moves out of the property into a nursing home and dies there in 2004. W continues to live in the property alone. H's will leaves all to his spouse W. However W has died on 31 October 2007, leaving her estate to her two adult children.
 
How should the GWR be addressed when dealing with the Inheritance Tax in her estate?

Editor’s Comments

The GWR rules 'bite' if a benefit is reserved during the relevant period. The 'relevant period' is the seven year period before the donor's death (or the date of the gift, if later). The gift of the property to the children was made in 2001, and both husband and wife died within 7 years of making it. A gift within 7 years normally becomes chargeable on death. In addition, the husband made a deemed gift for GWR purposes when he moved out of the property in 2002 and the reserved benefit therefore ceased. His wife continued to live in the property, and her reserved benefit continued until death. In both cases, there is a potential double charge to IHT on the same property, i.e. due to the lifetime gift becoming chargeable, and under the GWR provisions on death. However, there are rules to prevent a double tax charge where the GWR rules apply. As always, specific professional advise should be obtained.

Forum responses included those reproduced below.

Peter D commented:

I do not think it will make any difference. There was still a 'reservation' that W remained in the 'joint' owned property. I hope you realise that the changes to IHT rules on the 9th of October apply to this scenario and may assist you.

'maths' commented:

Whether any actual IHT liabilities arise depends, of course, on the amounts involved.

However,as a matter of principle, I do not think matters are as simple as Peter D perhaps suggests.

If in 2001 H and W gifted their respective shares to their adult children but H and W continued to live there. On their respective deaths their 50% gifted interest would be included as part of their death estate (as the gifts were GWR) at the values at death.

Nevertheless these initial gifts are also PETs giving rise to an IHT liability if death occurs within 7 years thereof.

In the case of H in 2001 he thus makes a PET of his 50%. In 2002, however, his reservation ceases (as he moved out)and this itself gives rise to a second PET.

H died in 2004 within 7 years of both PETs which causes both PETs to become subject to IHT (however, the charge in practice falls to be the higher of the two). As the reservation was released in 2002 no part of the 50% pre ownership falls part of his death estate.

The position is different for W.

She, like H, made a PET in 2001 of her 50%. She did not, however, release her reservation and thus on her death her pre 50% (valued at death) falls to be part of her death estate. In addition, as death occurred within 7 years of her PET this also becomes chargeable.

This double charge may be mitigated and in practice the higher of the two IHT charges applies.

Peter D commented:

I considered that but dismissed it as the property was not owned as Tenants in Common but joint so as such they could not creat individual GWR's Regards Peter

'adelante' commented:

I think you will find that there will be CGT to pay on the increase in value from 2001 until it is sold.

Peter D replied:

I agree and that is independant of IHT or not.

'maths' commented:

I would be very interested in other's comments as it seems to me that gifts of joint tenancies (as opposed to tenants in common) are perhaps rarer.

My view (for what it is worth) is as follows.

I note your comment Peter D but property held as beneficial joint tenants is owned equally by the co-owners.Thus, on death only 50% of the value of the property is deemed to pass by survivorship on death and so only 50% of the property's aggregate value is included as part of the deceased's estate (ie not 100%).

Neither co-owner under a beneficial joint tenancy is of course able to dispose of the whole property; both co-owners (if two of them) need to agree.

Accordingly I would argue that for GWR purposes each of the husband and wife can only make a gift of 50% of the property not all of it. Otherwise it would seem to me that on the deaths of H and W if each retained the reservation the property would be subject under the GWR rules in its entirety to IHT twice.

'tugsni07' replied:

Thank you all for the useful advice and opinions. Some further info - when H died in 2004, an Inheritance Tax return was not prepared as it was not deemed necessary (all other assets were held jointly with spouse and the 50% value of GWR fell within H's NRB at that time). But now on W's estate, IHT is payable.

Will we have to report to HMRC regarding H's 50% GWR at this stage? I hope this makes sense.

'maths' replied

I would have thought that in 2004 an IHT 200 would have been required as the IHT 205 (excepted estates) would have been inapplicable as H had made a GWR (see Q3 on the IHT 205 both for deaths whether before or after 1.9.06).

That aside, re W, yes W will need to report the GWR on IHT 200 including D3 (same as reasons above if I am correct).

The amount I would suggest is 50% although I note Peter D has a different view.

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