Drive a harder bargain!
Mark McLaughlin looks at a possible let-out from an inheritance tax charge on certain asset transactions.
If an individual gifts an asset to another individual, it will generally be a ‘potentially exempt transfer’ (PET) for inheritance tax (IHT) purposes, unless a specific IHT exemption applies (e.g., for gifts between UK domiciled spouses).
A PET is provisionally treated as an exempt transfer when made, which becomes exempt if the donor survives at least seven years thereafter.
Too cheap? No problem!
So much for gifts, but what happens if someone sells an asset to another individual, but a higher price could have been obtained? Is the difference between the asset’s value and the disposal proceeds a PET (which could be chargeable if the transferor dies within seven years)?
Not necessarily. The IHT legislation (IHTA 1984, s 10) provides that a disposition is not a transfer of value if it was not intended (and was not made in a transaction intended) to confer a ‘gratuitous benefit’ on any person, and either of the following conditions are satisfied:
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It was made in an arm’s length transaction between unconnected persons; or
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It was such as might be expected to be made in an arm’s length transaction between unconnected persons.
Care is needed; if the transferor intended to make a gift or confer bounty on another person, this exception from an IHT charge cannot apply. Furthermore, the exception does not apply to a sale of unquoted shares (or unquoted debentures) unless it is shown that the price was freely negotiated or was at a price that might be expected to have been freely negotiated, at that time.
A ‘bad’ bargain
A bad bargain does not itself mean that a transaction was not at arm’s length, so does not necessarily attract an IHT charge.
In IRC v Spencer-Nairn [1991] STC 60, in 1976 a landowner sold a farm to a company for £101,350 (he did not know at the time, but the company was a connected person for IHT purposes). The farm was subsequently valued at £199,000. The Inland Revenue (as was) issued a determination on the basis that there was a net chargeable transfer of approximately £94,000. However, the court held that the disparity between the actual sale price and the open market value was no more than a single factor to be taken into account. Based on all the circumstances, the Revenue’s appeal was dismissed.
Arm’s length
In HM Revenue and Customs’ (HMRC’s) view, ‘arm’s length’ implies the absence of any relationship (including close friendship, as well as family relationship) between the parties such as might lead to one being favoured by the other (see HMRC’s Inheritance Tax Manual at IHTM04164). In considering whether the arm’s length requirement is satisfied, possible factors that might be considered include whether the parties were separately advised, and whether negotiations show a sequence of offer and counter offer.
For transactions between connected persons, evidence of commerciality should be retained in case of any challenge by HMRC. The burden of proof rests with the person who contends that the transaction satisfies the IHT exception.
Practical tip
HMRC considers (see IHTM04151) that dispositions made on divorce (or dissolution of a civil partnership) for the benefit of a former spouse (or civil partner) as a result of arm’s length negotiations will not normally give rise to a transfer of value in view of the above exception (or that a separate IHT let-out for ‘dispositions for maintenance of family’ may apply instead).
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