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Capital Tax Review by Matthew Hutton, MA, CTA (Fellow), AIIT, TEP

Matthew Hutton MA, CTA (fellow), AIIT, TEP author of Capital Tax Review, examines a potentially unfortunate consequence of the Pre-Owned Asset Tax on newly-married couples.

Context

Now that so many stable relationships exist where the couple is not married, gifts subject to a gift with reservation of benefit (GWR) must have become commonplace, although generally unrecognised. Even those aware of the issue may have been relatively sanguine about a future potential IHT liability. But with the income tax charge on pre-owned assets (POAs) applying from 6.4.05, closer attention is required (even though the provisions in FA 2004 Sch 15 do not apply where the property is already subject to a GWR).

All gifts between unmarried couples acquire a new significance – and, in passing, subsequent marriage may not resolve the problem

Consider the following example:

Adam is a struggling writer, largely supported by his partner, Eve, who has a steady job. One day, after many rejections, Adam's novel finds a publisher who feels he has spotted the next J K Rowling and Adam receives a huge advance. Straightaway Adam buys the country cottage for Eve that she has longed for.

Some time later they marry and then live comfortably on Adam's royalties and film rights, dividing their time between a London flat Adam bought in their joint names and Eve's country cottage.

Even the half-alert will have spotted that Adam's gift to Eve of the country cottage was a gift subject to a GWR, in that he continues to enjoy occupation, albeit shared with Eve.

But does their subsequent marriage make any difference? Suppose Adam dies first; what is the IHT position if he leaves everything to Eve? The cottage is not part of his estate, so that FA 1986 s 102(3) applies.

The definition of ‘transfer of value’ in IHTA 1984 s 3(1) is extended to include events on death when tax is chargeable as if a transfer of value had been made (s 3(4)). The spouse exemption under s 18(1) applies only where the property becomes comprised in the estate of the transferor's spouse. In this case the cottage does not 'become comprised' in Eve's estate and it must therefore be subject to IHT on Adam’s death.

Suppose Eve dies first, but leaves the cottage to their son. What then? The analysis will depend on whether Adam continues to have use of the cottage and/or whether he survives Eve by seven years. If he ceases to have use of the cottage after Eve dies and he dies within seven years, perhaps leaving everything to his son, his executors will have to report a PET (under FA 1986 s102(4)), which will inevitably increase the IHT on his death.

There will be an IHT charge on Eve's estate by reference to the gift to her son, as well as that on Adam's death in consequence of the cessation of his interest in the cottage. Neither the quick succession relief provisions under IHTA 1984 s 141 nor the 1987 IHT (Double Charges Relief) Regulations seem to offer any relief.

These thoughts all assume an initial gift subject to a GWR. But suppose Adam's gift to Eve had been cash, which she had later used to buy her country cottage. That would not be a GWR. But it would fall within FA 2004 Sch 15 and, unless either a sufficient rent were paid by Adam or he elected for it to be treated as a gift subject to a GWR, he would have an income tax liability in respect of his occupation after 5.4.05 (unless within the de minimis).

All this arises despite Adam subsequently marrying Eve.

(TAXline June 2005 – Issue 6 p16, briefing by Ray Magill of AGN Shipleys)

There is one further exception which should be added to the penultimate paragraph above. This is of course that provided by FA 2004 Sch 15 para 10(2)(c), viz that the gift of cash was made at least seven years before Adam 'occupied' the cottage. It is perhaps unlikely on these facts that there would be much if any interval between purchase of the cottage by Eve and occupation by Adam. Capital Taxes have confirmed that a gift of cash made before 6.4.98 can never be caught by POA even if occupation followed within seven years, because such occupation must then have started before 6.4.05.

Comment

The big mistake here was of course that Adam did not propose, and Eve accept his proposal, immediately he received the ‘huge advance’! But the example is a good warning that the rules don’t necessarily work in the way that one (or especially clients) might expect them to.

August 2005

Matthew Hutton MA, CTA (fellow), AIIT, TEP

More Information

The above article has been taken from Matthew Hutton’s Capital Tax Review, a quarterly update for professional advisers of private clients. For more information, visit http://www.taxationweb.co.uk/books/capital_tax_review.php.

About the Author

Matthew Hutton is a non-practising solicitor (admitted 1979), who has specialised in tax for over 25 years. Having run his own consultancy (latterly through Matthew Hutton Ltd) until 30th September 2000, he now devotes his professional time to writing and lecturing.

Matthew Hutton’s Autumn Series of Estate Planning Conferences resumed on 15 September 2005 in Stratford-upon-Avon. The remaining dates and venues are listed below.

SDLT Conference

Matthew Hutton is running an SDLT conference in London on 31 October 2005. For further information, please visit TaxationWeb’s Tax Events Calendar: www.taxationweb.co.uk/taxevents

Matthew Hutton’s Autumn Series of Conferences

Thursday 15 September - Stratford Manor, Stratford-upon-Avon

Tuesday 27 September - Spa Hotel, Tunbridge Wells

Tuesday 4 October - Wood Hall, Wetherby

Tuesday 18 October - Renaissance Hotel, nr Derby

For further details, brochures and booking forms please contact Matthew Hutton: email – mhutton@paston.co.uk or telephone – 01508 528388.